Dealing with ISS and Other Proxy Advisory Firms this Proxy Season

by Snell & Wilmer

Set forth below are summaries of key ISS and Glass Lewis policy updates that will take effect for the 2013 proxy season.

ISS Policy Updates

Pay-for-Performance Evaluation

  • Revised Peer Group Methodology. ISS modified its peer group methodology to consider a public company’s self-selected peer group, recognizing that the peer groups historically used by ISS sometimes omitted competitors of the subject company and/or included companies that were not appropriate for pay-related comparisons. ISS also “slightly relaxed” its size requirements (primarily affecting very small and very large companies), although the firm stressed that it will continue to emphasize similarities in industry profile, size and market capitalization when formulating peer groups for purposes of its pay-for-performance quantitative analyses.
  • Analysis of “Realizable” Pay. In 2012, ISS observed more companies disclosing “realizable” total compensation in addition to the “grant date fair value” amounts required under SEC rules. In providing such additional disclosure, public companies attempt to show not only the Compensation Committee’s intent when it makes executive compensation decisions, but also how that compensation is subsequently affected by gains or losses in the company’s stock price. Beginning in 2013, ISS will include “realizable pay” in its qualitative analysis for large capitalization companies. Such pay will consist of the sum of cash and equity awards for the applicable performance period, with equity awards (whether actually earned or based on target future achievement) being valued using the stock price at the end of the performance period. Stock options and stock appreciation rights (SARs) will be valued using a Black Scholes model. ISS noted that its consideration of “realizable pay” could mitigate—or exacerbate—an individual company’s pay-for-performance concerns arising from the preliminary quantitative analysis.

“Majority-Supported” Shareholder Proposals

  • Historical Standard; Investor Feedback. Historically, ISS recommended a vote against the full board of directors if it failed to act on a shareholder proposal that received the support of a majority of the shares outstanding in the last year, or a majority of the shares cast in the last year and one of the two previous years. In a 2012 survey of institutional investors, ISS observed that 86 percent of respondents would expect a public company’s board to implement a shareholder proposal approved by a majority of the votes cast at the previous annual meeting (even if less than a majority of the shares issued and outstanding).
  • 2013 Transition Rule. In response to that feedback, and to provide for more flexibility in its recommendations, pursuant to a transition policy effective for the 2013 proxy season, ISS will recommend a vote against individual directors, committee members or the full board (as appropriate) if the board failed to act on a shareholder proposal that received the support of (i) a majority of the shares outstanding the previous year or (ii) a majority of the shares cast in the last year and one of the previous two years.
  • 2014 Proxy Season and Beyond. In the 2014 and future proxy seasons, ISS will recommend a vote against individual directors, committee members or the full board (as appropriate) if the board failed to act on a shareholder proposal that received the support of a majority of the shares cast in the previous year.
  • Case-by-Case Application; FAQ. ISS noted that the policy will be applied on a case-by-case basis.

Pledging and Hedging

  • Pledging “Significantly” Problematic. In 2012 surveys conducted by ISS, 49 percent of institutional investors and 45 percent of public company respondents indicated that they view pledging of shares by directors and executives as significantly problematic. Nevertheless, ISS’ proposal to consider pledging a “problematic pay practice” for purposes of a public company’s say-on-pay proposal was met with criticism from both audiences.
  • ISS Approach; Focus on Risk Oversight. Taking into account the criticism, ISS decided to take a case-by-case approach to determining whether share pledging represents a significant concern for shareholders. If it does, ISS will consider the share pledging to be a failure of risk oversight for which the board is accountable (i.e., instead of recommending a vote against the company’s say-on-pay proposal, ISS might decide to recommend a vote against the full board or individual directors).

Glass Lewis Policy Updates

Board Responsiveness to Negative Shareholder Votes

For the 2013 proxy season, Glass Lewis formalized its historical policy of scrutinizing a board’s response to a shareholder vote of at least 25 percent (excluding abstentions and broker non-votes) in opposition to management’s recommendation on any proposal. Previously, the written policy applied only to say-on-pay votes. Any such negative shareholder vote will trigger a detailed analysis of the issues giving rise to the vote and the board’s response, including through Glass Lewis’ review of the proxy statement and other public disclosures explaining the response. Ultimately, Glass Lewis will consider whether it believes the board’s response was proper and use that judgment as a factor in determining its voting recommendations with respect to the directors standing for election at the annual meeting.

Equity Compensation Plans (Share-Counting)

Glass Lewis has added “inverse full-value award multipliers” to the list of “overarching principles” that it uses when evaluating equity compensation plans. In other words, according to Glass Lewis’ principles, “plans should not count shares in ways that understate the potential dilution, or cost, to common shareholders,” for example, by counting options as less than one share granted for purposes of determining how many shares remain available for additional awards under an equity compensation plan. Currently, few public companies use that approach to share-counting, so the new policy is not expected to have a significant practical impact on future proposals relating to equity compensation plans.

Role of Committee Chair

Glass Lewis generally holds the chair of each committee primarily responsible for the committee’s actions. Accordingly, in connection with adverse committee-specific recommendations, Glass Lewis’ policy is to recommend a vote against the committee chair (rather than all members of the committee). If there is no committee chair, or if the committee chair is not standing for re-election as a director at the annual meeting, the policy is to recommend a vote against the senior member of the committee. Previously, if committee seniority could not be determined, the “no” vote recommendation applied to the longest-serving director who was a member of the committee. For 2013, that policy has been changed, such that Glass Lewis will now recommend a vote against all committee members in the absence of a chair if seniority cannot be determined.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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