ISS Weighs In On Public Company Hedging and Pledging Activities

Over the past few years, there has been an increasing focus on public company insider hedging and pledging activities. Institutional shareholders and proxy advisory firms have been pressuring public companies to disclose their policies on hedging and pledging. Under the Dodd Frank Act, enacted in 2010, Congress charged the SEC with adopting rules regarding disclosure of this activity in SEC filings.  However, the SEC has not yet proposed or adopted rules implementing this mandate.  The SEC has eliminated its expected rulemaking timetable for this and certain other Dodd-Frank provisions and, instead, the SEC’s website now indicates that the rulemaking is “pending action.”

Taking matters into its own hands, the shareholder advisory firm Institutional Shareholder Services (ISS) specifically addressed hedging and pledging activity its 2013 U.S. corporate governance policy updates, which were posted on November 16, 2012. Among other policy updates, ISS added a footnote to its policy on voting for director nominees in uncontested elections in circumstances where there are perceived governance failures. Currently, ISS will recommend that shareholders vote “against” or “withhold” votes from directors (individually, committee members, or the entire board) due to, among other things, “[m]aterial failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company”. The new footnote cites hedging and significant pledging of company stock as examples of activities that will be considered failures of risk oversight. Other cited examples of risk oversight failures include bribery; large or serial fines or sanctions from regulatory bodies, and significant adverse legal judgments or settlements.

By identifying the existence of hedging and significant pledging as a risk oversight and corporate failure, ISS will attempt to hold directors accountable for permitting that practice to exist. “Against” or “withhold” recommendations may not be limited solely to individuals that actually engage in hedging or pledging activity.

As rationale for this update, ISS states that director and executive stock ownership, whether resulting from equity compensation grants or open market purchases, should serve to align executives' or directors' interests with the interests of shareholders. ISS asserts that hedging severs the alignment of these interests and, therefore, any amount of hedging will be considered a problematic practice warranting a negative voting recommendation.

Pledging is treated differently. As noted by the Society of Corporate Secretaries & Governance Professionals in a comment letter on the proposals (PDF), ISS’ initial proposal was to consider pledging by executives as a problematic practice in all cases. In its comments, the Society argued that “an across the board policy was inappropriate, and that it could affect many smaller, founder-led companies where company stock constitutes the majority of an executive's (or other director's) net worth and such pledging has been used judiciously for an appropriate reason such as purchasing a home.” In response to these and other comments, ISS revised its policy to state that only “significant” pledging will be considered a problematic practice warranting a negative voting recommendation. What constitutes “significant” pledging will be determined on a case-by-case basis.  In making voting recommendations for election of directors of companies who currently have executives or directors with pledged company stock, ISS will take the following factors (in additional to “other relevant factors”) into consideration:

  • Whether the company has an anti-pledging policy that prohibits future pledging activity;
  • The magnitude of aggregate pledged shares in relation to the total shares outstanding, market value or trading volume;
  • The company’s progress or lack of progress in reducing the magnitude of aggregate pledged shares over time; and
  • Whether shares subject to stock ownership and holding requirements include pledged company stock.

ISS’ 2013 policy updates will be in effect for shareholder meetings on or after February 1, 2013.

Comment. Companies who currently have executives or directors with pledged company stock will likely include disclosures regarding these matters in the proxy statements for their meetings even in the absence of SEC rules mandating such disclosure. I would also expect to see companies without insider hedging or pledging activity call that out in their filings.  As Dave Lynn pointed out in his September 2012 InsideCounsel article, policies governing hedging and pledging activity are often included in a company’s insider trading policy, and companies will no doubt be reviewing their existing policies to assess the potential impact of ISS’ new policy recommendations.

