2016 Proxy Season Review and Outlook for 2017 Proxy Season October 27, 2016 Attorney Advertising
2016 Proxy Season Review and Outlook for 2017 Proxy Season
October 27, 2016
Attorney Advertising
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Speakers
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Lillian BrownPartnerWilmerHale
Jay BothwickPartnerWilmerHale
William FiskeSenior Managing DirectorGeorgeson
Meredith CrossPartnerWilmerHale
Christopher HaydenSenior Managing DirectorGeorgeson
Peter MichelsonPartnerCamberView Partners
Knute SalhusPartnerWilmerHale
Jonathan WolfmanPartnerWilmerHale
Agenda 2016 Proxy Season Review Governance Activism & Engagement Disclosure
4
2016 Proxy Season ReviewWilliam Fiske—Senior Managing Director, Georgeson
Agenda
Proxy Access Director Elections Say on Pay Shareholder Proposals
6
Proxy Access Proxy access was the most significant governance matter in the
2016 proxy season, although much of what occurred was outside the annual meeting voting process As of August 31, 2016
– 41% of the S&P 500 provides an access right– 26% of the Russell 1000 provides an access right
7
Total Shareholder Proposals Voted On
Average % of Votes Cast in Favor
Shareholder Proposals Passed
2016: 78 2016: 51% 2016: 39
2015: 88 2015: 55% 2015: 53
Director Elections Average support for directors was very high in 2016
– Russell 3000 – 96.1% votes cast; S&P 500 – 97.4% votes cast
Majority voting provisions have become commonplace among larger companies – activism now targeting smaller caps Institutional investors are increasingly concerned about board
accountability, responsiveness, succession planning, diversity and skill sets and are seeking to engage directly with the board
8
91
45
4644
38 39
46
0102030405060708090
100
2010 2011 2012 2013 2014 2015 2016
Director Votes – Majority Against/Withhold Russell 3000 (Source: ISS Voting Analytics)
2016 Director Votes (U.S. Russell 3000 Companies) ISS Recommendations “Withhold” Or “Against”
ISS issue
# of Directors Receiving Negative
ISS Recommendations
AverageShareholder Vote for Directors (% of votes
cast)
# of DirectorsReceiving
<50%of Votes Cast
Independence issues (non-independent directors on key committees or failure to
maintain amajority independent board) 374 87% 7
Compensation issues 192 80% 2Taking unilateral action that reduces shareholder rights (or failing to put pre-IPO restrictive provisions to a
shareholder vote) 127 85% 1Absence of a formal nominating
committee 100 90% 0Failure of risk oversight due to
pledging of shares by executives 73 84% 0Lack of responsiveness to
shareholderconcerns (e.g., failure to
implement asuccessful shareholder proposal) 66 66% 11
Poor attendance at board andcommittee meetings (<75%) 65 72% 5
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Say on Pay Vote Results 2011 – 2016 Russell 3000
72% 73% 76% 75% 76% 76%
21% 19% 15% 17% 16% 17%
6% 6% 6% 6% 6% 6%
1.40% 2.60% 2.50% 2.40% 2.80% 1.70%
2011 2012 2013 2014 2015 2016
Below 50%50-70%70-90%90%+
Percent Approval
Source: Semler Brossy
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Trends in Shareholder Proposals (S&P 500)
11 13
72
6231.76%
39.11%
55.05% 50.32%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
0
10
20
30
40
50
60
70
80
2013 2014 2015 2016
Adopt Proxy Access
# of Companies Avg. % Support of Votes Cast
5359 58
43
31.45%
30.63%
29.67%29.29%
28.00%28.50%29.00%29.50%30.00%30.50%31.00%31.50%32.00%
0
10
20
30
40
50
60
70
2013 2014 2015 2016
Independent Board Chair –Separate Chair-CEO
# of Companies Avg. % Support of Votes Cast
23
13
9
3
79.54%
81.24%
76.68%
80.10%
74.00%
75.00%
76.00%
77.00%
78.00%
79.00%
80.00%
81.00%
82.00%
0
5
10
15
20
25
2013 2014 2015 2016
Repeal Classified Board
# of Companies Avg. % Support of Votes Cast
20
24
7 8
58.55% 57.41%66.16% 51.44%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
0
5
10
15
20
25
30
2013 2014 2015 2016
Majority Vote to Elect Directors
# of Companies Avg. % Support of Votes Cast
11
More Shareholder Proposals (S&P 500)
33
26
12 11
23.74% 22.34% 23.16%
16.57%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
0
5
10
15
20
25
30
35
2013 2014 2015 2016
Executive Compensation-Require Equity to be Retained
# of Companies Avg. % Support of Votes Cast
15
911 13
71.70%64.98%
59.50%57.49%
0.00%10.00%20.00%30.00%40.00%50.00%60.00%70.00%80.00%
02468
10121416
2013 2014 2015 2016
Supermajority Provision-Eliminate or Reduce
# of Companies Avg. % Support of Votes Cast
10 10
19
16
41.65%
42.50%
43.21% 43.14%
40.50%
41.00%
41.50%
42.00%
42.50%
43.00%
43.50%
0
5
10
15
20
2013 2014 2015 2016
Shareholder Right to Call Special Meeting
# of Companies Avg. % Support of Votes Cast
26 27
35
17
40.25%
38.09%
39.26%
40.79%
36.50%37.00%37.50%38.00%38.50%39.00%39.50%40.00%40.50%41.00%
05
10152025303540
2013 2014 2015 2016
Shareholder Right to Act by Written Consent
# of Companies Avg. % Support of Votes Cast
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GovernanceKrystal Berrini—Principal, CamberView PartnersLillian Brown—Partner, WilmerHaleWilliam Fiske—Senior Managing Director, Georgeson
Agenda
Increased Focus on Board Oversight of Strategy Board Composition & Refreshment Proxy Access ISS Annual Survey Results Overboarding Say-on-Pay Focus on Governance Principles
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Increased Focus on Board Oversight of Strategy Investor governance teams are increasingly focused on the board’s oversight of long-term strategy
and how governance and executive compensation practices align with that strategy Several governance teams now expect to have substantive engagement discussions regarding a
company’s long-term strategy
− Overview of the business and segments
− Summary strategic plan
− Key performance metrics− Investment / return criteria− Summary of board involvement
− Implications for compensation− Implications for board composition
and skills
Companies engaging with governance teams should expand their disclosure of strategy and provide details including:
We are asking that every CEO lay out forshareholders each year astrategic framework for long-term valuecreation. Additionally, because boards havea critical role to play in strategic planning, webelieve CEOs should explicitly affirm that theirboards have reviewed those plans.BlackRock’s corporate governance team,in their engagement with companies, willbe looking for this framework and boardreview.
