CLIENT ALERT: ISS Releases U.S. Corporate Governance Policy Updates for the 2013 Proxy Season
On November 16, 2012, Institutional Shareholder Services Inc. (“ISS”) released its U.S. corporate governance policy updates for the 2013 proxy season. These updates are effective for shareholder meetings on or after February 1, 2013. What follows is an overview of what we believe to be the most significant policy updates as far as activist shareholders are concerned. The full text of ISS’s 2013 policy updates may be viewed at http://www.issgovernance.com/files/2013USPolicyUpdates.pdf.
The topics subject to key changes under the ISS policy updates for the 2013 proxy season, as discussed in more detail below, include the following:
- Board response to majority-supported shareholder proposals;
- Certain actions by directors and/or executives that are considered failures of “risk oversight”;
- Treatment of public company subsidiary boards in the context of determining whether a director is “overboarded”;
- Director attendance at board and committee meetings with an eye towards ensuring that adequate disclosure exists to make determinations as to whether a director attended 75 percent of the total board and committee meetings during such director’s “period of service”;
- Certain changes to how ISS categorizes directors as “inside directors,” “affiliated outside directors,” or “independent outside directors”;
- Certain changes to ISS’s pay-for-performance analysis in its evaluation of executive pay, including changes to its peer group methodology and the addition of a “realizable pay” concept for large market cap companies, when relevant; and
- ISS’s evaluation of proposals relating to a company’s “golden parachute” compensation in an acquisition, merger, consolidation, or proposed sale and a new focus on a company’s existing change-in-control arrangements.
Board Responsiveness – Majority-Supported Shareholder Proposals
- Beginning in 2014, ISS will hold a board of directors accountable for its failure to act on a shareholder proposal that received support of a majority of the shares cast in the previous year. Currently, ISS only evaluates a company’s response to a previous year’s shareholder proposal in the subsequent year if it received support of a majority of the shares outstanding. This will continue to be the case for 2013.
- In situations involving lack of board responsiveness to majority supported shareholder proposals, ISS has given itself flexibility to recommend against certain members of the board, as it deems appropriate, as opposed to a wholesale recommendation against the full board.
- ISS has provided guidance by way of a footnote as to what would constitute adequate action by a board in response to a shareholder proposal. ISS has noted that it will be releasing an FAQ document in December 2012 for further guidance related to the new policy.
Currently, ISS recommends voting against or withholding from the entire board if:
- The board failed to act on a shareholder proposal that received the support of a majority of the shares outstanding the previous year; or
- 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.
For 2013, ISS will start using a majority of shares cast in one year as the trigger in evaluating a company’s responsiveness to majority-supported shareholder proposals. This new one-year measuring period will commence with shareholder proposals appearing on companies’ ballots in 2013, which means that ISS will not begin assessing a company’s response to such proposals until 2014.
In addition, ISS has provided guidance as to what would constitute sufficient “action” by a board in response to a shareholder proposal.
Responding to a shareholder proposal will generally mean either full implementation of the proposal, or, if the matter requires a vote by shareholders, a management proposal on the next annual ballot to implement the proposal. Responses that involve less than full implementation will be considered on a case-by-case basis, taking into account:
- The subject matter of the proposal;
- The level of support and opposition provided to the resolution in past meetings;
- Disclosed outreach efforts by the board to shareholders in the wake of the vote;
- Actions taken by the board in response to its engagement with shareholders;
- The continuation of the underlying issue as a voting item on the ballot (as either shareholder or management proposals); and
- Other factors as appropriate.
ISS has also given itself flexibility to recommend against certain members of the board, as it deems appropriate, as opposed to a wholesale recommendation against the full board, in situations involving board failure to appropriately respond to majority-supported shareholder proposals.
Board Responsiveness – Governance Failures
Key Change: ISS has updated its policy to include hedging of company stock and significant pledging of company stock by directors and/or executives as “risk oversight” failures.
Current ISS policy is, under extraordinary circumstances, to vote against or withhold from directors individually, committee members, or the entire board, due to certain governance failures, including:
- Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company;
- Failure to replace management as appropriate; or
- Egregious actions related to a director’s service on other boards that raise substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders at any company.
For 2013, as mentioned above, ISS has updated this policy to include by footnote that hedging of company stock and significant pledging of company stock by directors and/or executives are considered “risk oversight” failures.
Hedging of company stock is where through derivative transactions, a director or officer severs alignment with shareholders’ interests. Any amount of hedging will be considered a problematic practice warranting a negative voting recommendation
Pledging any amount of company stock as collateral for a loan is viewed by ISS as an irresponsible use of equity that might have a detrimental impact on shareholders if the officer or director is forced to sell company stock to meet a margin call. The forced sale of a significant block of company stock might negatively impact the company’s stock price, and might also violate the company’s insider trading policies.
