On November 17, 2011, Institutional Shareholder Services (ISS) issued updates to its proxy voting policies applicable to shareholder meetings held on or after February 1, 2012. This Alert summarizes and discusses implications of those updates for US companies. The ISS proxy voting guidelines and the updates are available at http://www.issgovernance.com/policy.
ISS is generally considered the most influential proxy advisor in the US. Recent studies have found that ISS is able to influence shareholder votes by 6 percent to 20 percent. [1] In preparing for 2012 annual meetings, corporate counsel, corporate secretaries and directors (particularly those serving on compensation or nominating and governance committees) should review the ISS policy updates and consider how the changes may affect ISS’ evaluation of director re-elections, executive compensation matters and other matters for shareholder vote. Note that for the 2012 proxy season, ISS has identified over 50 circumstances that may support a negative vote recommendation (either “against” or “withhold”) in uncontested director elections.
This article is an excerpt from a Weil Gotshal client alert, originally posted on the HLS Corporate Governance blog.
Summary of Key Changes for the 2012 Proxy Season
1. Revised Policy on Pay-for-Performance Evaluation
Under a revised policy, ISS has refined its methodology for determining pay-for-performance alignment.
Discussion: Previously, if a company in the Russell 3000 index fell in the bottom half of its GICS industry group in total shareholder return over both a one-year and three-year period, and CEO pay was not aligned with shareholder performance over time (with special emphasis on the immediately preceding year), ISS would recommend a negative say-on-pay vote.
Under the revised policy, ISS will select a narrower peer group of 12 to 24 companies, using as guidelines market cap, revenues (or assets for financial firms), and GICS industry group. Additional guidance on the new approaches for selecting companies for peer groups will be provided in December.
ISS will now focus on: (i) the relative alignment between CEO pay and company TSR within the peer group for a one- and three-year period (with a 40 percent emphasis on the one-year period and a 60 percent emphasis on the three-year period); (ii) the multiple of CEO pay relative to the peer group median, and (iii) the absolute alignment between CEO pay and company TSR over a five-year period. The system for evaluating differences in rates of change to identify weak or strong alignment will be provided in additional guidance to be issued in December.
Where the alignment is perceived to be weak, ISS will consider how a number of qualitative factors affect alignment of pay with shareholder interests, including:
- The ratio of performance- to time-based equity awards;
- The ratio of performance-based compensation to overall compensation;
- The completeness of disclosure and rigor of performance goals;
- The company’s peer group benchmarking practices;
- Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
- Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (e.g., biennial awards); and
- Any other factors deemed relevant.
Implications: Companies should study the additional guidance that ISS plans to issue in December and assess how their alignment of compensation and performance is likely to be assessed under ISS’ new methodology. Companies should take special care to focus their CD&As on the alignment between compensation and performance, and explain any anomalies.
2. Revised Policy on Board Response to Say-On-Pay Vote
Under a revised policy, ISS will recommend votes on compensation committee members and the current year say-on-pay proposal on a case-by-case basis where, in the previous year, the company’s say-on-pay proposal received the support of less than 70 percent of the votes cast.
Discussion: Previously, ISS would recommend a negative vote for compensation committee members “in egregious situations” or when the board “failed to respond to concerns raised in prior [management say-on-pay] evaluations.” When evaluating ballot items related to executive pay, ISS considered the board’s responsiveness to investor input and engagement on compensation issues (for example, failure to respond to majority-supported shareholder proposals on executive pay topics, or concerns raised in connection with significant opposition to prior year’s say-on-pay vote) on a case-by-case basis.
Under the revised policy, ISS’ case-by-case analysis will take into account: (i) the company’s response to the concerns expressed by shareholders in the previous year, including disclosed engagement efforts with major institutional investors and specific actions taken to address the issues that led to the “low” level of support, as well as other recent compensation actions taken by the company; (ii) whether the issues raised are recurring or isolated; (iii) the company’s ownership structure (for example, significant insider ownership); and (iv) whether the support level was less than 50 percent, which ISS notes will “warrant the highest degree of responsiveness.”