- Larry Fink, CEO (2016)
We call on boards to view passive investors as long-term partners and to communicate how thecompany’s strategies, including their engagement with activists and board seat concessions, helpcreate sustainable long-term value for all shareholders.
- Rakhi Kumar, Head of Corporate Governance (2016)
…in 2014, we discussed the long-term company strategy in more than 30% of our engagements,up from 6% in 2013.
Once a board has developed a long-term strategy, it is important for the company to clearly communicatethis strategy to investors. Short-term and long-term performance goals based on key strategic driversshould be established and boards should evaluate senior executive and company performance againstthese goals. The board should also periodically evaluate the viability of the strategy based on thechanging business environment, competitive landscapes, regulatory requirements and othermacroeconomic factors. Any change in strategy should also prompt an assessment of director skills andexpertise to ensure that the board collectively has the background and knowledge to oversee theimplementation of the strategy.
- Ronald O’Hanley, CEO & Rakhi Kumar (2015)
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Board Refreshment, with a Focus on TenureBoard refreshment and director succession planning are viewed as the foundation of a well-functioning board
Investors are sharpening their focus on board composition and practices, seeking to learn: The skills, experience and qualifications necessary on the board to support company strategy Approach to board succession planning and refreshment Process for board/director/committee evaluations Board’s role in risk oversight, including at the committee level (e.g., sustainability risks, cybersecurity) Board’s role in establishing the company’s leadership structure and management succession plans
Investor voting policies often use tenure as a key proxy for board refreshment, given that it is a clear, objective metric with high perceived correlation to independence, diversity and “freshness” of skills
Encourages regular board refreshment to incorporate new viewpoints
Considers nominating committee responsible for refreshment
Director tenure likely a topic of conversation during engagement
May vote Against directors based on (1) poor board diversity; (2) evidence of "board entrenchment"; and/or (3) "failure to promote adequate board succession planning over time in line with the company’s stated strategic direction”
Evaluates tenure in context of board skills refreshment and independence
Discourages presence of long-tenured directors (13 years) 1 on key committees
Urges issuers to proactively address succession planning in engagement
May proactively engage with nominating committee where “problematic tenure”
Has sought greater engagement at companies with average board tenure in excess of 13 years (its calculation of one standard deviation from average tenure) and where one-third or more of the non-management directors have tenures in excess of 16 years (two standard deviations from average)
Recently amended its governance principles to request that, for directors with tenures >12 yrs, companies either classify director as non-independent or provide a detailed explanation
Scrutinizes boards where the average tenure of all directors exceeds 15 years for independence from management and for sufficient turnover to ensure that new perspectives are being added to the board
2017 Policy Survey requested investor views on tenure-related factors which would give rise to concerns about a board’s nominating and refreshment processes. 68% of respondents indicated that a high proportion of directors with long tenure is cause for concern. More than 50% identified an absence of newly-appointed independent directors (53%) and lengthy average tenure (51%) as problematic. 11% indicated tenure is generally not a concern
Beginning in 2017, will vote Against Nominating Committee Chair if average board tenure is >15 yrs or if no new appointments in prior 5 yrs
Votes Against key committee members and/or Lead Independent Director if tenure is >15 yrs
1 Determined based on standard deviation from market average
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Board Tenure at S&P 500 CompaniesAlthough the average age of independent directors has risen since 2005,
most company boards have relatively low average tenures (between 6 and 10 years)
Average Director Tenure Average Director Age*
17%
62%
17%
4%
5 years or less 6 - 10 years 11 - 15 years More than 15years
60.8
62.1
63.1
2005 2010 2015
Average tenure of S&P 500 boards: 8.5 years
Source: Spencer Stuart 2015 Board Index*Data in underlying bar chart represents average age of S&P 500 independent directors only
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Director Term & Age Limits at S&P 500
72 yrs37%
Co. Explicitly States in Corp. Gov. Guidelines That It
Does Not Set Director Term Limits
---------------------------------------------------------------------------------------------------
66%
Co. Does Not Address Director Term Limits in Corp. Gov. Guidelines
---------------------------------------------
31%
Co. Includes Director Term Limits in Corp.
