Small ISS Change Shakes Up Boards; Tweak to Influential Shareholder Adviser’s Recommendations Has Directors Rethinking Proposals

Small ISS Change Shakes Up Boards

Tweak to Influential Shareholder Adviser’s Recommendations Has Directors Rethinking Proposals

LIZ HOFFMAN

Dec. 26, 2013 9:09 p.m. ET

When Verizon Communications Inc. VZ -0.02% agreed this month to a step that should give shareholders more influence over its board, the company said it was “committed to best practices in governance.”But there could be another reason for the directors’ goodwill: fear of losing their jobs.

A little-noticed change in the way an influential shareholder adviser makes its up-or-down recommendations on director elections may have some companies like Verizon rethinking their responses to investor proposals. The tweak could also give activist funds a boost heading into the busy annual-meeting season.

The tweak focuses on the difference between shares that are outstanding and shares that are voted.

Starting in 2014, Institutional Shareholder Services Inc. is changing its guidelines to recommend ousting directors who don’t implement a shareholder proposal that got a majority of the votes cast at the 2013 meeting. Previously, ISS recommended “no” votes on directors only if the proposal received a majority of all the shares outstanding—a more forgiving standard for directors because many shares go uncast.

In Verizon’s case, the measure—which would let longtime stockholders nominate directors—got support from just 33% of the shares outstanding last May but 52% of the shares that were actually voted.

A Verizon spokesman declined to comment.

The ISS change has drawn the wrath of some company advisers. Law firm Wachtell, Lipton, Rosen & Katz, noted for its defense of corporate boards, called the policy “grossly unfair” when it was first proposed last year.

“This is potentially a real issue where directors are being held accountable by ISS to a vocal minority of the total shareholder base,” said Steven Haas, a Hunton & Williams LLP lawyer who advises companies on governance issues.

Many large pension and mutual funds follow ISS’s recommendations on director elections, giving the proxy adviser influence over the outcomes.

Patrick McGurn, ISS’s special counsel, said ISS was responding to investor clients who “wanted to see a higher bar” set for boards. He added that the policy doesn’t mean an automatic censure for directors and that ISS will consider the specifics of each situation before making its voting recommendations.

At least two dozen of the largest 1,000 public U.S. companies will potentially be affected by the ISS change in the coming months because of shareholder initiatives that passed in 2013 with a majority of votes cast but short of the tougher standard, according the Conference Board, which tracks corporate voting habits.

Among them: pushes for Kohl’s Corp. and Vornado Realty Trust VNO +0.77% to separate the roles of chief executive and chairman, and an effort to make Kellogg Co. K +0.43% ‘s directors stand for re-election every year instead of every three years.

Each initiative got support from less than half of all shares but a majority of the votes cast. In other words, directors at these companies could land on ISS’s no-vote list if they don’t implement the proposals. Representatives didn’t immediately respond to requests for comment.

The vote gap is mostly due to smaller investors, who tend not to vote their shares. Market-wide, about 30% of shares, mostly held by these retail investors, simply aren’t voted, according to a recent study by PricewaterhouseCoopers and vote-tallying firm Broadridge Financial Solutions Inc. BR 0.00%

Getting these investors to cast ballots can require an expensive door-to-door campaign. Moreover, as in politics, voters who feel strongly about an issue tend to show up in bigger numbers, said Matteo Tonello of the Conference Board.

“The raised bar will have meaningful consequences for companies,” Mr. Tonello said.

Verizon’s measure would let shareholders who have owned 3% of the company’s stock for three years nominate some directors. This past spring, Verizon said the proposal was “unnecessary and would decrease the effectiveness of the board.”

But Verizon now says it will put the question to a second shareholder vote, this time on its own ballot, with management’s seal of approval. Doing so will save its directors from a possible ISS ding.

Verizon isn’t the only company taking steps to be more responsive to shareholders as ISS toughens its stance.

Walt Disney Co. DIS -0.36% and Dover Corp. DOV +0.21% have blessed versions of proposals that would let shareholders call special meetings, a favorite tactic of activist funds and hostile bidders. Construction-materials maker Simpson Manufacturing Co.SSD -0.70% will set a higher voting threshold for directors to keep their seats in line with a ballot measure that narrowly passed last spring under the new ISS guidelines. Representatives at Disney and Dover declined to comment.

A representative for Simpson didn’t respond to requests for comment

Mr. McGurn said he expects more companies to respond similarly as they set agendas for their spring meetings. “The pace of engagement is improving, and that’s a good thing,” he said.

The ISS change could help activist hedge funds.

Timken Co. TKR +0.09% , for example, agreed to split in two after a proposal from hedge fund Relational Investors LLC and a large pension fund won broad investor support at its meeting last spring.

The measure got “yes” votes from only 46.5% of Timken’s 96 million shares outstanding, but it received about 53% of the 84 million votes that were actually cast.

Under the old ISS guidelines, Timken’s directors could have ignored the proposal for at least another year. Under the new ones, doing so invites a reelection fight. A Timken spokeswoman didn’t immediately comment.

Shareholder proposals “are a good tool,” said Steve Wolosky, a lawyer who has represented activist investors. “You can put a measure up to a vote and [if it passes], just sit back and wait. Directors have to adopt it or they get dinged.”