I had planned to blog about some pretty big and exciting news from the FASB, but on October 15, ISS announced their new methodogy for analysing stock plan proposals. You only have until October 29 to submit commits, so this anouncement trumps the FASB announcement.
My first thought upon reading the ISS announcement was “Seriously? People only have 14 days to read this and comment on it?” I don’t know, it kind of makes me think they don’t care about your comments.
Balanced Scorecard
Historically, ISS has employed a number of mechanisms to evaluate stock plan proposals, including 1) plan cost (e.g.’ the Shareholder Value Transfer test), 2) historical burn rates, and 3) a review of specific plan features. Each of these factors were evaluated as a series of pass/fail tests and a plan had to pass all three to receive a positive recommendation.
The proposed approach will still consider the three areas noted above (with a number of significant changes), but will look at them on a holistic basis, rather than as a series of separate tests. So plans that fail one test may still receive a favorable recommendation if the results of the other analyses are positive enough to outweigh the failure. I also suspect that means that plans that pass all three tests but with a low score on each could end up receiving a negative recommendation.
SVT Test Gets an Update
The SVT test will be performed not just on the shares requested for the plan but instead on 1) shares requested, shares currently available for grant, and shares outstanding, and 2) shares requested and shares currently available for grant.
Bad News for RSUs
Historically, allowing shares withheld for taxes to return to the plan just caused the award to be treated as a full value award in the SVT test. Which meant that it didn’t matter if you allowed this for full value awards becauuse they were already counted as full value awards in the SVT test.
Now “liberal” share counting features (e.g., returning shares withheld for taxes to the plan reserve) will no longer be part of the SVT test but will instead be considered separately as a plan feature. So it could be a problem to do this for both RSUs.
Burn Rate Commitments Are a Defunct
My understanding is that up until now, companies didn’t really worry about the burn rate test because if they failed it, they could fix the failure by simply making a burn rate commitment for the future. But the new methodology eliminates the ability to correct burn rate failures by committing to a burn rate cap.
Now, if you fail the burn rate test, you’ll have to hope that the plan cost is low enough and you have enough positive plan features (e.g., clawbacks, ownership guidelines) to outweigh the failure.
Be sure to tune in next week for my big FASB announcement (see the alert on the NASPP home page for a preview).
It’s that time of year again…when a stock plan administrator’s thoughts turn to proxy disclosures and stock plan proposals and ISS makes repeated appearances in the NASPP Blog. I recently blogged about the ISS policy survey and about their new Equity Plan Data Verification Portal. For today’s entry, I have another ISS update: the results of their policy survey. (And I’m not through with the topic of ISS yet–expect another entry when they release their updated policy and probably yet another when they release the burn rate tables for 2015).
Survey Respondents
ISS’s survey was completed by 370 respondents, 28% of which are institutional investors and 69% of which are issuers. Most of the respondents are located in the United States.
Balanced Scorecard
As I mentioned in my earlier blog, ISS has announced that they are moving to a “balanced scorecard” approach to evaluating stock plan proposals. This approach will weigh 1) the cost of the plan along with 2) the plan features and 3) past grant practices. (Since ISS already looks at all of these areas when evaluating a stock plan proposal, it’s not clear to me how this will differ from what they already do, but if they weren’t changing anything, I wouldn’t have anything to blog about, so I guess I can’t complain.)
The survey asked respondents how much weight each of these three factors should carry in ISS’s analysis of the plan. The results are kind of hard to parse, but I think the upshot is that respondents generally thought that plan cost should carry the most weight (in contrast to my informal and highly unscientific survey, where close to half of the respondents thought all three areas should carry equal weight). From the ISS press release:
With respect to how the plan cost category should be weighed in a scorecard, 70 percent of investors indicate weights ranging from 30 to 50 percent, with a 40 percent weighting cited most often. Sixty-two percent of investors suggest weightings from 25 to 35 percent for plan features; and 64 percent indicate weights ranging from 20 to 35 percent for grant practices. Weightings suggested by issuers were also quite dispersed, but generally skewed somewhat higher with respect to cost, and somewhat lower for plan features and grant practices compared to investors.
