Report on the ISS-2007 Canadian Proxy Voting Guidelines

Written By Stephen P. Sibold, Q.C., and Brandon D. Tigchelaar

In anticipation of the upcoming annual meeting season, Institutional Shareholder Services (ISS), formerly known as Fairvest, has updated its general voting guidelines covering items commonly put before securityholders at annual meetings. ISS generally issues specific recommendations concerning individual issuers and particular items of business to be acted upon at securityholder meetings after an issuer's meeting materials have been distributed.

This report addresses only those ISS recommendations that we perceive to be of particular interest to recipients of Securities Watch. Issuers that have a significant institutional securityholder base may also wish to review the ISS guidelines prior to completion and mailing of their proxy materials if they expect to ask security holders to consider items of business other than those discussed below.

While we do not necessarily endorse positions taken by ISS, it is clear that a significant number of institutional investors follow the voting recommendations issued by ISS. In many cases, the fact that ISS has taken a contrary position to management in relation to a matter to be put before shareholders only becomes known at an inopportune time — shortly before the meeting when a surprisingly negative proxy count is emerging. Like it or not, issuers who have a substantial percentage of their shares held by institutional investors need to be cognizant of the ISS voting recommendations and the potential for an adverse ISS reaction in relation to particular items of business.

A. Guidelines for TSX Listed Companies

I. Independence of Directors

The ISS guidelines include a list of the criteria that ISS relies upon in making recommendations concerning the election of directors. Notable in this list are long-term issuer performance and (excessive) executive compensation. We note that these two factors in particular are becoming more important as institutional shareholder groups increasingly “go after” boards that are perceived to have failed to adequately tie compensation of senior management to issuer performance.

In this post-Enron environment, “independence” (be it in respect of directors, auditors or other relationships), has become a recurring theme in the North American capital markets, finding expression in Multilateral Instrument 52-110 and Multilateral Instrument 58-102, which deal with audit committees and corporate governance respectively. Notwithstanding the focus on “independence” that characterizes the existing regulatory framework, ISS has developed its own tests for independence.

The ISS framework contemplates three types of directors: Independent Directors, Affiliated Directors and Inside Directors. Independent Directors are those directors whose only material ties to the issuer and management consist of the receipt of fees for service as a director and the ownership of securities of the issuer. At the other extreme, Inside Directors are those who are employees, executive officers or non-employee officers who are among the five highest paid officers of the issuer. As well, directors who beneficially own shares entitling them to control at least 50% of the voting rights attached to the issuer's outstanding voting securities are considered to be Inside Directors. In the middle, Affiliated Directors are those who have served as an executive officer of the issuer or an affiliate (including entities acquired by the issuer) within the last three years (except CEOs, for whom there is no sunset period), relatives of such individuals, persons who currently provide professional services to the issuer, persons having a contractual relationship with the issuer (other than investments in the issuer), and persons who are “founders” of the issuer.

II. Recommendations on Management Nominees to the Board

i. Committee Members

ISS recommends that securityholders withhold votes from any Inside Director where that person is also expected to be a member of the issuer's audit committee, compensation committee or nominating committee.¹ Moreover, where the nominee directors are presented as a slate, ISS recommends that securityholders withhold votes from the entire slate where an insider is expected to serve on any of those committees.

Where Affiliated Directors are expected to sit on the issuer's audit committee, compensation committee or nominating committee, although ISS will not directly recommend withholding votes from the director or slate, as the case may be, it will include cautionary language in its recommendations, to the effect that corporate governance best practices dictate that such committees should be composed entirely of Independent Directors.

ISS goes further in the case of former CEOs and CFOs who serve on the issuer's audit or compensation committees (though not the nominating committee). ISS generally recommends withholding votes from any former CEO, and any person who has served as CFO within the past three years, who is expected to sit on either of those committees.