In determining vote recommendations for the election of directors of companies that currently have directors or officers with pledged company stock, ISS will consider the following:
- Presence in the company’s proxy statement of an antipledging policy that prohibits future pledging activity;
- Magnitude of aggregate pledged shares in terms of total common shares outstanding or 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 company stock; and
- Any other relevant factors.
Director Competence – Overboarded Directors
Key Change: All subsidiary boards are now counted as separate boards for ISS’s determination of whether a director is “overboarded.”
Currently, ISS recommends voting against or withholding from individual directors who:
- Sit on more than six public company boards; or
- Are CEOs of public companies who sit on the boards of more than two public companies besides their own—in these situations, ISS will recommend a withhold for the CEO only at such CEO’s outside boards.
For 2013, ISS will no longer count publicly traded subsidiaries that are owned 20% or more by their parent as one board with the parent company. All subsidiaries with publicly traded stock will be counted as boards in their own right. However, ISS will not recommend a withhold vote from the CEO of a parent company board or any of the controlled subsidiaries (where parent owns more than 50% of the subsidiary), but will recommend withholding vote at subsidiaries that are less than 50% controlled and at boards outside the parent/subsidiary relationship.
Director Competence – Attendance at Board and Committee Meetings
- ISS has clarified that director attendance at board and committee meetings will be assessed based on such director’s “period of service.”
- ISS is taking a more stringent approach by recommending a vote against or withhold on any director whose attendance is questionable due to unclear and insufficient attendance disclosure. ISS will no longer seek to hold the full board accountable for insufficient attendance disclosure for individual directors.
ISS currently recommends voting against or withholding from the entire board if the company’s proxy indicates that not all directors attended 75% of the aggregate board and committee meetings, but fails to provide the required disclosure of the names of the directors involved.
Additionally, ISS currently recommends voting against or withholding from individual directors who attend less than 75% of the board and committee meetings where the reasons for absences are not related to medical issues or family emergencies.
For 2013, ISS has recommended that shareholders generally vote against or withhold from directors 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 for absence is disclosed in the proxy or another SEC filing. Acceptable reasons for director absences are generally limited to medical issues or family emergencies.
ISS states that company disclosures in the area of director attendance should be clear as to whether a director attended 75% of the total of his or her board and committee meetings for the period s/he served. The updated policy takes a stronger approach by recommending voting against or withholding vote for a director whose attendance is questionable due to unclear and insufficient attendance disclosure.
New nominees to the board are subject to case-by-case consideration.
Categorization of Directors
- ISS is simplifying the categories of directors, starting with its definition of “Inside Director.”
- ISS is broadening the definition of “Inside Director” to include not only a director who is serving as interim CEO, but also any director who is serving in any other interim officer positions.
- Any non-executive director who is named in the Summary Compensation Table due to the material nature of his or her compensation will now be deemed an “Inside Director.”
ISS is simplifying the categories of directors starting with the definition of “Inside Director.”
Currently, an “Inside Director” is defined as:
- An employee of the company or one of its affiliates.
- Among the five most highly paid individuals (excluding interim CEO).
- Listed as an officer as defined under Section 16 of the Securities and Exchange Act of 1934 (“Section 16 officer”).
- Current interim CEO.
- Beneficial owner of more than 50 percent of the company’s voting power (this may be aggregated if voting power is distributed among more than one member of a defined group).
For 2013, ISS will be defining “Inside Directors” as those who are currently employed or are officers of the company, or, control 50% of the voting power of the company.
The new categorization is as follows:
- Current employee or current officer1 of the company or one of its affiliates.
- Beneficial owner of more than 50 percent of the company’s voting power (this may be aggregated if voting power is distributed among more than one member of a group).
- Director named in the Summary Compensation Table (excluding former interim officers).
Although only named executive officers are normally included in the Summary Compensation Table, companies will sometimes include non-executive directors in the table because of the material nature of their compensation. Thus, any such director will be categorized as an Inside Director.
ISS further noted that while directors serving as interim officers are considered Inside Directors while serving in that capacity, such directors will generally again be considered Independent Outside Directors immediately upon their stepping out of that position.
Director compensation will continue to be an item for examination as a potential obstruction to director independence, but it will be under the “Affiliated Outside Director” category.
Advisory Votes on Executive Compensation – Management Proposals
- ISS is modifying its peer group methodology for 2013 to include both peers from the subject company’s Global Industry Classification Standard (“GICS”) as well as from GICS groups represented in the company’s self-selected peer group.