Gov. Guidelines ---------------------------------------------------------------------------------------------------
3%
Institutional investors and proxy advisors are generally against director term and age limits despite increasing focus on board tenure and refreshment
Mandatory Ret. Age Not Explicitly Addressed
27%
75+ yrs25%
73-74 yrs7%
<71 yrs4%
Mandatory Ret. Age Not Explicitly
Addressed27%
Age Limits
75+ yrs25%
<71 yrs4%
3% is down from 4% in 2011/2012, and 5% in 2010
Of the 3% of boards with director term limits in place:
− 38.5% of companies set limits between 10 – 14 years
− 46.1% of companies set limits between 15 – 19 years
− 15.4% of companies set limits at 20 years
Recent uptick in setting director retirement age at 75+ years
− Now utilized by 25% of all S&P 500 companies, compared to only 6% in 2005
− Three S&P 500 boards currently set retirement age at 80
Prevalence of 72 year age limit has remained consistent over the past decade (~half of all established age limits)
73-74 yrs7%
Source: Spencer Stuart 2015 Board Index
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Term Limits
Board Diversity Investors and others continue to advocate for greater diversity on
corporate boards, especially with respect to gender– A growing number of companies provide proxy disclosure regarding
directors’ gender, race and ethnicity– Others continue to focus on diversity of viewpoints, experience,
education, skill or other qualities or attributes At Chair White’s request, the SEC staff is reportedly developing a
recommendation regarding possible revisions to the SEC’s existing disclosure rule regarding diversity
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Proxy Access Overview To date, approximately 300 companies have implemented proxy
accessMost popular shareholder proposal topic in 2016
– In addition to “please implement” shareholder proposals, we are now seeing “fix-it” proposals requesting targeted changes to existing proxy access bylaws (focus shifting to “secondary” terms)
– Companies that implement bylaws in response to “please implement” shareholder proposals have received relief to exclude these proposals through the SEC’s no-action process on the basis that they have “substantially implemented” the proposals
– Companies that have received “fix-it” proposals, on the other hand, have thus far had limited success in receiving relief to exclude these proposals on the basis of having “substantially implemented” (to date, the staff has provided relief only where the company implemented some of the requested changes)
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Key Issues in Designing Proxy AccessVacatedRule 14a-11
NYC Proposal “Market” Approach
What percentage of stock must shareholders hold?
3% 3% Most common is 3%(few 5% implementations)
Can shareholders aggregate holdings?
Yes Yes Generally yes
Is there any limit on the size of the group acting together?
No No Most common upper limit is 20; some unlimited
How long must shareholders have held their shares?
3 years 3 years 3 years
What percentage of the board can shareholders seek to elect?
25% 25% 20% - 25%, but at least 2 seats
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Views of Advisory Firms & Institutional Investors
Proxy Advisory Firms: ISS
– Supports proxy access at 3%/3yrs for up to 25% of the board
– Supports minimal or no limits on aggregation
– ISS will issue a negative recommendation for boards of companies that are “unresponsive” to majority shareholder supported proxy access shareholder proposals (ISS is focusing not only on “key terms,” such as ownership threshold, but also “secondary” terms, and issuing negative voting recommendations if those secondary terms are too “restrictive”)
Glass-Lewis– Supports proxy access, but says it
takes a case-by-case approach
Institutional Investors: Supportive of 3%/3yrs model:
– BlackRock – CalPERS– CalSTRS– MFS– TIAA-CREF– T. Rowe Price – State Street – Vanguard (switched from supporting
5%/3yrs) Opposes proxy access:
– Fidelity
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Alternatives for Company Action Proactively adopt a proxy access bylaw now or announce that
company will present a proxy access bylaw proposal for shareholder vote at a future annual meetingWait until one or more shareholders request that the company
adopt a proxy access bylawWait until one or more shareholders submit a shareholder proposal
on proxy access for vote at a future annual meetingWait until a majority of the shareholders vote in favor of a
shareholder proposal on proxy access at a future annual meeting
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2016 ISS Policy Survey Results SummaryRespondents included 115 institutional investors (1/3 of which
>$100B under management), 270 corporate issuers and 17 consultants/advisors Key Takeaways:
– Both investors and issuers strongly favor using metrics other than TSR to measure pay-for-performance alignment
– Capital productivity metrics are the most favored alternative pay-for-performance alignment metrics among investors
– Institutional investors strongly support annual say-on-pay frequency– Board refreshment matters to institutional investors– Long-tenured directors, even with refreshment, continue to be a source of
investor concern– Institutional investors strongly support taking action against directors at firms that
are perceived to be taking advantage of Maryland law, many of which are REITs– Majority of institutional investors favor recommending against directors of IPO
companies debuting with multi-class capital structures
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ISS Overboarding Policy ChangeVote against or withhold from individual directors who: Sit on more than five public company boards Are CEOs of public companies who sit on the boards of more than
two public companies besides their own—withhold only at their outside boards
What has changed since last year? For meetings on or after February 1, 2017, ISS reduced policy from
6 to 5 board limit
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Overboarding: Potential Further ISS Change As part of the 2017 policy survey, ISS asked survey participants in
the U.S. how executive chairs should be analyzed in terms of being overboarded:– Well over half (64%) of investors favored holding executive chairs to the
same standard as CEOs (i.e., no more than three total boards) – 36% favored the current more lenient standard for non-executive
directors (i.e., no more than five total boards)– Some investors preferred leaving such decisions to the board
Among non-investor respondents to the survey:– 38% favored the stricter standard– 62% favored the more lenient five-board standard for non-executive
directors – Several commented that there should be room for discretion for
executive chairs to serve on outside boards depending on their scope of responsibilities
26
Glass Lewis Overboarding Policy Change Beginning in 2017, Glass Lewis will generally recommend voting
against a director:– Who is the executive officer of a public company and sits on more than
two public company boards – Who serves on more than five public company boards
Certain major institutional investors have more restrictive overboarding policies – For example, BlackRock may vote against directors who serve on more
than four public company boards
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Say on Pay: ISS Influence Voting recommendations from the proxy advisory firms, especially
ISS, can greatly alter the outcome of a proxy solicitation campaign– Shareholder support was 28% lower at companies with an ISS ‘Against’
ISS recommended that shareholders vote ‘Against’ Say on Pay at 12% of companies in 2016 – slightly up from 2015While proxy advisory firms and institutional investors use a screen
to identify pay for performance misalignment, qualitative review is important
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0%
20%
40%
60%
80%
100%
120%
Low Concern Medium Concern High Concern
78% For
49% For
97% For
ISS Recommendations by P4P Concern Level (2012 – 2016)
Say on Pay; Failures & Red-Zone Results
Pay and performance
relation
Problematic pay practices
Rigor of performance
goals
Shareholder outreach disclosure
Non-Performance Based Equity
Special awards/
Mega-grants
Most common
contributing factors for
failures
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Say on Pay: Addressing Concerns
Next year’s vote will depend on two criteria:– Responsiveness to 2016 poor Say on Pay vote– Pay for performance alignment for 2017 Say on Pay vote
Which is more important: Magnitude of pay or design changes?Do pay changes need to be immediate or will forthcoming changes
get credit?Do we need to address ongoing issues only or do legacy issues
also need to be addressed?Do we only need to focus on changes to CEO pay or are other NEO
pay issues significant as well?