Factors Important in Markets with Poor Disclosures
ISS notes that in some developing/emerging markets, the quality of stock plan disclosures is poor. The survey asked respondents what factors are most important to evaluating plans in these markets. The results exposed an interesting discrepancy of opinion between institutional investors and issuers (at least for developing/emerging markets). Investors placed a lot of importance on the use of performance conditions (76% of investors rated this as “very important”); issuers didn’t place nearly as much importance on this (only 49% of issuers rated performance conditions as “very important”). 10% of issuers rated performance conditions as “not important at all” whereas all investors thought performance conditions were at least somewhat important.
Have you ever thought that ISS got something wrong in their analysis of your stock plan? Now you have an opportunity–albeit short–to correct them. ISS has launched a new “Equity Plan Data Verification Portal” that allows you to see the data they are basing their analysis of your plan on and correct any errors therein.
Background
As you all know, when a new stock plan is submitted for approval (or shares are requested for an existing plan), ISS performs an analysis of the plan. The analysis looks at the features of the plan, as well as various statistical data (e.g., shares granted in the past three years, common stock outstanding). ISS collects the information used in their analysis from the information about the plan included in the proxy statement as well as the company’s other public filings (e.g., the ASC 718 footnote included in the financial statements). There are a lot of different sources of data, many of them are long and tedious, and some companies do a better job of clearly describing their stock plans than others. So there’s always a possibility that ISS will make a mistake.
Until now, there hasn’t been any way to discover and address a mistake in ISS’s analysis until after they’ve published their recommendation on the plan. The Equity Plan Data Verification Portal gives companies a chance to preview the research ISS has completed on their plan and let ISS know if anything doesn’t seem correct.
How the Portal Works
You have to register for a login to the portal. Once you have registered, you’ll get an email notifying you when your company’s equity plan information is available to review. Then you’ll have two days to review it–from 9 AM Eastern on the first business day after your company’s data is published to the portal until 9 PM Eastern the following business day. ISS has published an FAQ that includes a list of items they research on equity plans; you could go through this list in advance and note all the answers. That will make it a lot quicker to validate ISS’s analysis once your two-day review window opens.
Note that this is only available for companies that file their proxy statement at least 30 days before their annual meeting.
Beware the Spam Filter
My first thought upon reading about the two-day window was, “Gosh, what if the notification email goes into your junk email folder?” It could happen. If you miss the two-day window because you don’t get the email notice, my guess is that there’s not much you can do about it, since ISS is under a time-crunch to publish their recommendation. So you might want to register multiple people at your company and maybe even register both your work and your personal email addresses.
What Do You Think?
And now, a quick poll–will you use ISS’s new Equity Plan Data Verification Portal?
Don’t Miss the 22nd Annual NASPP Conference
Be sure to attend the panel “Navigating ISS & Glass Lewis” at the 22nd Annual NASPP Conference to learn more about engaging with ISS and Glass Lewis.
I’m looking forward to seeing everyone in Las Vegas! Be sure to tune in tomorrow when I’ll be offering some last minute “Know Before You Go” tips for Conference-goers.
I’ve told you to complete the ISS policy surveys in the past and I’m sure a lot of you have scoffed. But this year is different; this year, you might want to think twice about blowing off the survey. ISS has announced that they are considering a significant shift in how they evaluate stock compensation plans. The ISS Policy Survey is your opportunity to give ISS some feedback about how you think they should be analyzing your stock plans.
New ISS Policy on Equity Plans?
According to a recent posting in Tower Watson’s Executive Pay Matters blog (“ISS 2015 Policy Survey — Expanded Focus on Executive Compensation,” July 21), ISS has stated that it is considering using a more “holistic, ‘balanced scorecard’ approach” to evaluate equity plans. The good news is that this might allow for a more flexible analysis, rather than the very rule-based, SVT and burn rate analysis ISS uses today. But, as the Towers Watson blogs points out, it also might result in a less transparent process. Less transparency equates to less confidence in how ISS will come out on your plan when you put it to a vote (and perhaps also more business for ISS’s consulting group).
The 2015 Policy Survey
ISS uses policy surveys to collect opinions from various interested parties as to its governance policies. Corporate issuers are one of the many entities that are encouraged to participate in the survey. This year’s survey includes several questions on equity plans, including what factors should carry the most weight in ISS’s analysis: plan cost and dilution, plan features, or historical grant practices.
There’s a good chance your institutional investors are participating in the survey; don’t you want ISS to also hear your views on how your equity plans should be evaluated?
What Do You Think?
Say-on-Pay and CEO Pay
The survey also includes several questions on CEO pay (that ultimately relate to ISS analysis of Say-on-Pay proposals), including questions on the relationship between goal setting and award values and when CEO pay should warrant concern.
