ISS Releases QualityScore Updates and Opens Data Verification Period

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1 November 2, 2016 SIDLEY UPDATE ISS Releases QualityScore Updates and Opens Data Verification Period ISS Publishes New Questions and Other Methodology Updates to Its QualityScore (Formerly QuickScore) Governance Ratings Tool; Companies May Verify Data Through November 11 On October 31, 2016, Institutional Shareholder Services (ISS) released 15 new questions applicable to U.S. companies and other methodology updates, and opened its annual data verification period relating to its ISS Governance QualityScore corporate governance ratings tool (formerly known as QuickScore). This verification period provides companies with the opportunity to verify their data against QualityScore s methodology and ends November 11, November 11 Until November 21 November 21 Key Dates Deadline for company verification of QualityScore data (8:00 p.m. EST) QualityScore reports no longer accessible; ISS proxy voting reports will not contain QualityScore ratings Updated QualityScore reports available; data verification reopens Practical Implications Companies should verify their data prior to Friday, November 11 at 8:00 p.m. EST, and reference public filings where appropriate. The data verification tool is free for companies and is accessible from the Data Verification tab at the following link: Companies that do not already have a login for the ISS Governance Analytics platform may request login information by sending an to contactus@isscorporatesolutions.com. ISS has specified that data verification logins will only be issued to representatives of the subject company not law firms, compensation consultants, proxy solicitors or others. Companies that anticipate filing a proxy statement in the near future should be aware that data verification is not available during the period between the filing of a proxy statement and the publication of ISS proxy voting recommendations for that meeting. Data can also be verified after updated QualityScore reports become available on November 21. Consider providing information about QualityScore updates at the next meeting of the Nominating and Governance Committee and potentially the Compensation Committee, particularly in relation to increased ISS focus on director tenure, board refreshment, proxy access and CEO succession. Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, ; One South Dearborn, Chicago, IL 60603, ; and 1501 K Street, N.W., Washington, D.C ,

2 Page 2 Companies should review the section relating to management succession in the Corporate Governance Guidelines and/or the proxy statement, and consider expanding if appropriate. QualityScore Methodology Updates Details about the updated version of QualityScore are briefly summarized below and described in the technical document published by ISS available here. Like the previous versions of the tool, QualityScore assigns each company in the S&P 500 and Russell 3000 (as well as companies in several foreign indices) a numeric, decile-based score indicating its corporate governance risk relative to other companies in the applicable index or region. Scores range from 1 to 10, with 1 indicating the highest level of governance quality and lowest level of governance risk. ISS analyzes a company s corporate governance risk based on 107 factors applicable to U.S. companies across four pillars: Board Structure, Shareholder Rights & Takeover Defenses, Compensation/Remuneration, and Audit & Risk Oversight. ISS has updated its QualityScore methodology applicable to U.S. companies to include 15 new governance factors as set forth below. Although two of these new questions are zero-weighted and therefore will not impact a company s scoring, it is possible that ISS could change any or all of these factors from zero-weight to weighted in a future QualityScore update as it has done in this update with proxy access and as it has done previously with respect to the number of women directors and the number of audit committee financial experts. As with many existing factors, ISS does not provide guidance as to the thresholds or answers that ISS considers acceptable or those that ISS considers sufficient to raise a red flag. Board Structure New Governance Factors 1. What proportion of non-executive directors has been on the board for less than 6 years? ISS will award increasing credit for increasing proportions of the board represented by directors with less than 6 years of tenure; no additional credit granted for proportions in excess of 1/3. 2. Does the board have any mechanisms to encourage director refreshment? ISS notes that while the gold standard is a rigorous annual evaluation of all directors to ensure a continued match of their skill sets against the company s needs, it will now track other structural mechanisms to encourage refreshment; ISS provides mandatory retirement ages and term limits as examples; non-scored; tracked for information purposes only. 3. Does the company disclose the existence of a formal CEO and key executive officers succession plan? ISS will consider whether a company has a board-approved, periodically-evaluated succession plan for the CEO, other senior management, and key executive officers. 4. What is the proportion of women on the board? This new question is in addition to the existing question that asks about the number of women on the board. 5. Has the board adequately responded to low support for a management proposal? ISS considers low support less than 50% of votes cast for director elections and less than 70% of votes cast for say-on-pay proposals; ISS will also review adoption of a say-on-pay-frequency that received lower support than the frequency preferred by a majority or plurality of shareholders; note that other types of management proposals (such as auditor ratification) are not specifically addressed in this factor.

