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February 27, 2015
ISS Publishes U.S. Corporate Governance Policy Updates for the 2013 Proxy Season
The Policy Updates
On November 16, 2012, Institutional Shareholder Services (“ISS”) published in final form updates to its U.S. Corporate Governance Policies for 2013. The policy updates will be effective for shareholder meetings held on or after February 1, 2013. ISS indicated that it will issue Frequently Asked Questions to provide additional guidance on the new policies in December 2012. The following is a brief summary of the most significant policy updates for 2013 applicable to US issuers:
Voting on Director Nominees in Uncontested Elections. ISS added hedging of company stock or significant pledging of shares as a failure of risk oversight, which may result in a negative vote recommendation for directors. Noting that hedging company stock through covered call, collar or other derivative transactions severs ultimate alignment with shareholder interests, ISS stated that any amount of hedging will be considered a problematic pay practice warranting a negative vote recommendation. ISS noted that pledging of company stock as collateral for a loan may also have a detrimental impact on shareholders if the officer is forced to sell company stock — to meet a margin call, for example. The forced sale of a significant amount of company stock may negatively impact the company's stock price, and may also violate company insider trading policies. In addition, pledging of shares may be utilized as part of hedging or monetization strategies that would potentially immunize an executive against economic exposure to the company's stock, even while maintaining voting rights.
ISS will take a case-by-case approach in determining vote recommendations for election of directors of companies who currently have executives or directors with pledged company stock, considering such factors as:
- proxy disclosure of an anti-pledging policy that prohibits future pledging activity;
- the magnitude of aggregate pledged shares as a percentage of total common shares outstanding, market value or trading volume;
- disclosure of progress or lack thereof in reducing the magnitude of aggregate pledged shares over time;
- disclosure in the proxy statement that shares subject to stock ownership and holding requirements do not include pledged shares; and
- any other relevant factors.
Board Responses to Majority-Supported Shareholder Proposals. Under this revised policy, ISS would recommend a vote AGAINST or WITHHOLD for individual directors, committee members or the entire board if the board fails to act on a shareholder proposal that received the support of amajority of shares cast in the previous year. This is effective with respect to a board’s failure to act on a proposal appearing in a company’s 2013 proxy statement. Thus, ISS’ focus will be on the board’s response to any such proposal in 2014. This is in addition to the current ISS policy that remains in place for 2013, pursuant to which ISS recommends a vote AGAINST or WITHHOLD if: (i) the board failed to act on a shareholder proposal that received the support of a majority of the shares outstanding the previous year; or (ii) the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the last year and one of the two previous years. ISS stated that the policy change reflects a growing expectation in the market that issuers will implement shareholder proposals that receive support from a majority of votes cast, citing the results of its 2012-2013 Policy Survey that 86% of the institutional investor respondents and 47% of issuer respondents believe the board should implement a shareholder proposal that receives support from a majority of shares cast in the previous year.
Director Attendance. ISS also revised its policy with respect to director attendance. Under the revised policy, ISS will generally vote AGAINST or WITHHOLD from directors (except new nominees, who will be considered on a case-by-case basis) who attend less than 75% of the aggregate of their board and committee meetings for the period for which they served, unless an acceptable reason is disclosed in the proxy statement or another SEC filing, with the acceptable reasons generally being limited to: (1) medical issues/illness; (2) family emergencies; and (3) missing only one meeting (when the total of all meetings is three or fewer). The revised policy also states that if the proxy disclosure is unclear and insufficient to determine whether a director satisfied the 75% requirement, the director or directors in questions should receive an AGAINST or WITHHOLD vote. The key changes in the policy are (i) to focus on negative vote recommendations for individual directors as opposed to a negative recommendation for the entire board for insufficient attendance disclosures in the proxy statement and (ii) to focus the 75% analysis on all meetings for the period of the director’s service — a favorable change for directors that have a long period of service for the board.