Completing the Survey
You have until August 29 to complete the survey. There may be questions in the survey that you don’t have an opinion on or that aren’t really applicable to you as an issuer–you can skip those questions. But don’t wait to complete the survey, because I’m pretty sure the deadline won’t be extended. On the positive side, however, the survey is a heck of a lot shorter than the NASPP’s Stock Plan Design and Administration Surveys.
It’s once again proxy season and many companies will be asking their shareholders to vote on proposals relating to their stock plan. Most of these proposals probably add more shares to the plan, but there are a number of other plan amendments companies might seek shareholder approval for, including:
To add a new type of award that can be granted under the plan
To change the employees eligible to participate in the plan
To increase the limit on the number of shares that can be granted to one employee or some other plan limit
To extend the term of the plan
In some cases, companies aren’t making any changes at all to the plan, but are merely seeking shareholder approval to preserve the plan’s exempt status under Section 162(m) (where a plan doesn’t state the specific performance conditions that awards will be subject to, the plan has to be approved by shareholders every five years).
To Bundle or Not Bundle
It is not unusual for a company to have two or more changes to their stock plan that they are asking shareholders to approve. Where this is the case, the company can bundle all the changes into one proposal or can present each change as a separate proposal subject to a separate vote.
Bundling presents shareholders with an all-or-nothing proposition; they either approve all the changes or they approve none of them. It seems to me that this could go either way for the company. If shareholders are a little opposed to some of the changes but mostly supportive, they might overlook their niggling doubts and vote for the proposal. On the other hand, if shareholders strongly oppose one of the changes, they might vote against the entire proposal and the company doesn’t get any of the changes that it wanted.
Shareholders Wanting Their Cake and Eating It Too
Mike notes in his blog that there have been some recent lawsuits alleging improper bundling of changes (and expresses hope that the SEC’s new CDI will help resolve/prevent these suits), particularly where one of the changes is beneficial to shareholders. This is interesting to me because my guess is that where a company bundles a shareholder-friendly change with another change, the shareholder-friendly change is probably included solely to pave the way for shareholders to approve the other change.
For example, a company might bundle a proposal allocating new shares to the plan with an amendment to restrict the company from repricing options without shareholder approval. The repricing restriction is likely included because the company has received negative feedback from shareholders on this issue (repricing without shareholder approval is considered a poor compensation practice by ISS) and is afraid the share allocation won’t be approved without it. The two proposals have a symbiotic relationship: the company isn’t willing to agree to the repricing amendment unless shareholders agree to the share allocation. Forcing companies to unbundle the two amendments means the company could end up having to implement the shareholder-friendly amending without getting the other change that it wanted.
A Poll
I conclude this blog with a short poll on how you are handling your shareholder proposals this year.
Today I have a grab bag of short topics for you, each worth mentioning but none are really long enough for their own blog.
The Most Ridiculous Section 162(m) Lawsuit Ever Last year, a Delaware federal court ruled in favor of a company that was the subject of lawsuit alleging that their incentive plan had not been properly approved by shareholders for Section 162(m) purposes. The plaintiff argued that because Section 162(m) requires the plan to be approved by the company’s shareholders, all shareholders–even those holding non-voting shares–should have been allowed to vote on it. Shareholder votes are governed by state law but the plaintiff attorney argued that the tax code preempted state law on this matter. Luckily the judge did not agree.
The plaintiff also argued that the company’s board violated their fiduciary duties because they used discretion to reduce the payments made pursuant to awards allowed under the plan. The plaintiff stipulated that this violates the Section 162(m) requirement that payments be based solely on objective factors. In a suit like this, the plaintiff attorney represents a shareholder of the company; it seems surprising that a shareholder would be upset about award payments being reduced–go figure. In any event, it’s fairly well established that negative discretion is permissible under Section 162(m) and the judge dismissed this claim.
Glass Lewis Policy Update Glass Lewis has posted their updated policy for 2014. For US companies, the policy was updated to discuss hedging by execs (spoiler alert: Glass Lewis doesn’t like it) and pledging (they could go either way on this). With respect to pledging, Glass Lewis identifies 12–count ’em, that’s 12–different factors they will consider when evaluating pledging by execs.