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Focus on Governance Principles Commonsense Corporate Governance Principles (July 2016)
– Developed by a group of 13 public company executives and institutional investors for public companies, their boards of directors and their shareholders
BRT Principles of Corporate Governance (August 2016) NACD – Report of the NACD Blue Ribbon Commission on Building
the Strategic-Asset Board (September 2016) CII Corporate Governance Policies (updated September 2016)
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Activism & EngagementJay Bothwick—Partner, WilmerHaleChristopher Hayden—Senior Managing Director, GeorgesonPeter Michelson—Partner, CamberView Partners
Agenda
2016 Activism Trends Settlements with Activists and Investor Responses Proactive Investor Engagement Structural Defenses and Activism Vulnerabilities Defense Preparedness
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Number of Activist Campaigns Remains High
353
230219
242262
274
347357
251
0
50
100
150
200
250
300
350
400
2008 2009 2010 2011 2012 2013 2014 2015 2016 (YTD)
US Activism Campaign Announcements
Source: SharkRepellent.net as of October 21, 2016
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Activism Abounds in Companies of All Sizes
98 123 118 139 200 185 124
81135
108141
253236
190
130130
181252
355384
267
61 70 104144
163173
189
34 52 51115 129 166
209
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2010 2011 2012 2013 2014 2015 2016
LARGE (>$10b)
MID ($2b - $10b)
SMALL ($250m - $2b)
MICRO ($50m - $250m)
NANO (<$50m)
Source: Activist Insight as of October 17, 2016
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First Time / Occasional Activists Exceedingly Common
Since January 2014, approximately half of all activist campaigns were led by first time or occasional activists
Source: SharkRepellent.net as of September 19, 2016
First Time Activist(136 – 31.9%)
Activist with total # of campaigns
between 2 and 5(78 – 18.3%)
Activist with total # of campaigns >5(212 – 49.8%)
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Selected Recent Activist Trends and Activity
37
Activists and private equity firms have teamed up with companies and started acting as “White Knights” –reducing the risk of another activist targeting the company
Certain traditional, long-only investors have started waging campaigns as first-time activists, adopting activist tactics to compel change at portfolio companies
Activist agitation, and activists’ public and private pressure on portfolio companies, has resulted in an increased number of settlements and increased speed of settlements
Settlements Non-Traditional Activists “White Knights”
Most Threatened Proxy Fights Settle Before the Vote
There are 15 proxy contests currently pending.Source: SharkRepellent.net as of September 26, 2016
37 3852 51 37
2528 30 32
31 34
4242
47
4142
4427 36
47
45 44
2129
2741
2124 22 24
13
28
14
15
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD*
Pending
Withdrawn
Settled
Voted On
38
Most Threatened Proxy Fights Settle Before the Vote
89
74
61
51
68
73
91
117
62
14
25
8
8
11
18
16
10
4
0 20 40 60 80 100 120 140
2008
2009
2010
2011
2012
2013
2014
2015
2016
Campaigns Resulting in Board Seats
Granted Won via VoteSource: SharkRepellent.net as of October 21, 2016
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SSGA CEO Ron O’Hanley requested that boards “develop principles for engaging with activist investors to promote long-term value creation.” Specifically, SSGA calls for companies to:
1. Engage with long-term investors prior to entering into a settlement agreement with an activist2. Consider the benefits (in addition to the costs) of not rushing into a settlement and instead proceed down the initial path toward a
proxy fight, which offers “long-term investors and other market participants an opportunity to provide their views”3. Include provisions in settlement agreements to help align activist nominees with long-term investors, such as longer duration
standstills, post-settlement stock-holding requirements, minimum ownership thresholds and a prohibition on pledging company shares
Institutional investors are frustrated with rapid activist settlements and perceived short-term focus
SSGA’s main goal is to ensure that activists are helping to promote long-term value creation in whatever waythey choose to engage with companiesA recent rise in settlement agreements entered into rapidly between boards and activists and withoutthe voice of long-term shareholders concerns us, as we see evidence of short-term prioritiescompromising longer-term interests
We are concerned that in some cases these settlements are being reached too quickly and without any input from other shareholders.We believe boards should protect the interests of long-term shareholders in all activist situations, and carefully evaluatesettlement agreements
I have written to the CEOs of leading companies urging resistance to the powerful forces of short-termism…Reducing these pressures and working instead to invest in long-term growthWe are asking that every CEO lay out for shareholders each year a strategic framework for long-term valuecreation.
During the 2015 proxy season, in the 18 largest U.S. proxy contests (as measured by market cap), BlackRock voted with activists 39% ofthe time.
- BlackRock CEO, Letter to chief executives at S&P 500 and large European corporations, February 2016
Investors Are Concerned About Settlements
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Are Settlements in Investors’ Best Interests?
