ISS Issues Final 2013 Proxy Voting Policies

by Wilson Sonsini Goodrich & Rosati
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Proxy advisory firm Institutional Shareholder Services (ISS) has released its updated 2013 U.S. Corporate Governance Policy. The updated policy guidelines generally will be applied to ISS voting recommendations for shareholder meetings held on or after February 1, 2013. This WSGR Alert provides a summary of the new aspects of the 2013 ISS policy. Please see the prior WSGR Alert dated November 5, 2012, for a discussion of the proposed 2013 policy that ISS published last month. ISS will issue a Frequently Asked Question document in December 2012 to provide additional guidance on some of its new policies.

Advisory Vote on Executive Compensation – Management Proposals

Peer-Group Selection. ISS's annual pay-for-performance analysis for years has included a quantitative screen comparing the alignment of CEO compensation and company shareholder return against an ISS-selected peer group. The peer group is comprised of 14-24 companies drawn from the company's Global Industry Classification Standard (GICS) industry group.

Under its updated 2013 policy, ISS will use the company's self-selected benchmark peers as inputs in its peer-group selection process. The revised methodology will include peers drawn from the GICS industry group of the company's self-selected peer group (as reported in the proxy), subject to ISS size criteria, as well as those from the GICS group that includes the company itself. The new methodology will focus initially on peers in the company's eight-digit GICS subcode, making the peers more industry specific. It also will prioritize peers closely related in terms of industry that are in the company's peer group and that have chosen the company as a peer. Other changes are relaxed peer-group size requirements, especially at very small and very large companies, and using revenue instead of assets in selecting peers for some financial companies.

If a company satisfies the ISS test for alignment of CEO total pay to the peer-group total stockholder return, the ISS test evaluating CEO total pay relative to the peer-group median, and a separate quantitative test comparing alignment of CEO total pay and shareholder return, it is deemed to pass the ISS secondary qualitative pay-for-performance analysis. Improving the peer-group comparison may make it easier for some companies to pass the ISS initial quantitative pay-for-performance evaluation.

Realizable Pay. ISS will incorporate a comparison of "realizable pay" to grant-date pay as reported in the summary compensation table as part of its secondary qualitative CEO pay-for-performance test for large capitalization companies. We understand informally that ISS will consider companies with a $5 billion or greater market capitalization to be large capitalization companies for this purpose. "Realizable pay" will consist of cash and equity-based grants during the performance period being measured, based on equity award values for awards that have been earned and target values for ongoing awards, calculated using the stock price at the end of the performance period. A notable change in the final ISS guidelines is clarification that outstanding options and stock appreciation rights will be re-valued using the remaining term and updated assumptions, as of the performance period, using a Black-Scholes option pricing model. The realizable-pay analysis may mitigate or exacerbate the CEO's pay-for-performance analysis.

Advisory Vote on Golden Parachute Arrangements in Acquisitions

Under the Dodd-Frank Act, companies seeking shareholder approval for mergers or certain other transactions are required to obtain a separate advisory shareholder vote on potential "golden parachute" arrangements. ISS's current policy is to vote on a case-by-case basis on proposals to approve golden parachute compensation, consistent with its policies on problematic pay practices related to severance.

The ISS final 2013 policy eliminates the previous "grandfather" status of existing change-in-control arrangements with named officers. These now will be reviewed along with new or extended change-in-control arrangements. Under the final 2013 policy, ISS will scrutinize multiple legacy problematic features in change-in-control agreements, and recent amendments to incorporate problematic features will carry more weight in the analysis. ISS's list of problematic features in change-in-control agreements remains unchanged and includes:

  • single- or modified single-trigger cash severance;
  • single-trigger equity acceleration;
  • excessive cash severance (greater than three times the base and bonus);
  • excise tax gross-ups triggered and payable (as opposed to a provision providing excise tax gross-ups);
  • excessive golden parachute payments (on an absolute basis and as a percentage of transaction equity value);
  • recent amendments that incorporate any problematic features (such as the foregoing) 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; and
  • the company's assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote.

ISS states that the new, more rigorous golden parachute analysis responds to comments and surveys of its institutional investor clients regarding golden parachute practices. Companies should be prepared for increased ISS scrutiny of change-in-control agreements in 2013 merger or transaction proposals and the increased potential for "against" vote recommendations.

Board Responsiveness and Shareholder Proposals

Board Response to Majority-Supported Shareholder Proposals. Currently, ISS will recommend a vote against or a withhold vote from the entire board of directors (except new nominees, who should be considered on a case-by-case basis) 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.

In an attempt to "hold directors accountable for failure to respond to a shareholder proposal that receives one year of a majority of votes cast," the ISS final 2013 policy will transition the current test to a policy under which ISS will recommend a vote against or a withhold vote from individual directors or the entire board (except new nominees, who should be considered on a case-by-case basis) if the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. In response to comments received on its proposed policy, the new one-year "votes cast" policy will commence with shareholder proposals appearing on companies' ballots in 2013, and ISS's current policy will remain in force in connection with management's response to previous years' shareholder proposals.

Stock Pledging or Hedging. ISS has revised its Board Governance Failure policy for 2013 to add hedging of company stock or significant pledging of company stock by directors and executives as a failure of risk oversight, which may result in an "against" or "withhold" vote for directors individually, committee members, or the entire board. ISS originally proposed adding hedging and pledging as an additional problematic pay practice under its pay-for-performance analysis. However, based on comments received, ISS determined that the negative vote recommendation should be directed toward election of directors rather than a company say-on-pay proposal. ISS cited the potential detrimental effects of pledging on shareholders in the event of forced sales to meet margin calls and violations of insider trading policies. In addition, ISS noted that both hedging and pledging are adverse to shareholder interests because they immunize the director or officer from economic exposure to holding company stock while maintaining voting rights. Companies that explicitly prohibit hedging or pledging of company stock may wish to disclose such policies in their next proxy statements.

Environmental and Social Non-financial Performance Metrics (Sustainability Metrics). ISS has loosened its voting policy on shareholder proposals seeking to link executive compensation to environmental and social (sustainability) criteria. Rather than always recommending against such proposals, ISS will recommend on a case-by-case basis considering the following factors:

  • whether the company has significant and/or persistent controversies or violations regarding social and/or environmental issues;
  • whether the company has management systems and oversight mechanisms in place regarding its social and environmental performance;
  • the degree to which industry peers have incorporated similar non-financial performance criteria in their executive compensation practices; and
  • the company's current level of disclosure regarding its environmental and social performance.

For More Information

If you have any questions regarding this WSGR Alert, please contact any member of the employee benefits and compensation practice of Wilson Sonsini Goodrich & Rosati.

John Aguirre (650) 565-3603 Melody Barker (415) 947-2029
Jessica Bliss (650) 849-3470 Madeleine Boshart (415) 947-2057
Mark Cornillez-Ty (650) 849-3384 Stephen Francis (650) 849-3381
Brandon Gantus (415) 947-2138 Michael Klippert (650) 849-3276
Sriram Krishnamurthy (212) 497-7721 Scott McCall (650) 320-4547
Michael Montfort (202) 973-8815 Cisco Palao-Ricketts (650) 565-3617
Christa Sanchez (650) 849-3382 Roger Stern (650) 320-4818
David Thomas (650) 849-3261 Jackie Tokuda (650) 565-3904
Michelle Wallin (650) 565-3620    

Circular 230 Compliance: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this alert is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the U.S. Internal Revenue Code, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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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