The policy was also updated to discuss the SEC’s new rules related to director independence and how the new rules impact Glass Lewis’s analysis in this area. Although we now have three perfectly good standards for director independence (Section 16, Section 162(m), and the NYSE/NASDAQ listing standards), Glass Lewis has developed their own standards and they’re sticking to ’em. I’m sure I’ve asked this before, but really, how many different standards for independence do we need? I’m not sure director independence is the problem here.
Should Your Plan Limit Awards to Directors? As you are getting this year’s stock plan proposal ready for a shareholder vote, one thing to consider is whether to include a limit on awards to directors. In 2012, a court refused to dismiss one of the plaintiff’s claims in Seinfeld v. Slager because the plan did not place sufficient limits on the grants directors could make to themselves and, thus, were not disinterested in administration of the plan, at least with respect to their own grants.
ISS has published its burn rate tables for the 2014 proxy season and the news isn’t good. For most industries, the ISS burn rate caps have decreased for 2014. For today’s entry, I have a few fun facts about the new burn rate tables.
For Russell 3000 companies:
Burn rate caps decreased for 14 of the 22 industries in the Russell 3000 that ISS publishes caps for.
Caps increased for seven of the 22 industries (automobiles & components, banks, consumer services, insurance, retailing, semiconductor equipment, and transportation) and the cap stayed the same for the utilities industry.
The largest decrease was for the media industry, which dropped from 5.6% last year to 4.43% for this year (1.17 points). ISS did not decrease the caps for any other industries by more than 1 point.
The largest increase was for the automobiles & components industry, which increased from 3.28% last year to 3.81% this year (.53 points).
For non-Russell 3000 companies:
Burn rate caps decreased for 15 of the 22 non-Russell 3000 industries.
Just as for the Russell 3000 companies, ISS increased the caps for seven industries, but not the same seven. For non-Russell 3000 companies, the industries where the caps were increased are banks, capital goods, commercial & professional services, consumer durables & apparel, insurance, retailing, and technology hardware & equipment.
ISS did not leave the cap the same for any non-Russell 3000 companies.
The largest decrease was 2 points, which is the maximum change (either increase or decrease) ISS allows from one year to the next (yes, ISS puts a cap on the change in the cap).
There were two industries for which burn rates dropped by 2 pts: energy and diversified financials. For energy, the maximum burn rate dropped from 9.46% to 7.46%, but would have dropped to 6.26% without ISS’s cap on changes in maximum burn rates. For diversified financials, the maximum burn rate dropped from 9.56% to 7.56%, but would have dropped to 7.17% without the cap.
For just under half of the industries where the maximum burn rate decreased, the decrease was greater than 1 point. In addition to energy and diversified financials, these industries included automobiles & components, pharmaceuticals & biotechnology, telecommunication services, transportation, and utilities.
The largest increase was in capital goods, which went from 6.69 in 2013 to 8.16 in 2014 (1.47 points).
It’s Like We’ve Got a Good Set of Tarot Cards
For anyone that listened to the NASPP’s November webcast highlighting the results of our 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), this isn’t a surprise. The survey results foreshadowed this trend. Only 24% of respondents to the survey reported a three-year average burn rate of 2.5% or more (down from 31% in 2010) and, in the past year, almost one-fifth (19%) of respondents took action to reduce their burn rate. The ISS caps are extrapolated directly from actual burn rates (for each industry, the cap is generally the industry’s three-year average burn rate plus one standard deviation); ISS policy in this area simply reflects what is happening in practice.
But there’s one sound That no one knows What do the investors say?
Actually, What Do the Investors Say?
As we are heading into next year’s proxy season (and now that you have that horrible song in your head), I thought it might be a good time to look at what the investor hot buttons are likely to be with respect to executive and stock compensation. I listened to the recording of the session “Say-on-Pay Shareholder Engagement: The Investors Speak” at the 10th Annual Executive Compensation Conference and found a few recurring themes. The panelists were Aeisha Mastagni of CalSTRS, Karla Bos of ING, and Donna Anderson of T.Rowe Price; the panel was moderated by Pat McGurn of ISS.
The investor panelists take a rather dim view of retention grants. They also don’t like programs that grant the same value of stock to execs every year (so that when the stock price drops, execs get more shares).
They weren’t keen on TSR or EPS as performance metrics. They felt EPS is too easily manipulated and too short-term and they would rather see goals that drive TSR, not TSR goals themselves. Which is interesting because TSR and EPS are the two most popular performance metrics in our 2013 Domestic Stock Plan Design survey (co-sponsored by Deloitte).
