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Volume XI, Number 301


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ISS Publishes 2012 Updates to Benchmark U.S. Proxy Voting Guidelines

On November 17, 2011, Institutional Shareholder Services (ISS), the leading proxy advisory firm, published 2012 updates to its benchmark U.S. proxy voting guidelines. ISS will use the updated benchmark guidelines to formulate voting recommendations for public company shareholder meetings held on or after February 1, 2012.

ISS recommendations greatly influence the voting decisions of many institutional investors, and some institutional investors vote in accordance with ISS’ recommendations as a matter of policy. As a result, ISS’ voting recommendations have often impacted results of shareholder votes on matters of importance to public companies, and public company general counsels, corporate secretaries and other compliance personnel should familiarize themselves with the updated guidelines. We caution that some of the updated guidelines are unclear or remain subject to future ISS guidance. ISS has made it clear in the updated guidelines that its voting recommendations on issues it considers on a case-by-case basis or generally recommends voting for or against will be influenced by a public company’s disclosures and actions regarding the subject matter of the issue. Accordingly, compliance personnel should consult the updates and, when available, the complete voting guidelines and related guidance that ISS provides over the coming months when making governance and compensation decisions that may have implications for the 2012 proxy season and preparing 2012 proxy disclosure.

On December 7, 2011, ISS will conduct a webinar to discuss the 2012 U.S. updates and to provide insight about the key corporate governance issues for 2012. To register for the webinar, click here. ISS will publish its U.S. proxy voting guidelines summary and U.S. proxy voting concise guidelines later this month and, in January 2012, frequently asked questions on key policy issues and voting guidelines for its specialty policies (e.g., Socially responsible investors).

Board and Compensation Updates

Pay-for-performance evaluation. Many public companies conducted their first advisory vote on executive compensation (commonly referred to as say-on-pay) during the 2011 proxy season as mandated by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and Rule 14a-21 under the Securities Exchange Act of 1934 (Exchange Act). In connection with its evaluation of an issuer’s say-on-pay proposal, ISS evaluates the alignment of chief executive officer (CEO) pay with issuer performance over time. In response to comments from both investors and issuers that this pay-for-performance alignment should be viewed in a long-term context rather than focusing on the most recent year,1  ISS has revised its methodology for determining pay-for-performance alignment.

Under the new methodology, ISS will conduct a quantitative analysis for issuers in the Russell 3000 index, taking into consideration:

  • peer group2 alignment:
    • the degree of alignment between the issuer's total shareholder return (TSR) rank and the CEO’s total pay rank within the peer group as measured over both a one-year and three-year period (weighted 40% and 60%, respectively);
    • the multiple of the CEO’s total pay relative to the peer group median CEO pay level; and
  • the absolute alignment between the trend in CEO pay and issuer TSR over the prior five fiscal years (i.e., the difference between the trend in annual pay changes and the trend in annualized TSR during the five-year period).

ISS will not conduct additional pay-for-performance analyses if the quantitative analysis does not demonstrate "significant unsatisfactory long-term pay-for-performance alignment." However, ISS intends to perform an in-depth qualitative analysis if its initial analysis reflects “significant unsatisfactory long-term pay-for-performance alignment” (or as to issuers not included in the Russell 3000 index, ISS’ initial analysis otherwise indicates misaligned pay-for-performance). The qualitative analysis will focus on the following factors:

  • the ratio of performance-based to time-based equity awards;
  • the ratio of performance-based compensation to overall compensation;
  • the completeness of disclosure and rigor of performance goals;
  • the issuer’s peer group benchmarking practices;
  • actual results of financial and operational metrics (in both absolute terms and relative to peers), such as growth in revenue, profit and cash flow;
  • special circumstances (e.g., a new CEO or anomalous equity grant practices such as biennial awards); and
  • any other factors deemed relevant.

ISS believes the new methodology will identify strong as well as weak pay-for-performance alignment over a longer period, which will provide institutional investors a better view of the relationship between executive pay and issuer performance. However, the new methodology does not indicate how ISS will identify “strong” versus “weak” pay-for-performance alignment. Later this month, ISS is scheduled to publish additional guidance on its new pay-for-performance methodology.

As many aspects of the new pay-for-performance methodology are unclear (e.g., the initial analysis ISS will use to determine pay-for-performance misalignment for issuers not included in the Russell 3000 index and how peer groups will be selected), issuers should review not only the new methodology set forth in the updated guidelines but also the upcoming guidance to understand how ISS will evaluate their pay-for-performance alignment.

