ISS Provides Guidance on the Universal Proxy Card, Puts “Weakest” Directors on Notice

On August 23, 2022, Institutional Shareholder Services (ISS), the leading global proxy advisory firm, issued a special situations research note on the new, mandatory “universal proxy card” rules instituted by the U.S. Securities and Exchange Commission.

In its note, ISS declared the new rules the “superior” way for shareholders to exercise their voting franchise and observed that this system will make it “dramatically easier” and “cheap” for activist shareholders to launch proxy fights. ISS also offered perspectives on how the new system could help activists in their campaigns. Public companies should pay close regard to these perspectives in light of the weighty influence of ISS’s proxy voting recommendations on the outcomes of contested director elections. The most notable of ISS’s perspectives are that under the new framework, directors’ individual qualifications may come into greater focus relative to the merits of an overall slate and that a board’s “weakest” members may now become more vulnerable in a proxy contest.

Under the universal proxy card rules, which apply to shareholder meetings after August 31, 2022, the separate proxy cards issued by a company and dissident shareholder during a proxy contest for director elections must include both the company’s and dissident’s respective nominees, such that shareholders will be able to give proxy voting instructions in favor of any combination of properly nominated candidates up to the number of authorized seats for election. Under the outgoing system, shareholders received separate proxy cards from the company and dissident that each included only the respective parties’ different slates, and, as such, shareholders were not able to “mix and match” their voting instructions for any combination of director candidates from both slates. As discussed in a previous Shareholder Activism Update, the new rules have the potential to lead to increased proxy contest threats and less challenging campaigns for activists.

ISS’s key perspectives on the new system, and its role in that system, are as follows: 

• ISS stated that its two-prong framework for assessing the merits of a dissident proxy campaign will remain largely unchanged. ISS will still ask (1) is there a case for change? and (2) if so, how much change? “An activist leading with a brilliant nominee, but a weak case for change,” ISS observed, “will be less successful than the activist who leads with a detailed, insightful argument as to why a company may not be performing as well as it should ....”
• The second prong — “how much change?” — will come into sharper focus, given that shareholders will now be able “to more precisely adjust board composition.” ISS expects activist slates to be “proportionate” to the issues identified by the activist and implicitly cautions activists not to overreach in the number of directors they nominate, noting that doing so could “backfire” by undermining the overall quality of the dissident slate. 
• ISS emphasized the importance of qualifications of individual nominees, implying that ISS intends to scrutinize candidates on an individual basis to determine which combination of candidates will be best for the company, without undue focus on whether the candidate hails from the company or dissident slate. In this spirit, ISS “will continue to highlight ... nominees from either party who ... appear particularly well-qualified.”
• ISS observed that because the universal proxy system allows shareholders to precisely mix and match candidate choices from the company and dissident slates, boards will be “far less able to shield their weakest contributors.” As an example, ISS mentioned the potential for replacement of a “long-tenured, overboarded director who seems disengaged with a new nominee who brings clearly-relevant skills to the board, or perhaps enhances diversity.”

These observations suggest that the universal proxy system may facilitate a shift in the focus of proxy campaigns from the quality of a party’s overall slate to the quality of individual director candidates. In other words, campaign strategies may shift from focusing on company versus dissident platforms (i.e., a “slate contest”) to pitting an activist’s best individual nominees against the company’s nominees whom the activist regards as the weakest targets (i.e., a “candidate contest”).

As Sidley has observed, unlike for proxy advisory firms such as ISS, it is arguably more difficult for a shareholder to make informed voting decisions regarding individual nominees than regarding competing slates. As a result, under the universal proxy system, shareholders may end up delegating proxy voting decisions to proxy advisory firms even more than they did before the new rules became effective.

Some prospect of relief for incumbent directors may at least be found in ISS’s expressed skepticism about the prospects of proxy contests that would place a narrow focus on environmental, social, and governance (ESG)–themed “upgrades.” ISS notes that its framework for evaluating competing positions in a proxy contest favors activist campaigns that “connect the dots between ESG issues, operational concerns, and shareholder value.” This observation, however, also outlines a roadmap for activists to effectively leverage ESG themes as a means to bolster activist campaigns otherwise focused on traditional economic bases, a specter that Sidley’s Shareholder Activism practice has previously discussed. 

Recommendations for Public Companies

As public companies prepare for the onset of the universal proxy era, we provide the following practical guidance for consideration:

• Given that activist investors may focus on a board’s “weakest contributors” (as put by ISS), boards should have strong controls to monitor the quality and suitability of directors. Appropriate board evaluation and refreshment processes are a strong defense and may preempt dissident campaigns.
• Given the increased influence of proxy advisory firms, boards should assess incumbent directors with added attention to criteria proxy advisory firms consider important. These criteria are numerous and include directors’ ages and tenure, specific qualifications, diversity of experience, and degree of engagement on the board.
• Expect activist campaigns to get more “personal.” The universal proxy system will likely lead to added focus on the quality of individual directors. In addition to precautionary measures mentioned above, directors should be personally and professionally prepared for added scrutiny in a proxy contest. “Tabletop” preparations, guided by counsel, can aid directors to this end. 
• Boards should expect activists and other dissidents to use the universal proxy card as leverage in negotiations. The new regime will not give a dissident an advantage at the ballot box in every case. If faced with a threatened proxy contest, a board should seek expert advice to evaluate potential outcomes of a proxy contest before negotiating with activists and other dissidents. 
• To the extent a company has not been regularly and thoroughly evaluating its legal shareholder activism preparedness, now is a good time to start. Companies are not powerless in preparing for potential activist campaigns, and strengthening structural defenses before an activist appears is an important way to prepare for activism.
• Update bylaws to account for the universal proxy rules and to fill other gaps. The new rules are predominantly codified in new Rule 14a-19. Amendments to corporate bylaws can, among other things, require an activist shareholder relying on Rule 14a-19 to confirm its compliance with the rule on the company’s request and confirm that the company will disregard proxies solicited by the activist shareholder if it fails to comply with the rule.

For additional information on the topics covered in this Sidley Update, see recent publications of Sidley Austin LLP on our Shareholder Activism practice page, including SEC Dramatically Changes the Rules for Proxy Contests, Adopts Universal Proxy, Sidley Shareholder Activism Update (November 17, 2021); Kai H.E. Liekefett, Welcoming the Universal Proxy, Ethical Boardroom (Spring 2022); and Shareholder Activism and ESG: What Comes Next, and How to Prepare, Sidley Shareholder Activism Update (May 27, 2021).