The Rules of the Game

The pace of change in corporate governance has never been faster in Canada

The heat is on,
from both regulators and shareholders, for corporate governance reforms, starting with the selection, compensation and retirement of board members.

“When people look back at this last decade,” says Patricia Olasker, senior partner at Davies Ward Phillips & Vineberg LLP in Toronto, “it will be seen maybe not as a Golden Age, but as a period when the law and regulation moved in the direction of greater shareholder democracy and a growing professionalization of directors.”

Here are how some significant issues are unfolding.

 

Gender diversity

The Ontario Securities Commission (OSC) has adopted a “comply or explain” regime for the representation of women on corporate boards and in senior management. Of the total 3,275 board seats of issuers on the S&P/TSX Composite Index and the S&P/TSX SmallCap Index, only 343 (or 10.5 per cent) were held by women at the beginning of 2014, according to a publication by Davies.

In 2015, for the first time, TSX-listed companies and other non-venture issuers have to disclose in their proxy circulars the number and proportion of women in those positions. Under “comply or explain,” an issuer that has not adopted a policy on the identification and nomination of women directors or given consideration to their level of representation is required to explain why not.

Carol Hansell, founder and senior partner at Hansell LLP in Toronto, says that initially there will be more explaining than complying under this regime.

“But what it does at a minimum is raise awareness,” she says. “People have to address the issue. The likely scenario is, ‘we haven’t turned our minds to it, and now we will.’ Once boards engage in the process of identifying qualified women, they will see there are lots of them. I think it will actually break the barrier.”

 

Term limits

The OSC’s proposal on gender diversity included similar “comply or explain” requirements on listees’ adoption of director term limits. The thinking is that regular turnover of directors contributes to board effectiveness and provides opportunities for more gender and ethnic diversity. (Academic research, however, has shown no link between director performance and either length of term or age.)

“The issue of term limits has been live for a number of years, quite apart from any regulatory pronouncements,” says Patricia Koval, a partner at Torys LLP. “Boards that take governance seriously have always carefully reviewed incumbents. If they feel the time has come to tell a director to move on, they do so constructively. It becomes a question of weighing the contribution and quality that a director brings to the table versus simply imposing an arbitrary term limit. I think Corporate Canada is going to choose more of the ‘explain’ [option].”

 

Majority voting

As of June 2014, the TSX required all listed companies, except those that are majority controlled, to have majority voting for directors in uncontested elections. A director unable to win a majority of votes (absent “exceptional circumstances”) must resign.

Previously, if the majority of shareholders withheld their votes, a director could still be elected, as the only options were to vote “for” a nominee or to “withhold” a vote. Under the new regime, a director who receives a majority of “withhold” votes has to resign.

A TSX survey of 200 listees queried in 2013 found that 76 per cent had already adopted majority voting policies. The majority voting requirement follows earlier TSX-led governance reforms in 2012 that required directors to be elected annually and individually rather than collectively as part of a slate.

“No one wants to come in last on the ballot,” says Olasker at Davies. “While directors aren’t campaigning, they have in mind the potential impact of their decisions on how they will come out in that vote. Sitting on a compensation committee that approves a rich executive contract will now be a decision that directors will take with more thought on whether they’ll be targeted in the next round.”

 

Say on pay

The number of public companies voluntarily adopting a say-on-pay vote – a shareholder vote approving the company’s executive compensation arrangements – will likely continue to rise.

Say-on-pay votes started in Canada in 2010 at the major banks’ AGMs. Of the S&P/TSX 60 Index companies, 81.7 per cent gave stockholders a say on pay in 2014, according to Davies Governance Insights 2014. However, only one-third of approximately 250 companies in the S&P/TSX Composite Index have done so.

Where shareholders have revolted on pay, they’ve been heeded, says Hansell. She notes that Barrick Gold Corp. received an 85.2 per cent “no” vote on its compensation structure two years ago. “They heard the investors loud and clear and made changes to their compensation. Even if 30 per cent of the votes were ‘no,’ boards pay attention to that.”

 

Proxy advisory firms

Listed companies complain when they receive negative recommendations from proxy advisory firms, especially based on inaccuracies or on the issuers’ failure to meet “one-size-fits-all” governance standards set by the advisory firms.

“The weight that the advisory firms have is akin to rule-making power, without the checks and balances that other market participants have,” says Jean-Pierre Chamberland, partner at Fasken Martineau DuMoulin LLP's Montréal office. In particular, issuers feel that the proxy firms are too attentive to dissident shareholders in preparing their reports.

In April 2014, the Canadian Securities Administrators (CSA) proposed guidance for advisory firms – Institutional Shareholder Services Inc. (ISS) and Glass Lewis & Co. – to avoid conflicts of interest, improve their accuracy and be more transparent. The reforms are discretionary, but Chamberland says the firms have already started to implement several. “They understand that if they don’t, they’ll be regulated and have even less control.”

A key question is whether the advisory firms will provide a draft report for the company to review for inaccuracies. “A fallback position for issuers,” says Chamberland, “would be for the advisory firms to include in their final report whether or not they’ve consulted with the issuer and, if so, does the issuer agree with what’s in the report.”

 

Shareholder activism

In response to shareholder activism, some issuers are adopting bylaws as defensive tactics. Most common is an advance notice requirement that shareholders give reasonable notification prior to the annual general meeting rather than wait until the meeting to propose their own director nominees from the floor. The courts have upheld such bylaws as a contribution to transparency and informed decision-making.

“Whereas four years ago people in Canada had never heard of advance notice bylaws,” says Koval at Torys, “now it’s become almost a matter of practice when you’re IPOing a company or reviewing the governance of a company to include an advance-notice bylaw. My own view is that they serve the existing shareholders as well as the activists well. I think it’s an appropriate balancing of interests.”

Less common in Canada is an enhanced quorum for contested AGMs where dissidents wish to oust a majority of directors. “But in order to be effective, they require shareholder approval,” says Jeffrey Lloyd, a partner at Blake, Cassels & Graydon LLP in Toronto. “With ISS no longer supporting them, I don’t expect to see many companies continuing to adopt them.”

Adds Koval: “We’re a jurisdiction that’s much more about providing information to [shareholders] in order to help them make a reasoned decision rather than trying to force their decision.”

 

Rules on take-over bids

In 2013, when HudBay Minerals Inc. made an unsolicited take-over offer for Augusta Resource Corp., the BC Securities Commission ruled that the bid could stay open for 156 days well past the usual 60 to 90 days, giving Augusta more time to find a white knight.

The CSA is now proposing a 120-day period for all take-over bids. The new rules will also require the bidder to buy 50 per cent of the stock it doesn’t already own – currently, there’s no “minimum tender condition” – and, once that threshold is reached, to extend its bid for at least 10 days to allow other stockholders to tender their shares as well.

The proposed rules would “re-balance the dynamics between hostile bidders and target boards,” says Lloyd. “Shareholder rights plans will continue to be relevant but only to prevent ‘creeping take-overs’ by way of transactions exempt from the formal take-over bid rules.”

These rules would be positive for shareholders, says Chamberland. “There’s less coercion. They can take their time to review the bid and not be afraid [as previously] that if a sufficient number of shareholders tendered … you’d be left on the sidelines holding a less liquid stock.”

For bidders, however, the new rules will mean more uncertainty and risk in attempting a hostile take-over. “The longer open-bid period will mean increased financing costs to the extent that you need to have financing in place,” says Chamberland. “You’ll also see an increase in the risk of competing bids materializing, with potential impact on the pricing of the deal.”

The arc of history continues to bend, however gradually, toward corporate governance reform.