Incentive bonus plans and tax deductibility proposals for post-IPO issuers. The first time following its initial public offering that an issuer seeks shareholder approval for Internal Revenue Code Section 162(m) tax treatment of an equity compensation plan, ISS will now consider its voting recommendation on a case-by-case basis only after conducting a full equity plan evaluation. ISS indicated that it expects to continue to support the vast majority of Section 162(m) proposals that do not seek the authorization of additional shares, but that its recommendation would ultimately be based on an evaluation of all aspects of the plan. Companies that are currently planning an initial public offering should consider this updated guideline when preparing any equity plans and formulating pay practices in connection with the offering.

Board responsiveness to say-on-pay vote. As a result of investor feedback,3 if an issuer's previous say-on-pay proposal received less than 70% support of all the votes cast, ISS will make case-by-case voting recommendations on compensation committee members (or, in exceptional cases, the entire board) and the issuer’s say-on-pay proposal. Factors ISS will consider in formulating its recommendation for those issuers that received less than 70% say-on-pay support include:

  • the issuer's response, including:
    • disclosure of engagement efforts with major institutional investors regarding the issues that contributed to the low support level;
    • specific actions taken to address the compensation issues that contributed to the low support level;
    • other recent compensation actions taken by the issuer;
  • whether the issues raised are recurring or isolated;
  • the issuer's ownership structure; and
  • whether the support level was less than 50%, which would warrant the highest degree of responsiveness.

Item 402(b)(1)(vii) of the Securities and Exchange Commission’s Regulation S-K requires all issuers that conducted a say-on-pay vote in 2011 to discuss in their 2012 CD&A whether, and if so, how, the issuer considered the results of the most recent say-on-pay vote in determining compensation policies and decisions and, if so, how that consideration has affected the issuer’s executive compensation decisions and policies. However, ISS will more closely scrutinize the disclosure of those issuers that received less than 70% support for their previous say-on-pay vote. Issuers with less than 70% support should be aware that ISS will expect remedial actions to be taken and for those actions to be clearly disclosed in a readily identifiable place. For example, ISS noted that the specific remedial actions disclosed “should ideally be new rather than a reiteration of existing practices.”

Issuers that received less than 70% "for" votes on their say-on-pay proposal during 2011 should pay particular attention to this updated guideline when drafting their 2012 CD&A disclosure as the failure to satisfy ISS’ disclosure expectations could result in a negative voting recommendation against compensation committee members or, if on the ballot, the say-on-pay proposal. Such issuers should engage shareholders (subject to compliance with Regulation FD, of course) who may have a significant influence on the say-on-pay vote to discuss any concerns about executive compensation or governance that may have impacted the say-on-pay voting results and consider what actions are necessary in response to the voting results and the shareholder engagement. Even an issuer that received greater than 70% "for" votes, especially where the board determines that the issuer failed to receive a sufficiently high level of say-on-pay support, should ensure that its CD&A disclosure clearly addresses the matters identified by ISS in the updated guidelines and engage with their shareholders to identify areas of concerns that may need to be addressed.

Proxy access proposals. As a result of the Securities and Exchange Commission’s recent decision to allow the private ordering of proxy access,4 issuers should be prepared to receive shareholder proposals seeking proxy access during the 2012 proxy season. ISS noted that several investors have indicated their intent to bring proxy access proposals. At least two proxy access proposals have already been submitted, both of which are based on the precatory model proxy access proposal published by the United States Proxy Exchange, a non-profit organization.5

While ISS noted that it “supports proxy access as an important shareholder right, one that is complementary to other best-practice corporate governance features,” it will retain its existing case-by-case approach to proxy access proposals. However, it is expanding and refining the factors examined in formulating its voting recommendation to include:

  • issuer-specific factors; and
  • proposal-specific factors, including:
    • the ownership thresholds proposed (i.e., percentage and duration);
    • the maximum proportion of directors that shareholders may nominate each year; and
    • the method of determining which nominations should appear on the ballot if multiple shareholders submit nominations.

The list of factors is not intended to be exhaustive, and ISS may consider other factors when evaluating proxy access proposals, such as the proponent’s rationale for the proposal. What issuer-specific factors will be considered is unclear. ISS is also broadening the policy so that it applies to both management proposals and shareholder proposals.

ISS believes its updated policy is flexible enough to address the wide variety of proxy access proposals that is expected for the 2012 proxy season. In January 2012, ISS expects to provide additional guidance in the form of frequently asked questions and/or other reports based on an examination of the text of the various proxy access proposals submitted for consideration.

