SECURITIES REGULATION AND IR

Earlier this fall, ISS solicited comments on proposed amendments to three of its proxy voting guidelines. On November 21, 2013, ISS published the 2014 Updates to its Canadian Corporate Governance Policy (the “2014 Updates”), which included the final amendments to the three guidelines described below. The 2014 Updates are effective for shareholders meetings held on or after February 1, 2014.

1. Director Attendance and Overboarding (TSX listed issuers) – Under the 2014 Update, ISS will generally recommend a withhold vote for an individual director nominee if, irrespective of whether the issuer has adopted a majority voting policy, the director is overboarded[1] AND the individual director has attended less than 75% of his or her respective board and committee meetings held within the past year without a valid reason for these absences. Cautionary language will be included in ISS’ reports where directors are overboarded, regardless of attendance.

ISS’ rationale for its new position on director suitability and overboarding is that public company directors must be able to devote sufficient time and energy to a board in order to be effective representatives of shareholders’ interests and that while experience gained by directors on multiple public company boards is highly valued, as director responsibilities continue to become increasingly complex, time commitments required for board and key committee memberships are also rising. This necessitates seeking a balance between the insight gained by a director’s participation on different boards and a reasonable number of commitments that provides the director with sufficient time for the preparation for, attendance at, and effective participation in board and committee meetings. Interestingly, according to ISS’ data for TSX reporting issuer annual meetings that occurred between January and June 2013, approximately one-quarter of directors would be considered overboarded under ISS’ definition.

2. Problematic Accounting Practices (TSX listed issuers) – Under the 2014 Update, ISS will make voting recommendations on a case-by-case basis for members of the audit committee and potentially the full board if adverse accounting practices are identified that rise to a level of serious concern, such as accounting fraud, misapplication of applicable accounting standards, or material weaknesses identified in the internal control process. In the 2014 Update, ISS states that the severity, breadth, chronological sequence, and duration, as well as the issuer’s efforts at remediation, should be examined in determining whether withhold votes are warranted.

ISS’ rationale for its revised position with respect to problematic accounting practices is that in recent proxy seasons, there has been disclosure of material weaknesses in the internal control process at certain TSX reporting issuers, some of which have been remediated within a reasonable period of time, while others have not been remediated for an unacceptably lengthy period of time. The 2014 Update codifies ISS’ analytical approach with respect to those cases that would be determined to raise serious concern with respect to the audit committee’s oversight of the implementation by management of effective internal controls over the accounting process and financial reporting. The 2014 Update also recognizes that the audit committee has the primary responsibility for selecting and overseeing the external audit firm that would be expected to raise concerns related to problematic accounting practices, misapplication of applicable accounting standards, or material weaknesses in the issuer’s internal controls, as well as whether fraudulent activity is uncovered during the course of an audit assignment.

3. Pay-for-Performance Evaluation (TSX listed issuers) – ISS currently employs certain quantitative ‘pay-for-performance’ measures to determine if a Chief Executive Officer’s (“CEO”) pay is aligned with an issuer’s overall performance. Under the 2014 Update, ISS has revised and simplified its quantitative methodology so that it will calculate the difference between the issuer’s total shareholder return (“TSR”) rank and the CEO’s total pay rank within a peer group, as measured over a three-year period (or as many full fiscal years as the issuer has been publicly traded and disclosed pay data). Under the revised model, each year of TSR will be weighted equally and calculated to produce the annualized TSR for the measurement period, thus providing a smoother performance measure that does not emphasize any particular year during the measurement period. Relevant performance and pay in particular years will be addressed during the qualitative phase of ISS’ review, as applicable. ISS’ rationale for this change to its quantitative pay-for-performance evaluation is that a single measure, with its longer term, will provide a better view on long-term pay and performance alignment and avoid being overwhelmed by periods of volatility, which is better aligned with ISS’ stated principles of evaluating long-term shareholder performance.

The influence of proxy advisory firms such as ISS, Glass Lewis and others has grown significantly over the last few years. Interestingly, the Canadian Securities Regulators are now considering regulating such firms. While there has been criticism of the one size fits all model of corporate governance advanced by proxy advisory firms, there is no doubt that the annual recommendations of such proxy advisory firms continue to significantly affect the behaviour of issuers and therefore are an important element of the corporate governance landscape in Canada.

Hellen Siwanowicz is a Partner at McMillan LLP and gratefully acknowledges the assistance of David Mendicino, an Associate at McMillan LLP, in preparing this article.