Say-on-Pay Votes: New Resources Make It Easy to Keep Score

The Semler Brossy compensation consulting firm is publishing a very useful resource for those of us who want to “keep score” on the results of Say-on-Pay votes in 2012. “2012 Say on Pay Results” is a weekly publication of the cumulative results of Say-on-Pay shareholder advisory votes at Russell 3000 public companies. The most recent report includes the following stats:

  • The majority of companies continue to pass Say-on-Pay in 2012 with substantial shareholder support. So far, 71% of these companies have passed with over 90% support.
  • The report analyzes how vote results have changed in 2012. Companies that were below 70% in 2012 have generally received increased vote support in 2012. So far, all companies that failed in 2011 have passed in 2012.
  • ISS has recommended an “against” vote at 25 of these companies (16%) in 2012, compared to 12% in 2011. On average, shareholder support was 27% lower at companies with an ISS “against” recommendation.
  • So far, two companies have failed to get a majority positive Say-on-Pay vote: Actuant Corp. and International Game Technology. The Semler Brossy report provides data such as the 1-year, 3-year and 5-year total shareholder return (TSR) levels for these companies.
  • In “Vote of the Week”, the report analyzes a particular (high profile) Say-on-Pay vote. The March 28 report analyzes the Disney vote and the possible reasons they got a 57% positive vote, a decrease of 20% from their 2011 result.

I recommend bookmarking the URL: The most recent weekly Semler Brossy PDF report will pop up, including the most up-to-date statistics throughout proxy season.

Another good resource for analyzing early results is this report by Towers Watson. In the last section, this report includes a discussion of the companies that have done supplemental proxy filings, generally to counter points raised by ISS or other proxy advisory firms. Over 100 companies filed such additional soliciting materials last year, and Towers Watson reports that over 10 companies have used such filings this year. The report also analyzes the impact of an ISS “for” or “against” recommendation on Say-on-Pay votes.

Thanks to Broc Romanek in his Advisors Blog on (subscription site) for pointing out these resources.

ISS 2012 Policy Updates, Continued: Board Response to a High Negative Vote

As discussed in my last post, the proxy advisory firm ISS recently issued its 2012 Updates to its U.S. Corporate Governance Policy (PDF). One important change relates to the board’s response to a high negative vote. For companies that experienced a lot of “thumbs down” votes from shareholders at the last annual meeting, ISS’s evaluation of the board’s responsiveness will affect ISS’s recommendation on the upcoming Say-on-Pay vote. Not only that, but this evaluation will also inform ISS’s voting recommendations for compensation committee members in the election of directors.

The new formulation is much more specific than in the previous Policy. ISS will evaluate responsiveness on a case-by-case basis if the previous Say-on-Pay proposal received less than 70% of the votes cast. Therefore, ISS has for the first time specified the “red zone” range where the negative votes are high enough to create significant concern. For these under-70% companies, ISS’s evaluation will take into account the company’s responsiveness to the negative votes, including:

  • Disclosure of engagement efforts with major investors;
  • Actions to address issues that contributed to the low level of support and other recent compensation actions;
  • The recurring or isolated nature of the issues raised;
  • The company’s ownership structure; and
  • Whether support was less than 50%, which requires the highest degree of responsiveness.

In its “Rationale for Update,” ISS specifies the disclosures it will look for in the proxy statements of these companies that received under 70% the previous year:

. . . At companies that fail to receive a meaningful level of support on their say-on-pay proposals, shareholders will seek substantive and meaningful disclosure in determining whether the company has taken sufficient actions to address the compensation issues that contributed to the low level of support. Companies should discuss their outreach efforts to major institutional investors and provide the specific actions that they have taken to address the compensation issues that resulted in a significant opposition votes. These specific actions should ideally be new rather than a reiteration of existing practices. Companies should refrain from providing boilerplate disclosure, as it does not enable shareholders to gauge the level of effort taken by the company. Placement of such information should be readily identifiable.

For the companies in this situation for their upcoming annual meeting, it is important to be making explicit engagement efforts now rather than waiting until after the proxy statement is mailed. These engagement efforts should be aimed at determining the reasons for the negative votes. These efforts should be completed far enough in advance of the annual meeting to plan specific actions to address shareholder concerns, and to draft appropriate disclosures in the proxy statement. Note that ISS is looking for proxy descriptions of specific new actions taken by the board and expects the information on engagement and responsiveness to be in a readily identifiable place in the proxy.

For more thoughts on the joys of “engagement” with shareholders, see my special Valentine’s Day post on engagement. Love is in the air!