Board responsiveness to say-on-frequency vote. In addition to mandating an advisory say-on-pay vote, Dodd-Frank Section 951 and Exchange Act Rule 14a-21 also mandated an advisory shareholder vote on whether the say-on-pay vote should occur every year, every two years or every three years (sometimes referred to as say-on-frequency). ISS adopted a new policy that it will recommend voting against or withholding votes from the entire board if the board implements a say-on-pay vote on a less frequent basis than the frequency that received the majority of votes cast in the most recent say-on-frequency vote. Unlike incumbent directors, ISS will consider whether to recommend voting against or withholding votes from new director nominees on a case-by-case basis.

In cases where a single frequency option failed to receive a majority of the votes cast, ISS acknowledged that the preference of shareholders may be unclear. If a board implements a frequency option that is less frequent than the option receiving a plurality, but not majority, of votes cast in the most recent say-on-frequency vote, ISS will formulate its voting recommendation on a case-by-case basis after considering:

  • the board's rationale for selecting a frequency that differs from the frequency that received a plurality;
  • the issuer’s ownership structure and vote results;
  • ISS’ analysis of whether there are compensation concerns or a history of problematic compensation practices; and
  • the say-on-pay support level from the previous year.

ISS will not consider problematic a board’s decision to implement a more frequent say-on-pay vote than the one that received majority or plurality shareholder support. However, boards that implemented a less frequent say-on-pay vote than the one that received a majority of the votes cast (and in some cases depending on an issuer’s circumstances, a plurality) should, at a minimum, reach out to major shareholders to discuss the rationale for the decision (again, subject to Regulation FD requirements). To avoid ISS issuing a negative voting recommendation against the entire board, such boards may also want to consider whether they need to reevaluate their frequency decision.

Board accountability for governance failures. ISS updated the list of matters that, under extraordinary circumstances, will trigger a recommendation to vote against or withhold votes from individual directors, board committee members or the entire board to add an explicit reference to “risk oversight.” ISS noted that the update was not intended to “penalize boards for taking prudent business risks or for exhibiting reasonable risk appetite,” but rather to address situations involving a material failure in a board’s role in overseeing an issuer’s risk management practices and because of the “multitude of well-publicized failures of board risk oversight.”

Social & Environmental Updates

Hydraulic fracturing disclosure proposals. ISS adopted a new policy to generally recommend a vote in favor of shareholder proposals requesting greater disclosure of an issuer’s hydraulic fracturing operations. In making its recommendation, ISS will consider:

  • the issuer’s current level of disclosure of relevant policies and oversight mechanisms;
  • the issuer’s current level of such disclosure relative to its industry peers;
  • potential relevant local, state or national regulatory developments; and
  • controversies, fines or litigation related to the issuer’s hydraulic fracturing operations.

Political spending disclosure proposals. In an area of increasing shareholder and media focus, ISS revised its policy on shareholder proposals seeking greater disclosure of an issuer’s political contributions and trade association spending from a case-by-case approach to generally recommending a vote in favor. The revised policy also explicitly included as a consideration point the issuer’s disclosure of policies and oversight mechanisms related to its direct political contributions and payments to trade associations or other groups that may be used for political purposes.

Issuers should consider whether they should re-examine their policies on political spending or need to enhance their oversight mechanisms related to political contributions and whether they should include or enhance their disclosure involving political spending policies and oversight mechanisms.

Lobbying activity proposals. ISS revised its policy on shareholder proposals seeking information on an issuer’s lobbying activities to clarify that the policy applies to proposals (1) seeking information on lobbying activities generally and not only to those seeking information on an issuer’s lobbying initiatives and (2) addressing grassroots lobbying activities as well as formalized, political lobbying activities.

Workplace safety report proposals. ISS adopted a new policy to make voting recommendations on a case-by-case basis for proposals seeking workplace safety reports, including reports on accident risk reduction efforts. In making its recommendation ISS will consider:

  • the current level of disclosure of an issuer’s workplace health and safety performance data, health and safety management policies, initiatives and oversight mechanisms;
  • the nature of the issuer’s business, specifically regarding issuer and employee exposure to health and safety risks;
  • recent significant controversies, fines or violations related to workplace health and safety; and
  • the issuer’s workplace health and safety performance relative to industry peers.