ISS has indicated that the new policy does not establish a bright line test, and that it may apply its case-by-case analysis to companies where the say-on-pay proposal received the support of more than 70 percent of the votes cast, including companies with significant insider ownership.
Implications: Companies whose say-on-pay proposal received a significant percentage of negative votes (even if the proposal was approved by more than 70 percent of the votes cast) should conduct outreach with their large institutional shareholders to discuss compensation concerns that contributed to negative votes and discuss what actions the board has taken, plans to take, or is considering in order to address these concerns (within the confines of Regulation FD). ISS notes that “these specific actions should ideally be new rather than a reiteration of existing practices.” In the CD&A, companies should consider disclosing efforts to engage with shareholders and consider their viewpoints (for example, the percentage of shareholders contacted). There may be instances where the board, after considering all relevant facts and circumstances with due care – including the shareholder say-on-pay vote – may decide that no change is appropriate. Where this is the case, the basis for this conclusion should be presented in the CD&A.
Note that shareholder outreach efforts on compensation concerns may be useful in avoiding a shareholder derivative lawsuit alleging that directors breached their fiduciary duties in connection with a failed say-on-pay vote.
3. New Policy on Board Response to Say-on-Pay Frequency Vote
Under a new policy, ISS will recommend that shareholders vote against or withhold votes from all incumbent directors if the board implements a say-on-pay vote on a less frequent basis than the frequency that received a majority of the votes cast. When no frequency received a majority, ISS will apply a case-by-case analysis if a particular frequency received a plurality of the votes cast and the board implements a say-on-pay vote less frequently.
Discussion: Last year, US corporate issuers were required to afford shareholders an advisory vote on the frequency with which the say-on-pay vote should be held, and will have to revisit say-on-pay frequency at least once every six years thereafter. Under a policy issued last year, ISS recommended voting for annual say-on-pay votes, rather than biennial or triennial say-on-pay votes. It appears that many large companies are opting for an annual say-on-pay vote.
Where a frequency option received a majority of votes cast and the board implements a less frequent say-on-pay vote, ISS will recommend that shareholders vote against or withhold votes from the entire board (except new nominees, who will be considered on a case-by-case basis). In a situation where no frequency received a majority of votes cast in support, and the board implements a less frequent say-on-pay vote than the frequency that received plurality support, ISS will take a case-by-case approach and consider additional factors in determining its recommendations, including the board’s rationale, the company’s ownership structure and vote results, any compensation concerns or history of problematic compensation practices, and the say-on-pay support level from the prior year.
Although ISS’ rationale for the new policy states that “[m]ajority support for a particular frequency should be viewed as a mandate to the board,” ISS will not issue negative vote recommendations where even though the shareholder’s “mandate” is for a frequency other than annual voting, the board implements a more frequent say-on-pay vote.
Implications: Companies that have disclosed they plan to implement a less frequent say-on-pay vote than the frequency option preferred by their shareholders should consider outreach efforts aimed at explaining why a less frequent say-on-pay vote is best for their circumstances. Some such companies may wish to revisit whether to implement the shareholder-preferred say-on-pay frequency.
4. Revised Policy on Incentive Bonus Plans and Tax Deductibility Proposals (Post-IPO Companies)
This year, ISS will apply a more rigorous analysis for the initial approval of equity plans under Section 162(m) of the Internal Revenue Code.
Discussion: Generally, ISS has recommended that shareholders support equity plan proposals solely for compliance with Section 162(m) of the Internal Revenue Code, due to the favorable tax deduction companies may take on performance-based compensation paid to named executive officers. Under the revised policy, ISS will evaluate, on a case-by-case basis, equity plans that are to be voted on for the first time following an IPO even if only for the purpose of obtaining favorable Section 162(m) treatment. ISS will perform a full analysis, taking into consideration total shareholder value transfer, burn rate (if applicable), repricing, and liberal change in control. If appropriate, ISS may also consider other factors such as pay-for-performance or problematic pay practices (such as perquisites).