Pay-for-Performance Evaluation. With respect to ISS’ pay-for-performance evaluation, which can impact its recommendation on management “say on pay” advisory votes, ISS has: (i) modified its methodology for selecting peer groups as part of its quantitative analysis and (ii) incorporated comparisons of “realizable” compensation to grant date pay as part of its qualitative analysis of pay-for-performance alignment.
- Peer Group Selection. Currently, the first element of ISS’ pay-for-performance evaluation is a quantitative comparison of a company’s performance to that of a peer group determined by ISS based on the company’s Global Industry Classification Standard (GICS) classification. Under the policy revisions on peer group selection, ISS would include company-selected peers as an input in ISS’ peer group determination, while maintaining an approach that takes account of company size and market capitalization parameters. According to ISS, this would alleviate concerns that its current methodology may omit competitors of the target company and/or include firms that are not properly considered “peers” for any number of reasons.
- Realizable Pay. ISS also added “realizable pay compared to grant pay” to its qualitative analysis of say on pay proposals, in an effort to analyze actual payouts of performance-based awards or changes in value of awards due to changes in stock price. ISS defines“realizable pay” as “the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period”. Options would be recalculated as of the performance period under a Black-Scholes methodology. ISS stated that realizable pay consideration may mitigate or exacerbate concerns with a CEO's pay-for-performance alignment.
Say on Golden Parachute Proposals. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), issuers are required to hold separate shareholder votes on potential golden parachute payments when they seek approval of mergers and similar transactions. ISS updated its current policy on such golden parachute proposals to (1) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (2) to place further scrutiny on multiple problematic features in change-in-control arrangements that will result in a negative recommendation (such as single trigger cash severance, acceleration of unvested equity awards or excessive severance). ISS noted that recent amendments that incorporate problematic features will tend to carry more weight on the overall analysis, but the presence of multiple legacy problematic features will also be closely scrutinized. In cases where the golden parachute vote is incorporated into a company's advisory vote on compensation (management say-on-pay), ISS stated that it will evaluate the say-on-pay proposal in accordance with these guidelines, which may give higher weight to that component of the overall evaluation.
Environmental, Social and Governance Compensation-Related Proposals. Finally, ISS updated its existing policy with respect to linking executive compensation to environmental or social non-financial metrics (often referred to as “sustainability metrics”). Under the revised policy, ISS would consider proposals to link executive compensation to sustainability metrics on a case-by-case basis. The prior policy was to generally vote AGAINST such proposals. Through this policy update, ISS seeks greater flexibility to better incorporate developments in this area, particularly in certain industries where sustainability metrics have grown to have a greater prominence. ISS also noted the results of its 2012-2013 Policy Survey, where approximately two thirds of institutional investor respondents stated either that the use of sustainability metrics in executive compensation would be beneficial or that a case-by-case approach is appropriate.
As indicated above, the policy updates will be effective for annual meetings on or after February 1, 2013. It is not too early for you to begin to consider the ramifications for your company and what actions may need to be taken in response to them.
Specifically, consider the following:
- Consider how you can better make your case to ISS for inclusion of peer companies that ISS has previously omitted from its peer group determination.
- Run an analysis of realizable pay if you do not do so already, and determine if that analysis helps or hinders your pay-for-performance analysis. If it appears it may be an exacerbating factor in a finding of misalignment, prepare to defend your position to ISS on this point.
- Evaluate the current hedging or pledging practices of your directors and review aggregate pledged shares against total common shares outstanding, market value or trading volume. Consider adopting a policy on hedging and pledging of company stock by directors if you do not currently have one in place and evaluate how your company shapes up with respect to the other factors on pledging enumerated by ISS, including in particular the proxy disclosure factors.
- If you are in an industry for which sustainability metrics are in vogue, be prepared for ISS to support shareholder proposals linking compensation and sustainability.
- The “Bad Actor” Rule: SEC and Dodd-Frank Act
- Financial Industry Regulatory Authority (FINRA) Revises Proposal to Adopt Consolidated FINRA Rule 2231
- Federal Reserve and Consumer Financial Protection Bureau (CFPB) Announce Increases in Dollar Thresholds in Regulations Z and M for Exempt Consumer Credit and Lease Transactions