Water-related risk proposals. ISS adopted a new policy to make voting recommendations on a case-by-case basis for proposals requesting an issuer report on, or adopt a new policy on, water-related risks and concerns. In making its recommendation ISS will consider:

  • the issuer’s current disclosure of relevant policies, initiatives, oversight mechanisms and water usage metrics;
  • whether or not the issuer’s existing water-related policies and practices are consistent with relevant internationally recognized standards and national/local regulations;
  • the potential financial impact or risk to the issuer associated with water-related concerns or issues; and
  • recent, significant controversies, fines or litigation regarding water use by the issuer and its suppliers.

Recycling proposals. ISS broadened its policy on recycling proposals to take into account proposals seeking information on an issuer’s existing recycling programs. The recycling policy was also revised to explicitly include an issuer’s current level of disclosure of such programs as a factor to consider when making a voting recommendation.

Other Updates

Exclusive venue management proposals. In 2011, some issuers sought shareholder approval of charter amendments to add a provision designating an exclusive venue for shareholder litigation in response to a court opinion that suggested that exclusive venue bylaw provisions adopted solely by the board may not be enforceable. Based on institutional investor feedback, ISS revised its policy from recommending a vote against these proposals to a case-by-case approach and to add an issuer’s litigation history to the list of factors to be considered when making a voting recommendation.

Dual-class capital structure proposals. ISS consolidated the factors it will consider on proposals to create dual-class common stock structures and added additional factors to be considered when making a voting recommendation.

1. ISS obtained feedback from institutional investors and issuers by conducting an annual policy survey and holding various one-on-one engagements and policy roundtables throughout 2011. ISS also solicited and received comments on a draft of the 2012 updates.

2. The ISS-constructed peer group will generally be comprised of 14 to 24 companies based on market cap, revenue (or assets for financial firms) and Global Industry Classification Standard industry group. ISS indicated that its peer group selection process is designed to select peers that are closest to the subject issuer and where the subject issuer is close to median in revenue/asset size. Unfortunately, issuers will need to wait until a later date to gain more clarity as to how ISS will construct its peer groups. ISS intends to disclose its peer group methodology and rationale in “various communications leading up to the 2012 proxy season.”

3. Based on ISS’ 2011-2012 Policy Survey results, 72% of investor respondents indicated that boards should make an explicit response regarding pay practice improvements when the say-on-pay opposition levels were “more than 30 percent.”

4. Please see our September 20, 2011 client alert, DC Circuit’s Proxy Access Decision to Stand, but SEC to Allow “Private Ordering” of Proxy Access.

5. The model proposal asks an issuer's board to amend the bylaws and governing documents to establish a proxy access mechanism that would permit director nominees from (1) any party of one or more shareholders that has held continuously, for two years, 1% of the issuer’s securities eligible to vote for the election of directors, and/or (2) any party of shareholders of whom 100 or more satisfy Exchange Act Rule 14a-8(b) eligibility requirements (i.e., those who hold at least $2,000 in market value, or 1%, of the issuer’s securities eligible to vote for the election of directors for one year). An eligible party may nominate the greater of one director or a number of directors equal to 12% of the current number of board members, rounding down.

Copyright © 2021, Hunton Andrews Kurth LLP. All Rights Reserved.National Law Review, Volume I, Number 336

About this Author

Jeff C. Dodd, Andrews Kurth Law Firm, Securities Attorney

Corporate, Securities and Corporate Finance: experience in diverse domestic and international corporate transactions, including representing issuers and underwriters (and investment bankers) in connection with public and private securities offerings (including IPOs and secondary offerings); representing venture capital and other investment groups or funds, as well as portfolio companies, in private debt and equity financing transactions; representing various participants (buyers, sellers, financing sources) in merger and acquisition and change of control transactions, public...

Edward A. (Ted) Gilman, Andrews Kurth Law Firm, Securities Attorney

Ted's practice includes corporate and securities law, predominantly in the context of entrepreneurial and emerging growth companies. Ted represents several publicly traded companies with respect to their 1934 Act filings. He also has a transaction-based practice, focusing on private equity and debt offerings, public equity offerings, and mergers and acquisitions. His experience includes representation of both acquirers and targets in a variety of public-public and public-private business combination transactions, as well as issuers, underwriters and venture capital firms in public and...

Dudley W. Murrey, Corporate, Securities, Attorney, Andrews Kurth, Law firm

Dudley Murrey practices in numerous areas of corporate and securities law. He represents multinational companies and others in domestic, cross-border and international corporate finance transactions, including public and private securities offerings, structured finance transactions, commercial lending arrangements, and facility and equipment financings. Dudley regularly advises clients on securities law compliance, corporate governance matters and the implications of the Dodd-Frank Wall Street Reform and Consumer Protection Act for their businesses. In addition, he represents clients in...