ISS Releases FAQs: New Defensive Bylaw May Lead to Negative Vote Recommendations in Director Elections

Public companies that have recently adopted or are considering adopting bylaws that disqualify director nominees who receive compensation from anyone other than the company should be aware of new FAQs released yesterday by Institutional Shareholder Services (ISS) and the potential impact the FAQs may have on forthcoming director elections. Such bylaws typically operate in conjunction with advance notice bylaws that require proponents to disclose compensation arrangements with their nominees. Compensation payable by a third party for director candidacy and/or board service – for example, by an insurgent in a contested director election – may call into question a director's undivided loyalty to the company and all of its shareholders.

ISS' new FAQs discuss how it views a board's adoption of a bylaw that disqualifies any director nominee who receives compensation from a third party (a "director qualification/compensation bylaw"), where such adoption was not approved or ratified by shareholders. The FAQs are available here.

According to the FAQs, ISS considers board adoption of director qualification/compensation bylaws without shareholder approval as a "material failure of governance because the ability to elect directors is a fundamental shareholder right…[and] [b]ylaws that preclude shareholders from voting on otherwise qualified candidates unnecessarily infringe on this core franchise right." Pursuant to its US proxy voting policy relating to "Governance Failures," ISS may therefore issue a negative vote recommendation against directors individually, committee members or the entire board. In contrast, ISS stated in the FAQs that it will not recommend against directors at companies whose board has adopted bylaws precluding from board service those director nominees who fail to disclose third-party compensatory payments (for example, advance notice bylaws). According to ISS, such bylaws "may provide greater transparency for shareholders, and allow for better-informed voting decisions."

In the event that a board seeks shareholder approval of a director qualification/compensation bylaw, ISS has stated that it will review the proposal "case-by-case…taking into consideration among other factors the board’s rationale for proposing the bylaw, whether the proposed bylaw materially impairs, and/or delivers any off-setting improvements in shareholder rights, and any market-specific practices or views on the underlying issue."

In the context of a proxy contest, ISS has stated that it considers compensation arrangements with director nominees as a factor in its case-by-case analysis.

This Weil Alert was re-published on the website of the Harvard Law School Forum on Corporate Governance and Financial Regulation.