In late March, ISS issued an updated Equity Compensation Plans FAQ. This development was largely eclipsed by the FASB’s issuance of ASU 2016-09, so I haven’t had a chance to get around to it until now. Here is a quick summary of the most significant updates:
Plan Amendments
FAQ 2 has been updated and a new FAQ 28 has been added to clarify that plan amendments may be evaluated under the Equity Plan Scorecard (EPSC), if the amendment could increase the potential cost of the plan. (By “cost,” ISS means dilution or shareholder value transfer; ISS is less concerned with the actual P&L expense.)
In other cases, i.e., amendments that don’t increase cost to shareholders, ISS evaluates the amendment based on whether it is favorable to shareholder interests, but without going through the whole EPSC.
Plans submitted for shareholder approval solely for Section 162(m) purposes fall into a separate category and ISS hasn’t changed or clarified anything with respect to these proposals.
Share Withholding
ISS suggests requesting new shares or extending the term of a plan as examples of the types of amendments that would trigger a new EPSC evaluation, but my guess is that this would also include amendments to allow share withholding for taxes up to the maximum tax rate when the shares withheld will be returned to the plan (my blog from last week explains why these amendments are necessary).
It’s possible that the timing of the release of these updated FAQs is not coincidental. It’s also possible I’m paranoid; hard to say. But then again, just because I’m paranoid, doesn’t mean ISS won’t apply the EPSC to your share withholding amendment. This issue is definitely a hot button for ISS. If your plan allows shares withheld for taxes to be returned to your plan, it’s a good idea to discuss this with whoever advises you on ISS concerns before you amend your plan.
Performance Awards
Previously, the FAQ provided that ISS would consider performance awards as being subject to accelerated vesting upon a CIC, unless the amount paid was tied to the performance achieved as of the CIC and was pro rated based on the amount of the performance period that was completed.
The new FAQ states that:
If a plan would permit accelerated vesting of performance awards upon a change in control (either automatically, at the board’s discretion, or only if they are not assumed), ISS will consider whether the amount of the performance award that would be payable/vested is (a) at target level, (b) above target level, (c) based on actual performance as of the CIC date and/or pro rated based on the time elapsed in the performance period as of the CIC date, or (d) based on board discretion.
I’m not sure this changes much, but it does seem to be a more nuanced position.
One area of ISS’s voting policy that you can count on changing every year are the burn rate benchmarks. ISS updates these benchmarks based on historical data. In theory, if granting practices haven’t changed, the burn rate benchmarks won’t change either. But, inevitably, practices change (in response to changes in the economic environment, the marketplace, and compensation practices, not too mention pressure to adhere to ISS’s burn rate benchmarks) and the burn rate benchmarks change as well.
Surprise, Surprise (Not!)—Burn Rate Benchmarks Lower in 2016
It seems like a self-fulfilling prophecy to me that if ISS sets a cap that burn rates can’t exceed and companies are forced to manage their grants to come in under that cap, burn rates are going to keep decreasing. This year, by my calculations, burn rate benchmarks dropped for 40% of industries in the S&P 500, 59% of industries in the Russell 3000, and 68% of industries in the Non-Russell 3000. ISS indicates that the median change across all industries/indices is a decline of .07%.
It’s a “Benchmark” Not a “Cap”
ISS calls the standard a “benchmark” not “cap.” When they made this change last year, I thought maybe this was because they thought the word “benchmark” sounded friendlier. This isn’t the case at all, however. It’s a “benchmark” because the cap is actually lower than the benchmark. To get full credit for the burn rate test in ISS’s Equity Plan Scorecard (EPSC), a company’s burn rate has to be less than 50% of the benchmark. In other words, the cap is 50% of the benchmark.
Burn Rate Scores Can Go Negative
Laura Wanlass of Aon Hewitt tells me that, just like the score for the SVT test (see “Update on the ISS Scorecard,” July 21, 2015), the burn rate score can also be negative.
Burn Rate Is Important
Burn rate is not quite as important as a plan’s SVT score, but it’s still significant—a negative score could be impossible to come back from in the EPSC. Laura tells me that it is the largest percentage of points in the Grant Practices pillar, which is worth less than Plan Cost (i.e., the SVT test) but more than the Plan Features pillar.
Before the EPSC, burn rates didn’t matter as much. If a company didn’t pass the burn rate test, they simply made a three-year commitment to stay under ISS’s cap in the future—no harm, no foul. But those three-year commitments are just a distant fond memory under the EPSC.
The Burn Rate Test Is Getting Harder
While the standard to earn full points for burn rate remains 50% of the benchmark, overall, the benchmarks have been lowered for most industries/indices. In addition, Laura tells me that ISS is recalibrating the test so that burn rates above 50% of the benchmark will earn fewer points and will go negative sooner than last year.
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.
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.