Pros: Avoid significant costs and
distractions Reduce public scrutiny May be able to extract
concessions in a settlement that are otherwise not available in a contest
The activists might have good ideas and / or support of shareholders
Cons: Activist will be viewed by the
public as having been given a “mandate” by the board
Perception that the board is putting short-term interests ahead of long-term interests
Board dynamics may be disrupted
Impairment of relations with existing institutional shareholders (deprives them of information / choice)
41
Short Activism is on the Rise as Hedge Funds Seek New Strategies
42Source: SharkRepellent.net, Hedge Fund Research, as of December 31, 20151 Activist Insight; includes U.S. shorts measured between the disclosure of activist short and 15-Jan-2016
3650
99118
[VALUE]
[VALUE]
13 1936 36
4733
2011 2012 2013 2014 2015 2016 YTD# Campaigns # Short Sellers
2016 Annualized: 136 campaigns; 52
short sellers
# of Short-Activist Campaigns & Short Sellers (U.S. Only) 2015 Avg. Decline in Stock Price After Short1
= Average maximum fall in stock price1
= Average rise in S&P 500 index over corresponding periods
Key Factors Driving Activist Short Campaigns
Multi-year economic expansion and low interest rates have increased valuations Competition in the hedge fund industry is driving a need to find alternative
sources of alpha and to differentiate Saturation in the long-activism market is forcing activists to look elsewhere; short
activism leverages their skillsets Over time, short-activism “know how” spreads as PMs and analysts start their own
funds and switch firms Regulators remain largely indifferent to issuer concerns surrounding short attacks New tactics (due to technology, lowered norms for acceptable behavior, etc.) Short attacks fuel the media cycle and attract a disproportionate amount of attention
"There is no doubt that we are in thefirst innings of a washout in hedgefunds and certain strategies”- Third Point Letter to Investors, April26, 2016
[S]hort sellers are slowly gaining moreand more tools…[s]ocial media hasprovided short sellers with the ability tospread bearish commentary almostinstantaneously.- Activist Insight Monthly, October 2016
9%
-53%
Shareholder EngagementInvestors engaging with companies on governance more frequently. Why? Say-on-pay vote requirement (since 2011) Voting policies on responsiveness to shareholder proposals Increased level of hedge fund activism Continued high level of activity by governance activists Changing expectations of mainstream institutional investors
– Institutional investor letter-writing campaigns – BlackRock (short termism perils, director tenure/attendance/diversity)– TIAA-CREF (proxy access)– SSGA,Vanguard, CalPERS, CalSTRS (calling for direct engagement with the board)– CII (continued focus on majority voting)
Outreach pros and cons Builds relationships in advance of when the company needs to ask for a specific vote Enables company to receive useful feedback from investors about their concerns Can serve as an early warning of potential activism targeting the company
Outreach Best Practices Signaling the specific agenda to investors is important, as is identifying the company participants,
so that firms know whom to bring on their end and can be prepared. Consider providing investor deck in advance Combination of IR and corporate governance engagement Off-season engagement is best An effective IR department is the first line of defense for fending off an activist Involvement of independent directors where appropriate
43
44
Engagement Best Practices to Meet Constituencies that Impact Outcomes
Who Influences Proxy Voting Decisions?
How A Company Can Maximize Impact
Governance Teams
Proxy Advisory Firms
(ISS & Glass Lewis)
PMs & Analysts
Engaging Upon Attack. Timing of shareholder engagement will vary heavily based upon developments; however, there are several phases of engagement with continued shareholder dialogue in the interim
― “Post Strategy” – outreach following strategy announcement involving in-person and telephonic discussions with identified key shareholders
― “Post-earnings / Launch” - outreach associated with earnings and potentially the announcement of a dissident slate
― “Final push” – the final ~5 weeks leading up to the vote will involve a comprehensive roadshow for investors and proxy advisors
Engagement Planning. Core messaging should be consistent across all constituencies, but certain elements may be emphasized based on the type of investor
― Actively managed funds and hedge funds will be heavily focused on strategy, economic elements, and timing
― Governance teams and proxy advisors are generalists – while strategy and economics are important, they will require education on a company’s story and will be moderately-to-heavily focused on board process and governance issues
― As necessary, retail efforts will leverage core themes, but at a summary / high-level
% of S&P 500 Equity Owned by Institutional Investors with Influential Governance Teams1
Impact of Investor Governance Teams
Investors have formed sophisticated teams to decide governance issues
For passive funds, governance teams are outcome determinative
For active funds, governance teams will be highly influential
Proxy advisors do not determine decisions but doprovide critical research
Governance teams are critical for securing positive voting outcomes
In the past, some have mistakenly assumedthat our predominantly passivemanagement style suggests a passiveattitude with respect to corporategovernance. Nothing could be further fromthe truth.
Vanguard CEO, Letter to PortfolioCompanies, February 2015
We are asking that every CEO lay out each year astrategic framework for long-term value creation.BlackRock’s corporate governance team, intheir engagement with companies, will belooking for this framework and board review.Those activists who focus on long-term valuecreation sometimes do offer better strategies thanmanagement. In those cases, BlackRock’scorporate governance team will supportactivist plans.BlackRock CEO, Letter to chief executives at S&P500 and large European corporations, February2016
…We are in the midst of a significant shift ininvestor and board relations…In the future,direct dialogue between investors anddirectors will be the expected norm andinvestors will evaluate board quality andgovernance practices in the context of the long-term business strategy and performance of thecompany.