Finally, ISS cautions that where information disclosing the audit and non-audit fees paid to an issuer's external auditor for the most recently completed fiscal year is not provided in a timely manner prior to a meeting at which ratification of auditors is a voting item (either in the AIF, in the proxy circular or upon request), ISS may recommend withholding votes from members of the audit committee.

ii. Meeting Attendance

ISS indicates that, as a general rule, it will recommend withholding support for nominees who attended fewer than 75% of the board meetings held in the prior year (unless the director missed only one meeting or one day of meetings), unless the director had a valid reason for missing meetings – valid reasons include illness or conflicting issuer business.

III. Shareholder Proposals

In respect of proposals by shareholders, ISS has indicated that it will generally make the following recommendations:

1. vote for proposals seeking separation of the offices of the Chairman and CEO;
2. vote for proposals asking that a majority, or up to two-thirds, of directors be independent;
3. vote for proposals asking that the audit, compensation and/or nominating committees be composed entirely of independent directors;
4. vote for resolutions to change the issuer's by-laws, such that directors must be elected by an affirmative majority of votes cast at an annual meeting;
5. vote for proposals for cumulative voting; and
6. vote for proposals requesting that some, but not all, share options be tied to the achievement of performance hurdles.

IV. Shareholder Rights Plans

From a conceptual standpoint, ISS is opposed to shareholder rights plans in their traditional form. However, it is willing to consider plans in cases where the purpose of the plan is plainly and exclusively to maximize shareholder value in the event of an attempted takeover. In this regard, ISS has indicated that a plan is worth reviewing where: (i) it gives the board more time to find an alternative value enhancing transaction; and (ii) it proposes to ensure the equal treatment of all shareholders.

ISS will generally recommend against shareholder rights plans that go beyond those two purposes by giving the board discretion to: (i) determine whether actions by shareholders constitute a change of control; (ii) amend material provisions of a plan without shareholder approval; (iii) interpret other provisions; (iv) wind-up the plan without shareholder approval; or (v) prevent a takeover bid from going to shareholders. ISS will oppose plans with any of the following characteristics: (i) unacceptable key definitions; (ii) a provision allowing shareholders to buy stock at a discount in any post-merger entity resulting from a hostile takeover bid; (iii) a permitted takeover bid period of greater than 60 days; (iv) a maximum triggering threshold below 20% of the issuer's outstanding securities; (v) a prohibition on partial takeover bids; (vi) a requirement that a shareholder meeting be convened to approve a takeover bid; or (vii) a requirement that the bidder provide evidence of financing. Finally, ISS has indicated that it will not recommend that shareholders accept any shareholder rights plan unless it has the following characteristics: (i) it exempts “permitted lock up agreements”; (ii) it provides clear exemptions for money managers, pension funds, mutual funds, trustees and custodians who are not making a takeover bid; and (iii) it excludes reference to voting agreements among shareholders.

V. Capital Structure

i. Authorized Capital and Private Placements

In keeping with the ISS fixation on shareholder democracy, ISS recommendations on capital structure are generally directed to limiting, within reason, the discretion of management and the board.

However, ISS will generally recommend voting for private placement proposals where the placed securities represent up to 30% of the issuer's outstanding securities and a specific purpose for the proceeds of the placement is disclosed to securityholders.

ii. Multiple Voting Shares

ISS will generally recommend that securityholders vote against the creation of a new class of common stock with multiple (or fractional) voting rights. ISS does provide guidance on the limited circumstances under which it will consider such an arrangement acceptable, but the first criterion – the arrangement is necessary due to foreign ownership restrictions and extra-territorial financing is necessary – is sufficiently restrictive that the application of the exception is very narrow.

VI. Executive and Director Compensation

i. Share-Based Compensation

ISS's approach to share-based compensation plans is to review such plans with an eye to its perception of the total transfer of shareholder wealth to the participants under the plan. The total cost, adjusted to reflect voting power dilution, is expressed as a percentage of enterprise equity value and compared to an allowable cap derived from compensation plan costs of the top performing quartile of peer group issuers.

ISS will generally recommend voting for equity compensation plans only where the cost (calculated in accordance with its framework) is within a range determined on an industry basis. However, ISS will recommend voting against plans where the participation of outside directors is discretionary or excessive; where the plan does not include reasonable limits on director participation (characterized, in the case of non-executive director options, as between 0.25% and 1.00% of outstanding common shares); or where the plan provides for repricing of options without shareholder approval.