ISS’ rationale for the policy update explains that the revised policy aligns with the recently proposed Treasury rule related to Section 162(m). The proposed rule would require newly public companies to obtain shareholder approval before awarding certain performance-based restricted stock units to named executive officers before the end of the standard post-IPO transition period to qualify as performance-based compensation.
Implications: Newly public companies seeking initial shareholder approval of an equity plan for Section 162(m) purposes should expect ISS to perform a full analysis and should not consider a favorable ISS recommendation to be a foregone conclusion. Companies should consider this policy change in both plan design and pay practices.
5. Revised Policy on Proxy Access
ISS’ revised policy expands and refines the factors it will consider in determining recommendations on proxy access proposals, and broadens the policy to apply to management proposals as well as shareholder proposals.
Discussion: Until now it had been ISS’ policy to recommend that shareholders vote case-by-case on shareholder proposals asking for proxy access, taking into account (i) the ownership threshold proposed in the resolution, and (ii) the proponent’s rationale for the proposal at the targeted company in terms of board and director conduct.
On September 20, 2011, the SEC’s amendment to Rule 14a-8 took effect, [2] providing that companies may no longer automatically exclude from proxy materials shareholder proposals seeking to amend company by-laws to require future inclusion of shareholder-proposed director nominees in company proxy materials on the ground that such proposals relate to director elections. Of course, companies may seek no action relief for exclusion of such proposals on other grounds pursuant to Rule 14a-8, and some companies may decide to pre-empt shareholder action through management proposals on proxy access.
ISS’ revised policy will apply a case-by-case approach to recommendations on proxy access proposals, taking into account a range of company-specific and proposal-specific factors, including: (i) the ownership thresholds proposed in the resolution, (ii) the maximum proportion of directors that shareholders may nominate, and (iii) the method of determining which nominations should appear on the ballot if multiple shareholders submit nominations. Because ISS supports proxy access in principle, the revised policy de-emphasizes the proponent’s rationale for the proposal. ISS has indicated that its company-specific review will focus on the company’s size and shareholder demographics, rather than the company’s corporate governance profile and practices. ISS has also indicated that its analysis of the appropriateness of the core features of proxy access proposals will be more exacting in the case of binding bylaw amendments than for precatory requests for board actions, since precatory requests permit boards an opportunity to review and revise the proposed procedures and thresholds for proxy access prior to adopting a policy.
ISS’ revised policy does not include any guidance on specific terms in a proxy access proposal that it considers to be favorable or unfavorable, noting that “the access debate is fluid and likely to gain more attention in 2012.” ISS’ executive summary of the updates, however, indicates that “[i]n January 2012, as part of [its] policy update process, ISS expects to provide additional guidance (via FAQs and/or through other reports) based on an examination of the specific proposal texts.”
Implications: It remains to be seen how frequently proxy access shareholder proposals will be brought, whether they will be structured as precatory requests for board action or as binding bylaw amendments, and the range of ownership thresholds proposed in the resolutions (i.e., percentage and duration). Companies should closely monitor proxy access shareholder proposals, as well as corresponding ISS recommendations and shareholder support. As of November 15, 2011, two precatory shareholder proposals seeking proxy access had been filed by Ken Steiner, an individual shareholder involved with the U.S. Proxy Exchange (USPX), a coalition of individual retail shareholders. The proposals, submitted to Textron and MEMC Electronic Materials, were the first 2012 access proposals to be publicly disclosed. The Steiner proposals (which are substantially identical) provide a lower threshold of stock ownership for shareholder nomination of directors than that contemplated by the SEC’s vacated Rule 14a-11, which required ownership of three percent of a company’s outstanding shares for a period of three years in order to nominate one or more director (with a 25 percent cap). The Steiner proposals recommend that the company’s proxy include nominees of “any party of one or more shareholders that held continuously, for two years, one percent of the Company’s securities eligible to vote for the election of directors” or any party of 100 or more shareholders that satisfy SEC Rule’s 14a-8(b) eligibility requirements ($2000, or one percent of a company’s securities eligible to vote, continuously held for at least one year). Companies and boards should follow these developments closely.
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