- ISS is including a comparison of realizable pay to grant date pay as part of the qualitative evaluation of pay-for-performance alignment in large cap companies, when relevant.
ISS annually conducts a pay-for-performance analysis to identify strong/satisfactory alignment between pay and performance over a sustained period of time. This analysis considers how a company’s total shareholder return (“TSR”) and CEO’s total pay rank within a peer group as well as how the trend in CEO pay aligns with TSR over the prior five fiscal years.
ISS has modified its peer group methodology for 2013 to include both peers from the subject company’s GICS as well as from GICS groups represented in the company’s self-selected peer group. The methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s self-selected peer group and that have chosen the subject company as a peer. Other changes include using slightly relaxed size requirements, especially at very small and very large companies, and using revenue instead of assets for certain financial companies.
The revised peer group for 2013 will generally comprise 14-24 companies that ISS selects using market cap, revenue (or assets for certain financial firms), GICS industry group and company’s selected peers’ GICS industry group with size constraints, via a process designed to select peers that are closest to the subject company in terms of revenue/assets and industry and also within a market cap bucket that is reflective of the company’s.
If ISS’s pay-for-performance analysis demonstrates significant unsatisfactory long-term pay-for-performance alignment, ISS may consider certain qualitative factors to assist in its determination of how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests. For 2013, ISS has modified these qualitative factors and may include a comparison of realizable pay to grant date pay as part of the evaluation of pay-for-performance alignment in large cap companies, when relevant.
The full list of qualitative factors ISS may consider in 2013 is as follows:
- The ratio of performance- to time-based equity awards;
- The overall ratio of performance-based 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 FY or anomalous equity grant practices (e.g., bi-annual awards);
- Realizable pay compared to grant pay; and
- Any other factors deemed relevant.
Voting on Golden Parachutes in an Acquisition, Merger, Consolidation, or Proposed Sale
Key Changes: In its analysis of “golden parachute” compensation proposals, ISS will consider existing change-in-control arrangements maintained with named executive officers, rather than focusing solely on new or extended arrangements. ISS has indicated that (i) recent amendment(s) that incorporate problematic features will tend to carry more weight on the overall analysis and (ii) the presence of multiple legacy problematic features will also be closely scrutinized.
The Dodd-Frank Act requires companies to hold separate shareholder votes on potential “golden parachute” payments when they seek shareholder approval for mergers, sales, and certain other transactions. Currently, ISS recommends how one should vote on proposals to approve a company’s “golden parachute” compensation on a case-by-case basis. Features that may lead to a vote against a proposal currently include:
- Recently adopted or materially amended agreements that include excise tax gross-up provisions (since prior annual meeting);
- Recently adopted or materially amended agreements that include modified single triggers (since prior annual meeting);
- Single trigger payments that will happen immediately upon a change in control, including cash payment and such items as the acceleration of performance-based equity despite the failure to achieve performance measures;
- Single-trigger vesting of equity based on a definition of change in control that requires only shareholder approval of the transaction (rather than consummation);
- Potentially excessive severance payments;
- Recent amendments or other changes that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders;
- In the case of a substantial gross-up from pre-existing/grandfathered contract: the element that triggered the gross-up (i.e., option mega-grants at low point in stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger); or
- The company’s assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. ISS would view this as problematic from a corporate governance perspective.
For 2013, ISS has modified the above list of problematic features and specified that an “against” recommendation will depend on the number, magnitude, and/or timing of such problematic features. For example, the new list of problematic features specifies that excessive cash severance is greater than three times base salary and bonus, whereas the old list merely included “potentially excessive severance.”
The list of problematic features for 2013 includes the following:
- Single- or modified-single-trigger cash severance;
- Single-trigger acceleration of unvested equity awards;
- Excessive cash severance (greater than 3x base salary and bonus);
- Excise tax gross-ups triggered and payable (as opposed to a provision to provide excise tax gross-ups);
- Excessive golden parachute payments (on an absolute basis or as a percentage of transaction equity value);
- Recent amendments that incorporate any problematic features (such as those above) or recent actions (such as extraordinary equity grants) that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders; or
- The company’s assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote.
Recent amendments that incorporate the above problematic features will tend to carry more weight in ISS’s overall analysis. Additionally, the presence of multiple legacy problematic features will be closely scrutinized.
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For more information about ISS corporate governance policy updates, please contact the Olshan attorney with whom you regularly work or one of the attorneys listed below.
 Definition of officer includes current interim officers.
 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.