SSgA, “Changing Board Practices and Cultureto Meet Investor Expectations,” August 2015
1 Capital IQ, as of August 10, 2016, based on S&P 500 constituents in August 2016
23%2005
41%2016 YTD
Governance Investor Teams Are a Critical Element to Successful Company Outcomes
45
Shareholder Engagement in the Context of Activism
Engagement with shareholders is key in building credibility and convincing shareholders the current path is best
Need to proactively communicate early and often People who vote are often not the analysts who cover the stock Know your investors’ “hot buttons” and voting guidelines / history Be prepared to tackle difficult questions that may arise Have an agenda when reaching out to your investors – don’t waste
their time Consider including board representation on calls with larger investors
for certain subjects (i.e. compensation or succession) Tie your governance story to the value creation and compensation
story
46
S&P 500 S&P 600
Dire
ctor
Ele
ctio
ns
Annually Elected Directors 90% 56%
Majority Voting 89% 39%
Proxy Access 41% 2%
Cumulative Voting 3% 6%
Take
over
Def
ense
s
Poison Pill in Force 4% 6%
Special Meeting Right 63% 52%
Written Consent Right 29% 28%
Source: SharkRepellent.net as of October 21, 2016
Overview of Structural Defenses – Large vs. Small & Mid-Cap
47
Classified Board. Activists typically pursue short slates (and investors are inclined against full slates) – 1/3 of the seats are typically “enough”
Poison Pill. Activists often accumulate < 10-15%, can accumulate positions quickly, and proactive adoption is disfavored by investors
Supermajority voting provisions. Typically does not impact ability of activists to secure representation
Proxy Access. Implementation may build equity with long-term investors, but will not be used by activists due to timeline restrictions
Dual Class. Provides significant tactical advantage against activism, but is not a complete protection (e.g., 21st Century Fox, Dillard’s, MI Developments)
Special Meeting / Written Consent Rights. Shareholder ability to call special meetings or act by written consent allows activists to act rapidly and “off-cycle”; attempts to constrain use of these rights will draw significant investor criticism
Majority Voting. Majority voting creates an opportunity for activists to run a “vote no” campaign to remove directors without running a formal proxy fight (e.g., Tempur-Sealy)
What Provisions Are MaterialWhat Provisions Are Not Material
Governance Provisions / Defenses in the Context of Activism
48
How Activists Assess Targets
49
Potential for Economic GainStrategic Outcome
• Is the company a logical target for a strategic acquirer?• Are there opportunities for divestitures, restructuring, spin-offs, etc.?
Operational Improvement
• How do revenue growth and margins compare against peers?• Are there opportunities for significant cost savings or other operational initiatives?
Capital Structure Improvement
• Is there excess cash with a poorly defined strategy for deployment?• Can the company sustain additional leverage?
Passive Investment Thesis
• Is the company trading below intrinsic value?• Is there a reason to think the valuation disconnect with resolve over the investment horizon?
With Mitigants to Downside RiskStable Business Model
• What’s the variability of the business?• Is the business subject to macro or other cycles?
Valuation Support
• Is the business trading at a discount to historical or peer multiples?• Are there buyers if the stock cracks?
And a High Likelihood of Success in a Campaign
Clear Path • Is the company vulnerable from a structural defense standpoint?
Corporate Governance Concerns
• Does the company have corporate governance, board, compensation or similar deficiencies that can be leveraged to establish a need for change?
• Do shareholders have concerns about whether the board provides effective oversight?
Shareholder Support • Based on the factors above, will the company’s shareholders support a dissident proxy fight?
ROI of investment is
evaluated both in absolute terms AND
relative to other potential targets
Valuation, business fundamentals and strategic factors will drive the initial investment thesis of activists…
…but activists will focus on the governance attributes of a company to determine whether they can prevail in a fight.
Selected Company Fundamentals Selected Corporate Governance Factors
Selected External / Strategic Factors
Board Composition Board Leadership Director
Experience
DirectorTenure
Governance Provisions
Structural Defenses
Executive Compensation
StructureAlignment of Pay and Performance
Oversight of Potential Conflicts
Voting History (Withholds / Say-
on-Pay)
History of Shareholder Proposals
History of Shareholder
Responsiveness
Business StrategyBusiness Strategy
Portfolio Rationale / Break-up Potential
Portfolio Rationale / Break-up Potential
Operational Performance
(Growth / Margins)
Operational Performance
(Growth / Margins)
Capital Structure and
Allocation
Capital Structure and
Allocation
Shareholder Returns Track
Record
Shareholder Returns Track
Record
Valuation (Absolute and
Relative)
Valuation (Absolute and
Relative)
Attractiveness to Acquirers
Competitive Landscape
Relationship with Shareholders
Government / Regulatory Interaction
Shareholder Returns Track
Record
Valuation (Absolute and
Relative)
Think Like an Activist – Key Areas of Vulnerability to Assess
50
Developmentof Investment Thesis
Detailed screening of target candidates based on multi-factor qualitative / quantitative process Deep industry and company-specific due diligence May reach out directly or indirectly to current shareholders or potential acquirors
Accumulation of Stake
Initial “Toehold” purchases used to establish meaningful stake without moving price May use derivatives to accumulate – potentially increases the speed of accumulation and may
delay regulatory filing requirements Will typically buy rapidly once a disclosure threshold is passed or on stock price weakness
Private Engagement / Agitation
Initial private engagement will typically be with IR or finance staff Will seek subsequent meetings with senior management May also seek meetings or discussions with directors and / or the board Will provide presentations / letters to management or board to create paper trail
Public Announcement of Stake
Public announcement of stake through 13D, 13F, public statement, or “leak” If >5%, will often have significant time to accumulate additional shares before 10-day
disclosure requirement under 13D If <5%, can defer for significant amount of time by seeking confidential treatment
Public Agitation Initial disclosures will often be accompanied by public letters and media campaign May provide detailed presentations or conduct “investor days” to push agenda Increasingly leverage social media to create sustained pressure
Proxy Fight /Consent Solicitation
Submission of nominees to replace existing directors through a proxy fight Broad-based public media campaign utilized to attack the target’s management and board Attacks on governance are a cornerstone of the activist’s message
Activists Have Developed Well-Established Escalation Paths
51
Risk Assessment & Mitigation
Identify key areas of investor focus – financial, strategic, and governance Develop alternatives and determine whether to pursue proactively or reactively Establish a periodic review of shareholder returns, board structure, governance
provisions, and remuneration policies
Core Message Refinement
Establish unified message regarding the company’s strategy, performance, and governance that can be used across all communication methods – traditional IR, governance outreach, normal course disclosures (e.g., quarterly earnings, proxy), etc.