ISS Policy Updates Shed Light on Pay-for-Performance Analysis

The proxy advisory firm ISS last week issued the 2012 Updates to its U.S. Corporate Governance Policy (PDF). The Updates outline this year’s changes to ISS’s policies in recommending investor votes at public companies’ shareholder meetings. Essentially, the policies say when ISS will act like the popular kids on Facebook and “like” a company’s postings – see this prior post. These recommendations are especially important in the upcoming proxy season, the second year of mandatory Say-on-Pay votes on public company compensation. ISS’s methodology and rationale also provide useful guidance for drafting compensation disclosures, as described below.

The 2012 Updates have been widely reported; for example, see these helpful summaries by the compensation consultants Frederic W. Cook & Co., Inc. (PDF) and Towers Watson. This post focuses on ISS’s pay-for-performance (p4p) methodology, which is critical in determining its Say-on-Pay vote recommendations. My next post will discuss another critical ISS policy – its evaluation of the board of director’s response in cases where the company experienced high levels of opposition in a previous Say-on-Pay vote.

P4P Methodology. Starting on page 9 of the Updates, ISS describes its new methodology for determining pay-for-performance alignment. This is described as a two-part test – first, ISS screens companies to identify the level of alignment between pay and performance over a sustained period; if a company shows unsatisfactory alignment, then ISS uses a second-stage qualitative analysis to arrive at a final recommendation.

For companies included in the Russell 3000 index, in the first phase ISS uses quantitative tests of alignment relative to a peer group and on an absolute basis. First, ISS compares the company’s TSR (total shareholder return) rank within a peer group, as measured over one-year and three-year periods, and the multiple of the CEO’s total pay relative to the peer group median. The peer group is generally comprised of 14 to 24 companies selected based on size and industry group. Second, the quantitative analysis also considers alignment on an absolute basis between the company’s trend in CEO pay over the past five fiscal years and the trend in the company’s TSR over the same period.

For companies not included in the Russell 3000 index, in the first phase ISS uses an undefined process to determine whether pay and performance are misaligned.

Where the first phase indicates unsatisfactory alignment, there is a second phase qualitative analysis that examines the following factors “to determine how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests”:

  • 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.

ISS based its Policy Updates in large part on the results of its 2011-2012 Policy Survey (PDF). In its “Rationale for Updates”, ISS reports:

“. . . 94 percent of institutional respondents to ISS' 2009-2010 Policy Survey indicated that pay-for-performance is a critical or important consideration in their vote determinations. This year, another overwhelming majority of institutional respondents to ISS' 2011-2012 Policy Survey indicated two factors as relevant to evaluating pay-for-performance alignment: pay relative to peers is considered very relevant by 62 percent and somewhat relevant by 32 percent; and 88 percent believe pay increases that are disproportionate to the company's performance trend are very relevant to this evaluation (plus 11 percent who consider it somewhat relevant). . . .”

“In cases where alignment appears to be weak, further in-depth analysis will determine causal or mitigating factors, such as the mix of performance- and non-performance-based pay, biennial grant practices, impact of a newly hired CEO, and rigor of performance programs. For example, 81 percent of investor respondents to ISS' 2010-2011 Policy Survey said that the way a company's short-term and long-term incentive metrics relate to the company's business strategy is among their most important considerations in evaluating executive pay. If long-term alignment of TSR performance and CEO pay opportunities is weak, investors expect current pay and pay opportunities to be strongly performance-based.”

Comment. The Updates feature some welcome changes, including ISS’s more individualized approach to peer group identification, a longer-term approach through use of a five-year metric and a heightened focus on specific qualitative factors in the second phase of analysis.

Public companies should take heed of the survey statistics cited above and the resulting quantitative and qualitative factors to be considered by ISS in connection with its recommendations. In evaluating their compensation programs and their compensation disclosures, public companies should be mindful of these factors, which can serve as a checklist of compensation features and processes that should be highlighted in next year’s CD&A disclosures.


What Should Public Companies Know About the Proxy Advisors?