3 Page 3 Shareholder Rights & Takeover Defenses 6. Does the company have a fee-shifting provision? ISS notes that such provisions violate the ordinary American practice where each party is responsible for its own litigation costs. 7. Does the company have an exclusive venue/forum provision? ISS notes that such provisions restrict shareholders rights and, in the absence of past harm, it is not always clear the restrictions are justified; it is unclear if this factor will evaluate whether such a provision is justified on the basis of past harm or otherwise. 8. Does the company have a representative claim limitation or other significant litigation rights limitations? ISS will consider whether a company requires a minimum level of support for a shareholder to initiate a lawsuit against the company, or other type of limitation on shareholder litigation rights. 9. Can the board materially modify the company s capital structure without shareholder approval? ISS includes as an example Maryland-incorporated REITs that have the ability to increase or decrease authorized capital without a shareholder vote. 10. What is the ownership threshold for proxy access? ISS notes that most companies have adopted a 3% threshold. 11. What is the ownership duration threshold for proxy access? ISS considers a holding period of longer than three years to be excessive. 12. What is the cap on shareholder nominees to fill board seats from proxy access? ISS notes that generally investors have approved a range of 20-25% of the board, and that many companies have adopted a greater of 2 persons or 20% standard. 13. What is the aggregation limit on shareholders to form a nominating group for proxy access? ISS notes that an aggregation limit of 20 shareholders has generally been considered a minimal restriction. These four new scored questions relating to proxy access are in addition to the existing factor that tracks whether or not the company has adopted proxy access; that existing factor was previously zero-weight but is now scored; for purposes of the existing proxy access factor, ISS will not give credit for a proxy access provision that includes problematic provisions that nullify proxy access as a practical right for shareholders such as (i) counting mutual funds under common management as separate shareholders for aggregation limit purposes, (ii) requiring nominating shareholders to pledge to hold their shares past the meeting date, (iii) providing the board with broad and binding authority to interpret the provision, or (iv) provisions that, in combination, are deemed sufficient to nullify the proxy access right Subscribers will be able to access granular details regarding companies proxy access provisions, including ownership and duration thresholds and shareholder aggregation limits Compensation/Remuneration 14. Does the company employ at least one metric that compares its performance to a benchmark or peer group (relative performance)? ISS will consider whether a company uses a metric in any short term or long term incentive plan that is set relative to an external group, such as a peer group, an index or competitors. Audit & Risk Oversight 15. What is the tenure of the external auditor? Non-scored; tracked for information purposes only.

4 Page 4 ISS has also updated existing factors in the Board Structure and Shareholder Rights & Takeover Defenses pillars as follows: Updates to Existing Governance Factors What proportion of non-executive directors on the board has lengthy tenure? ISS has deleted the reference to > 9 years as indicating lengthy tenure and replaced it with higher than the recommended local best practice. Although it is unclear what, if any, impact this amendment will have on U.S. companies, given new question 1. referenced above, it is possible that ISS is now using six years (rather than nine) as the benchmark for determining whether a director s service is lengthy. How many non-executives serve on a significant number of outside boards? ISS has tightened the number of public company board seats it considers acceptable, from more than six to more than five, in line with changes to its proxy voting policy guidelines that will take effect in Do all directors with more than one year of service own stock (who can legally/practically do s0)? ISS has clarified that this factor will exclude directors who cannot practically own shares, such as those who are prohibited by internal policies from personally holding shares (including employees or representatives of significant shareholders or investment firms who may be so prohibited to avoid the appearance or possibility of front-running ). Has ISS review found that the board of directors has taken unilateral action that materially reduces shareholder rights or the company has had other governance failures? ISS has updated this factor so that ISS will now consider whether the board has had any other governance failures. Governance failures that ISS considers to be material include material failures of governance, stewardship, risk oversight or fiduciary responsibilities at the company; failure to replace management as appropriate; or egregious actions related to a director s service on other boards that raise substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders at any company. ISS noted as the most common categories of governance failures (i) excessive pledging of shares and (ii) failure to opt-out of state laws requiring a classified board (such as those in effect in Indiana and Iowa). ISS has also clarified that adverse charter and bylaw provisions and class structure adopted by newly public companies are subject to scrutiny under this factor. Are all directors elected annually? This factor has been supplemented so that ISS will now also consider whether a company without a classified board could nevertheless classify its board without shareholder approval. Does the company require a super-majority vote to approve amendments to the charter and bylaws? As updated, ISS will now also consider whether shareholders have the right to amend the bylaws (through a binding shareholder proposal or proxy fight) or whether a company has restricted that right in its charter. ISS also announced that it modified its scoring methodology with respect to a limited number of factors in each of the four pillars in light of evolving corporate governance expectations but did not provide further details. ISS has indicated that it will provide further information in the coming weeks regarding the QualityScore methodology enhancements, among other things. In reviewing these methodology changes and verifying data, companies should bear in mind that QualityScores are relative and scores may be average or below average even if the company has adopted many best practices advocated by ISS. Directors and management should continue to ensure that a company s governance structure is appropriate for that company and resist the temptation to make governance decisions for the purpose of increasing QualityScores.

5 Page 5 If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or Holly J. Gregory Partner holly.gregory@sidley.com John P. Kelsh Partner jkelsh@sidley.com Rebecca Grapsas Counsel rebecca.grapsas@sidley.com Claire H. Holland Special Counsel cholland@sidley.com Sidley Corporate Governance and Executive Compensation Practice Lawyers in Sidley s Corporate Governance and Executive Compensation practice regularly advise corporate management, boards of directors and board committees on a wide variety of corporate governance matters, including shareholder activism and engagement, fiduciary duties, board oversight responsibilities, board investigations and special committees, SEC disclosure, legal compliance, corporate responsibility, board evaluation, board and committee structures and issues arising under Sarbanes-Oxley and Dodd-Frank. Our advice relates to the procedural aspects as well as the legal consequences of corporate and securities transactions and other corporate actions, including takeover defenses, proxy contests, SEC filings and disclosure issues, stock option issues and general corporate law matters. Our broad client base allows us to provide advice regarding best practices and trends in such matters as directors and officers responsibilities, board and committee practices, disclosure controls and procedures, internal controls, executive compensation and other matters. To receive Sidley Updates, please subscribe at BEIJING BOSTON BRUSSELS CENTURY CITY CHICAGO DALLAS GENEVA HONG KONG HOUSTON LONDON LOS ANGELES MUNICH NEW YORK PALO ALTO SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C. Sidley Austin refers to Sidley Austin LLP and affiliated partnerships as explained at