Leverage investor feedback to supplement core messages Identify key inflection points, positive and negative, that may require material changes
to core messaging
ShareholderEngagement
Develop relationships with investors’ governance teams and proxy advisors –including conducting “off-season” shareholder engagement with your proxy voters
Craft effective, consistent messaging to build goodwill with key constituencies Solicit investor feedback and determine appropriate responses
DefensePreparedness
Designate team to respond to potential developments Develop logistics / playbook for potential future escalation Monitor trading and shareholder base evolution Select key personnel – including members of the board where warranted – who will
speak on activism/governance matters (“speak with one voice”)
Actions Should Be Taken Preemptively to Prepare For and Address Future Activism / Raid Challenges and Create Goodwill with Institutional Investors
Long-Term Proactive Preparedness Actions
52
Core response group (CEO, CFO/Finance, GC/Legal, IR) takes the lead in coordinating internally and communicating with activist / externally
Focus on gathering information from activist, with responses to demands generally limited to “we will get back to you” until board has taken a position
Leverage pre-planned initial actions – e.g., investor communications, media outreach and substantive actions (as warranted)
Following initial communications with activist and external communications / actions, designated team to update board and determine next steps
Capitalize on strong relationships with long-only investors and proxy advisors to help prevent the activist from gaining momentum
Build the record to Company’s advantage / avoid pitfalls – careful, deliberate, fully informed decision-making process
Immediate Response Steps Upon Initiation of Activism
53
Have a “ready team” that has been prepared in advance to support the company in its response and follow-up
Respond to any dissident / activist interest within 24 hours
Regularly prepare and educate the board and C-Suite executives on activist issues and possible company actions
Look through the lens of shareholders and encourage constructive dialogue
Know your investors and how they have voted in the past on all ballot items
Identify likely dissident / activist issues and vulnerabilities in advance –benchmark & think like an activist
Don’t wait for a proxy fight to call your shareholders
Don’t assume that silence equals support Don’t be defensive - solicit critical views
and consider them Don’t ignore the activists – they likely
won’t go away on their own Don’t operate in a vacuum; keep your
board up to date Don’t allow mixed messages to flow from
different parts of the company during the heat of a fight
What Not to DoWhat to Do
Preparedness Best-Practices
54
What’s In Store for 2017?
Activism is likely to remain robust, with new entrants replacing funds that leave the field
With hedge funds experiencing significant outflows and returns challenges, activism remains an option to generate alpha to bolster returns
Increasing and more innovative short seller activism Potential expansion of private (and public) activist tactics by
traditional long-only funds Potential chilling effect of the ValueAct – HSR Settlement Will the SEC start to more vigorously enforce 13D? Brokaw Act? Universal Ballot? Proxy access?
55
DisclosureMeredith Cross—Partner, WilmerHaleDavid Martin—Principal, CamberView PartnersKnute Salhus—Partner, WilmerHale
Agenda 2016 Form 10-K Proxy Statement for 2017 Annual Meeting Pending SEC Rule Changes Social and Environmental Disclosures Action Items
57
2016 Form 10-KWhat’s New Form 10-K Summary PageMay 2016 CDIs re Non-GAAP Measures
Other Focus Areas Expected impact of adoption of new accounting standards (revenue
recognition; leases; credit losses) Effectiveness of internal control over financial reportingMD&A: Disclosure of known trends and uncertainties and key
performance indicatorsRisk factors: Brexit; cyber and data security Segment identification and disclosureConsistency of 10-K with company’s other public disclosures
58
Proxy Statement for 2017 Annual MeetingWhat’s NewNasdaq 5250(b)(3): Disclosure of third party compensation
arrangements Say-on-frequency vote (round 2)March 2016 CDI re clear and impartial identification of proposals
Other Focus AreasQualifications, diversity and refreshment of directors Proxy access related disclosures (for companies with proxy access) Perks and related person transactions Shareholder approval of limits on director compensationConsider expanded audit committee report disclosuresCaution: March 2016 case re misleading biography (Kelsey v. Allin) Application of non-GAAP rules to proxy statement
59
Evolution of the Proxy Statement Historically, the Proxy Statement was written and mailed in order to satisfy
legal and regulatory requirements– Extensive boilerplate, legalese and repetition– In 1999, issuers became required to write proxy statements using “Plain English”
Today’s Proxy Statement has evolved into a marketing document and may include:– Substantive introductory letters from the CEO or key committees/board members– Summaries of the Proxy Statement and CD&A that provide additional color – Increased use of graphs, colors, and infographics to make information as
digestible as possible– Graphical depiction of director skill sets, tenure and diversity, such as through a
skills matrix– Specific information dictated by ISS, such as compensation incentive plan
metrics, the results of shareholder engagements and detailed descriptions of lead director responsibilities
60
The following slides provide examples of current proxy statement market practices
Notable Proxy Statement DisclosuresCEO and Chair/LID Letters
Time Warner (TWX)AIG (AIG)
AIG and Time Warner’s joint letters to shareholders serve to emphasize key strategic priorities, recent performance and shareholder engagement