In the second year of mandatory Say-on-Pay votes on public company compensation, the proxy advisory firms such as ISS and Glass Lewis will be like the popular kids on Facebook: it’s important to get them to “like” the company’s postings. In other words, their positive recommendations are an important factor in winning the Say-on-Pay vote by the widest possible margin.

Therefore, one of the best parts of attending the recent Proxy Disclosure Conference sponsored by (subscription site) was attending the session called “The Proxy Advisors Speak”, featuring Carol Bowie of ISS and David Eaton of Glass Lewis. Seeing these individuals speak was like meeting the people behind the Facebook profile pictures.

These close encounters reinforced my conclusion that, whether or not you agree with their guidelines or recommendations, the representatives are serious professionals doing their best to navigate a flood of information and help institutional shareholders figure out how to vote. In other words, proxy advisors are people too.

Here are some of the important observations by Carol Bowie of ISS:

  • ISS has a team of trained analysts preparing for the proxy season, and every report passes through at least two analysts.
  • ISS tries to deliver research reports at least 21 days before the annual shareholders’ meeting; however, this can be 13 days during proxy season or less in contested meetings. S&P 500 companies receive draft reports shortly before publication to allow them to check the facts.
  • The compensation discussion and analysis (CD&A) section of the proxy statement should include an executive summary that outlines the overall structure of the compensation program. Also, it’s helpful if the CD&A provides key information in one place about short-term and long-term compensation programs, including why the company uses particular metrics; what were the targets and how were they determined; and what were the company’s financial results and the associated awards?
  • ISS is updating its policies for evaluation of Say-on-Pay votes in 2012, and the final policy updates will be released before Thanksgiving. As shown by its draft of the updated policies, ISS will still focus heavily on total shareholder return (TSR) (essentially, stock price) in evaluating the “performance” component of pay for performance. ISS is trying to strike a new balance between short-term and long-term factors, using a combination of one-, three- and five-year analyses.
  • In assessing compensation programs in 2012, ISS will focus a high level of scrutiny on companies whose proposals received less than 50% support from votes cast. In addition, for companies that received less than a 70% positive vote, surveyed institutional investors indicated that they expect an explicit response from the board with respect to shareholder engagement and actions taken as a result of the vote. ISS will likely give the Say-on-Pay votes of those under-70% companies more scrutiny as well.

In a future post, I’ll share observations of the Glass Lewis representative. Hopefully, these insights can help companies be “liked” in the upcoming proxy season.

GE Amends Terms of Existing Stock Options, Facilitates Positive Say-on-Pay Vote

Bloomberg reported on Wednesday that General Electric Company received a positive Say-on-Pay vote at its annual shareholders meeting. As disclosed in GE’s proxy statement filings, the company achieved this result, or at least increased the likelihood of an affirmative vote, through its recent restructuring of an existing equity award originally granted to the CEO in 2010. This may be a preview of things to come in the shifting balance of power between boards and shareholders, facilitated by the reforms under the Dodd-Frank Act of 2010. Here’s the time line:

  • On March 14, 2011, GE filed its annual meeting proxy statement. As required under the Dodd-Frank Act, the proxy statement included a non-binding shareholder advisory vote on executive compensation (Say-on-Pay).
  • On April 7, GE filed additional soliciting materials. The company disclosed that ISS, the shareholder advisory service, had issued a report recommending a “no” vote in GE’s Say-on-Pay vote. GE challenged ISS’s conclusions, including ISS’s valuation of the grant of 2 million stock options to CEO Jeffrey Immelt in March 2010. GE had valued the options at $7.4 million, while ISS valued the same options at $14.5 million. GE also challenged other aspects of ISS’s negative report.
  • On April 18, GE made an additional proxy filing reporting that the compensation committee, “with Mr. Immelt’s full support,” had modified the 2010 options to add performance-based vesting. Half of the options will now vest based on GE’s industrial cash flow, and the other half will vest based on the company’s total shareholder return compared to that of the S&P 500. GE reported that the change in the option award was based on “a number of constructive conversations with our shareowners.” In her Bloomberg article, “GE Ties CEO Options to Performance as Investor Meeting Nears,” Rachel Layne reported that, after the change in the options, ISS changed its negative recommendation and advised shareholders to support a positive Say-on-Pay vote.
  • On April 27, GE’s shareholders voted to approve the Say-on-Pay resolution, with 85 percent of the shares voted in favor of the resolution.

