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 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.