ISS continues to recommend against discretionary participation by non-employee directors in option plans.

ii. Amendment of Share-Based Compensation Plans

ISS notes that the TSX has altered its rules governing the amendment of share-based compensation plans, including the circumstances in which an issuer is required to obtain securityholder approval to amend an option plan. Indeed, TSX listed issuers that do not have specific amending procedures in their share based compensation plans prior to June 30, 2007, will be required to seek shareholder approval for any amendment, even in relation to trivial matters. Against that backdrop, ISS anticipates a large number of amendments to such plans in the immediate future.

ISS has indicated it will generally recommend voting against the introduction of amending procedures in share based compensation plans, if those procedures allow the directors of the issuer make any of the following amendments to the plan, without shareholder approval: (i) an increase in the number of shares reserved; (ii) reduction in exercise price or cancellation and reissue of options; (iii) an amendment that extends the term of an award beyond its usual expiry; (iv) an amendment that expands the universe of eligible participants, where non-employee participants may be added or previously imposed limits on nonemployee directors may be increased; or (v) an amendment respecting transferability or assignability of awards under the plan, other than for normal estate settlement purposes.

iii. Repricing of Options

ISS will generally recommend voting against proposals to reprice existing option grants unless the repricing forms a part of a broader amendment to the existing plan that contemplates, at a minimum, the following: (i) a value-for-value exchange; (ii) the exclusion of the five top paid officers of the issuer; and (iii) a “no reload” feature or a commitment on the part of the issuer to an annual cap on its option “burn rate”.

iv. Employee Stock Purchase Plans

ISS usually recommends that securityholders approve employee stock purchase plans (open to employees other than individuals with 5% or more beneficial ownership), provided that: (i) participation is limited (generally on the basis of a percentage of base salary); (ii) the effective stock price is not less than 80% of fair market value; (iii) the offering period is 27 months or less; and (iv) potential dilution, together with all other equity-based plans, does not exceed ten percent of the outstanding common shares (on a non-diluted basis).

VII. Other Business

ISS recommends that unspecified “other business” on proxy ballots should be voted against.

B. Additional Guidelines for S&P/TSX Composite Companies

I. Independence

ISS will generally recommend that votes be withheld from any Inside Director or Affiliate Director where independent members of the board of directors comprise less than a majority, or where the board lacks a separate compensation or nominating committee. Where a slate only election is contemplated in such circumstances, ISS will generally recommend withholding votes for the entire slate.

II. Multiple Directorships

ISS has indicated that it will include, in its recommendations to institutional shareholders, information concerning additional public issuer board service in respect of any issuer CEO who sits on more than two outside public issuer boards. Moreover, ISS will include similar information for any outside professional directors of composite index issuer boards, who serve on more than six public issuer boards in total.

C. Guidelines for Venture Issuers

Generally, the ISS guidelines for TSX listed issuers also apply to issuers listed on the TSX Venture Exchange. However, given the distinct nature of venture issuers, ISS has published separate guidelines for TSXV listed entities. The more meaningful distinctions are as follows.

Given the limitations presented by smaller boards, ISS will generally not recommend withholding votes for Inside Directors who serve on the issuer's compensation committee or (where there is one) nominating committee, as long as such committees are comprised of a majority of independent directors. Where the board, sitting as a whole, serves as the compensation or nominating committee, ISS will generally recommend withholding votes for Inside Directors unless a majority of the board is independent.

Moreover, as meeting attendance is not a reporting requirement for venture issuers, ISS does not make recommendations based upon meeting attendance

Finally, given the prevalence of the dual CEO/Chairman role within venture issuers, ISS does not force the issue in the case of TSXV listed issuers.

Notes

1. Note that in the case of audit committees, this recommendation is mandated by Multilateral Instrument 52-110 except in British Columbia and compliance will accordingly be near universal. In the case of compensation and nominating committees, the recommendation appears in National Policy 58-201 as a corporate governance best practice.