GE joined a number of companies this year that filed supplemental proxy materials challenging a negative recommendation by shareholder advisory services, as reported by Broc Romanek in Blog. At least one other company has made changes to its compensation programs in response to a negative recommendation. The Walt Disney Company eliminated tax gross-ups for golden parachute payments, which caused ISS to change its recommendation, as reported by Janine Sagar in Business Insider, and enabled a positive Say-on-Pay vote.

However, the GE saga marks a new era in direct communications about specific compensation terms that may be acceptable or unacceptable. It’s one thing for Disney to eliminate gross-ups, which are high on shareholders’ lists of unacceptable pay practices. It is another thing for GE to adjust, as part of a dialogue with shareholders, specific terms of a past award to base the payout on different performance metrics (i.e., industrial cash flow and relative shareholder return, rather than simple stock appreciation inherent in a stock option). This negotiation appeared to tip the balance in favor of a positive Say-on-Pay vote.

This back-and-forth dialog is the most obvious example yet of the increased power of shareholders, and shareholder advisory services, to limit or even define executive compensation under the Dodd-Frank Act regime.

Useful Resources for Year-End Executive Compensation Tax Planning

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (PDF), signed by President Obama on December 17, extended existing tax rates through 2010. The Act avoided changes that would have caused a flurry of planning activity at year end. Still, this is the last chance for a last-minute consideration of any year-end tax planning considerations.

The subscription service recently came out with two helpful web articles:

“What impact does the new 2010 Tax Relief Act have on stock compensation and year-end financial planning?”

“Ten Ideas For Year-End Tax Planning With Stock Options And Company Stock”

I found these articles to be a useful and comprehensive checklist for stock plan professionals – good for issue-spotting, if nothing else (even though some of the links represent content that can’t be viewed without a subscription). The discussion of alternative minimum tax (AMT) rates is especially helpful.

By the way, the new tax law is only 30 pages long. After all the times I have linked to the 800 page-plus Dodd-Frank Act, a 30 page law is a pleasant surprise.

ISS Issues FAQs on Frequency Vote and Other Policies

Last week, the shareholder advisory service ISS issued Frequently Asked Questions on its 2011 compensation policies, including several questions on the frequency vote. As reported in this previous post, ISS is recommending that shareholders vote in favor of an annual Say-on-Pay vote. Mark Borges of Compensia, in his Proxy Disclosure Blog on (subscription site), offers some useful observations on the FAQs:

Question No. 2: Would a management recommendation of a two-year or three-year frequency trigger a negative recommendation from ISS on other proxy items? Answer: We have no policy concerning management's recommendation for the say on pay frequency. [Borges] Observations: In other words, during the 2011 proxy season (or, at least, the next four or five months) a recommendation of the board of directors for a biennial or triennial ‘Say on Pay’ vote will not have adverse collateral consequences on other compensation-related proposals (or the election of directors) that are slated for consideration at the annual meeting of shareholders. . ..

Question No. 4: In the event that a company's board decides not to adopt the say on pay vote frequency supported by a plurality of the votes cast, what are the implications in terms of ISS' voting recommendations at subsequent meetings? Answer: This policy has not been determined. The policy will be decided after review of the first year of voting results and after consultation with ISS's clients, and will be included in the policy updates for 2012. [Borges] Observations: . . . While ISS could go in many different directions, I expect that, where a board of directors selects a frequency for future "’Say on Pay’ votes that differs from the frequency supported by a plurality of the votes cast, it will consider that a basis for recommending a "withhold" or "against" vote for compensation committee members (and, potentially, all directors). Of course, the analysis of the board's decision may not always be that straightforward. . . . Ultimately, I suspect that whether ISS considers this important enough to warrant a formal policy will depend less on the vote results themselves, but on how companies respond to those results.

Happy Holidays from Maslon!

Here is the Holiday greeting from Maslon Law Firm - I wanted to share it with all of you. Have a wonderful holiday season, and safe travels!

Image: flikr