61
Notable Proxy Statement DisclosuresProxy Summary: Performance Highlights
Honeywell (HON) Apache (APA)
Honeywell and Apache both utilize clean, straightforward charts and graphs to emphasize performance highlights and enhance readability
62
Notable Proxy Statement DisclosuresProxy Summary: Board Overview
In varying levels of detail, Monsanto, Bristol-Myers Squibb and General Dynamics each provide a consolidated view of director skill sets, tenure and diversity in clear visual layouts to facilitate investor analysis
Monsanto (MON) Bristol-Myers Squibb (BMY) General Dynamics (GD)
63
Notable Proxy Statement DisclosuresDirector Nomination Process & Criteria
General Mills (GIS) Walmart (WMT)
General Mills and Walmart include diagrams and graphics in this typically text-heavy section, helping to make the document more user-friendly for investors
64
Notable Proxy Statement DisclosuresDirector Bios
Bank of America (BAC) Pfizer (PFE)
Bank of America and Pfizer highlight directors’ key skills/expertise and outside board memberships by including the information in discrete sections of each director bio
65
Notable Proxy Statement DisclosuresRisk Oversight & Committee Responsibilities
Target utilizes tables to provide investors with a clear view of risk oversight and board committee responsibilities and functions
Target (TGT)
66
Notable Proxy Statement DisclosuresCD&A Executive Summary
AbbVie (ABBV) Coca-Cola (KO)
Both AbbVie and Coca-Cola incorporate graphics to identify key performance metrics and their connection to program design, and to illustrate the evolution of each company’s compensation program;
AbbVie also includes a Table of Contents to enable investors to navigate the section more easily
67
Notable Proxy Statement DisclosuresCD&A: Shareholder Engagement
Starbucks (SBUX) General Dynamics (GD)
In addition to standard text, Starbucks and General Dynamics include diagrams and tables on the shareholder engagement process and its impact on executive compensation
68
Dodd-Frank Compensation MandatesDodd-Frank Section Topic Status of SEC
Rulemaking953(a) Pay-vs-performance Proposed April 29, 2015;
Comment period ended July 6, 2015
953(b) Pay ratio Adopted Aug. 5, 2015; First disclosure required in 2018 proxy statement; CDIs issued October 18, 2016
954 Clawbacks Proposed July 1, 2015; Comment period ended Sept. 14, 2015
955 Hedging by employees, officers and directors
Proposed Feb. 9, 2015; Comment period ended April 20, 2015
69
Disclosure Effectiveness & Other Initiatives SEC staff is encouraging companies to be proactive in
improving disclosures Redundant, duplicative, overlapping, outdated, or
superseded disclosure requirements (Proposed Rule; July 2016)
Business and Financial Disclosure (Concept Release; April 2016)
Financial statement disclosure by entities other than the registrant (Request for Comment; Sept. 2015)
Hyperlinked Exhibits (Proposed Rule; August 2016) Universal Proxy Card (Open Meeting; October 26, 2016)
70
Social and Environmental Disclosures Investors and certain politicians are advocating for
expanded disclosures about social and environmental issues
Over 80% of S&P 500 companies now publish sustainability reports (up from 20% in 2011)
The Sustainability Accounting Standards Board (SASB) is advocating for greater integration of material CSR information into SEC reports
Some State AG’s have become aggressive in alleging incomplete or misleading disclosure with respect to social and environmental issues
71
Action ItemsD&O QuestionnaireRevise to address new Nasdaq rule re: third-party compensation
arrangements Evaluate any further changes needed to reflect new controls and
procedures around related person transactions
Corporate Governance GuidelinesConsider changing overboarding policy in light of new ISS and GL
policiesConsider benchmarking against new and revised model codes
(Commonsense Principles, Business Roundtable, CII)
Code of EthicsReview whistleblower provisions in light of recent enforcement
actions relating to language that might be viewed as chilling the right to whistle blow
72
Action ItemsAudit CommitteeUpdate charter references to PCAOB Auditing Standards to reflect
codification that is effective 12/31/16 (e.g., AS No. 16 becomes AS 1301 and AS No. 18 becomes AS 2410)Consider changes in response to SEC’s highlighting of board’s
oversight role regarding use of non-GAAP measuresConsider robustness of current procedures designed to ensure
auditor independence
Compensation CommitteeReview adequacy of compensation committee process for
approving share surrenders under Rule 16b-3(e)
Other Policies, Procedures and AgreementsUpdate confidentiality agreements for Defend Trade Secrets Act
and National Labor Relations Board guidance
73
Questions? Krystal BerriniPrincipal, CamberView Partners+1 415 906 [email protected]
Lillian BrownPartner, WilmerHale+1 202 663 [email protected]
Jay BothwickMergers & Acquisitions Group Co-Chair and Partner, WilmerHale+1 617 526 [email protected]
Meredith CrossPartner, WilmerHale+1 202 663 [email protected]
William FiskeSenior Managing Director, Georgeson+ 1 212 440 [email protected]
Christopher HaydenSenior Managing Director,Georgeson+ 1 212 440 [email protected]
David MartinPrincipal, CamberView Partners+ 1 212 235 [email protected]
Peter MichelsonPartner, CamberView Partners+1 415 906 [email protected]
Knute SalhusPublic Company Counseling Group Co-Chair and Partner, WilmerHale+1 212 230 [email protected]
Jonathan WolfmanPublic Company Counseling Group Co-Chair and Partner, WilmerHale+1 617 526 [email protected]
© 2016 Wilmer Cutler Pickering Hale and Dorr LLP 74
© 2016 Wilmer Cutler Pickering Hale and Dorr LLP 75
Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/code-of-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2016 Wilmer Cutler Pickering Hale and Dorr LLP