They didn’t have a lot of use for supplemental proxy filings but opinions were mixed as to the value of realizable pay disclosures.
For next year’s proxy season, the main areas of focus that they generally agreed on were performance awards and metrics, CIC provisions, and employment contracts (e.g., retention bonuses). If you don’t have a good story to tell on those topics, you might want to get cracking.
They all thought the CEO pay-ratio disclosure was of dubious value.
They all also insisted that they were very open-minded about stock and executive compensation and that they don’t blindly follow ISS (it’s just that they happen to agree with ISS on most issues).
Another key takeaway for me was that all of the investors explained that they focus on “the outliers” when reviewing proxy statements. They have lots of proxies to review and can’t do an in-depth analysis of each one. But if something about your executive pay grabs their attention because it is outside the norm, they will look closer at your company. So make like a junior high student and try to blend in.
There aren’t any surprises, at least when it comes to executive and stock compensation. ISS didn’t make any changes specific to stock compensation and the only change that relates to executive compensation is that they’ve changed the Relative Degree of Alignment measure to be a three-year calculation only, rather than a weighted average of the one and three-year calculations.
Six Degrees of Kevin Bacon
The Relative Degree of Alignment measure doesn’t have anything to do with Kevin Bacon (although it might be argued that it would be a lot more interesting if it did). Instead, as I noted in my blog on ISS’s proposed changes (“ISS Policy Changes for 2014,” October 29, 2013), it simply compares the company’s TSR ranking among its peers to its CEO pay ranking. Ideally (from ISS’s perspective, that is–your CEO might feel differently), your company will have a high TSR ranking and a CEO pay ranking that is equal to or lower than its TSR ranking. A low TSR ranking and a high CEO pay ranking will result a negative RDA and probably a lot more attention from ISS than you’d like.
What’s Changed
The old calculation averaged the one-year RDA and the three-year RDA with a respective weighting of 40/60. The new calculation is just the three-year RDA.
Why Change?
Because the most recent year was included in both the one-year and three-year calculations, the prior RDA measure placed significant emphasis on this year. By eliminating the one-year RDA measure, the most recent year will be deemphasized in favor of the longer three-year period. As a result, short-term changes in TSR and CEO pay rankings will have a smaller impact on this aspect of ISS’s analysis. ISS also notes that the longer term calculation will help alleviate timing mismatches in pay for performance that result from equity awards being issued early in the fiscal year, before the corresponding performance year.
No Burn Rates Yet
The burn rate tables aren’t available yet. I expect them some time in mid to late December. Hmmm, maybe I’ll be able to get three blog entries out of this whole policy update.
Don’t Miss Your Chance to Update Your Peer Group with ISS
The companies that ISS considers to be your peers are critical for the RDA measure as well as numerous other analyses that ISS performs. ISS will consider your self-selected peers when constructing your peer group. You have until December 9 to let ISS know which companies are in your self-selected peer group. For more information see, ISS’s Peer Group Methodology FAQ. You can submit your peers and any other feedback you have for ISS on your peer group at http://www.issgovernance.com/PeerFeedbackUS.
ISS has proposed changes to its corporate governance policy for 2014. You have until November 4 to comment on the changes.
What’s Changed?
In terms of stock compensation, or even compensation in general, not much. So the good news is this maybe isn’t something you have to spend a lot of time on this year and I can have a short blog entry today. Of course that’s also the bad news–things aren’t going to get any better next year in terms of the restrictions ISS places on your stock compensation program.
Evaluating Alignment of Pay to Performance
The only proposal that relates directly to compensation that ISS is looking at changing is the Relative Degree of Alignment (RDA) measure, which compares the difference between a company’s TSR ranking and its CEO’s pay ranking among its peers. For example, if the company’s TSR ranks in the 25th percentile among its peers (meaning that the company’s TSR is better than only 25% of its peers) and its CEO’s pay is in the 75th percentile (i.e., the CEO’s pay is more than 75% of his/her peers), ISS might be concerned that there is a pay for performance misalignment. This is just one of several measures ISS uses to assess whether CEO pay aligns with company performance.
Currently ISS calculates RDA on a one-year and three-year basis. They are proposing to eliminate the one-year calculation and instead consider only three-year RDA. If your RDA score has been trending downwards, you are probably pleased as punch about this; if your RDA score has been trending upwards, you are probably a little less thrilled (but what goes up most come down and, under the proposed calculation, if you do have a down year, that year won’t impact your RDA score as much).