I’m a San Diegoan at heart, and, as I write today, I’m thinking about a picture taken last year on a beautiful beach day. The water was sparkly, reflecting the bright sun. The beaches were filled with sunbathers. Someone snapped a photo of this perfect day, and accidentally captured something amazing – the image of a shark swimming through a wave, virtually unnoticed. People were smiling, nobody seemed to have a care in the world. That day ended well – it seems no one was bitten by the shark, and people probably didn’t even understand the potential danger until they saw that image later that evening on the news. So why on earth am I talking about sharks in this equity compensation blog? Well, as you’ve probably garnered by now, I’m drawing a parallel to an issue I feel is looming, somewhat under the radar, for many companies.
Stock Plan Sharks
You’ve probably heard the buzz over the past year or so about a wave of litigation surrounding say-on-pay and proxy proposals. The litigation, in short, has been brought as a series of class action suits by shareholders who want to see more information disclosed in the proxy around various proposals that are being submitted to shareholders for a vote. Many of these proposals involve stock plans (approval of a stock plan, increasing shares in an existing plan, and so on). The theory behind the lawsuits is that that shareholders have a right to be fully informed before they vote. The claim is that proxy statements lack a complete and full disclosure of material information that would aid in the shareholder’s ability to make an informed decision. In the past year there have been 21 of these cases filed. Of those, 10 cases were “successfully resolved” according to the plaintiff’s lawyer (successful meaning they resulted in a preliminary injunction or restraining order, which paved the way to an acceptable outcome). While 21 may seem to be a small number, keep in mind that this is the actual number of cases “filed” with a court. There have been many more instances where companies have received a letter from plaintiff’s attorneys, which ultimately opens a door that most companies would prefer remain closed.
Although many companies seem to have cognizance of these lawsuits, it seems that most still think “it can’t happen to us”. There have even been rumors that the litigation is dead. If you’re thinking those thoughts, think again. These lawsuits appear to be far from dead. In fact, in a unique set of circumstances at this year’s annual conference, we had both the plaintiff’s attorney and defending attorneys at front and center in these lawsuits come together to share their perspective on these suits.
The session was interesting, and I can’t do it full justice in this blog (the materials are available online for conference attendees, and the audio is available for purchase). However, I wanted to raise awareness of this concern and share some of the “red flags” that the plaintiff’s attorney shared during this session.
An Invitation to a Plaintiff’s Attorney?
Share Increases: Increasing the number of shares in an equity plan? Plaintiffs attorneys are scouring proxies to see if companies have disclosed information such as any projections that helped determined the number of shares to request.
Consultants: If the company or board hires a consultant who uses things like analysis of “share value transfer” in their assessment, and the board evaluates or relies on that information in making compensation decisions, then that information should be disclosed in the proxy.
Peer Groups: If the board determines that executive compensation should be based on peer group data points, then plaintiff’s attorneys are looking for information on the companies in the peer group, the metrics evaluated (e.g. number of employees, enterprise value), and any performance metrics, such as TSR.
Now, before you shoot the messenger – I’m not taking a stance advocating these disclosures. I’m relaying what I heard the plaintiff’s attorney identify as “red flags” when they are looking at proposals and evaluating proxy statements. If you have items going before shareholders in a vote this upcoming proxy season (yes, the proxy is months away for calendar year-end companies, but proposals are likely to be discussed in the near-term), then you absolutely want to be aware that plaintiff’s attorneys are going to look at your proxy through this lens.
Advance Mitigation
You know the sharks are out there – now what? Before I answer that, I just have to disclose that the term “shark” was borrowed from the panel’s own chosen title – so I’m not labeling anyone a shark, and I certainly appreciated the entire panel’s contribution to our conference. Now, back to the sharks and how to avoid them – there are a few suggestions that I gleaned from the presentation:
Consider including more disclosure (if it won’t hurt, it might make you appear to be a less easy target)
Advise your board of directors that a proxy proposal could result in litigation
Consider getting 3rd party advice on how to size your equity pool
Additional details, such as insight about what to do if your company is contacted by a plaintiff’s attorney can be found in the materials and audio for the conference session titled “Stock Plan Proposal and Say-on-Pay Litigation: How to Avoid the Sharks”. This is definitely an area where companies should focus some attention as they prepare for the 2014 proxy season.
Thanks to panelists Douglas Clark and David Thomas of Wilson Sonsini Goodrich & Rosati, Juan Monteverde of Faruqi & Faruqi, and John Grossbauer of Potter Anderson & Corroon for the content that I used in writing this blog.
By now, you are probably finishing off any remaining leftovers from Thanksgiving. On that theme, I have a few leftover items for the blog and now seems like a good time to use them up. Sort of like making a casserole out of turkey, mashed potatoes and stuffing, but not quite as tasty.
Update on Proxy Disclosure Lawsuits On November 6, I blogged about plaintiffs’ attorneys that are now bringing lawsuits alleging that companies’ disclosures related to their stock plan or Say-on-Pay proposals are inadequate (“Martha Stewart and Your Proxy Statement“). The lawsuits seek an injunction to delay the shareholder votes on these proposals (which, in effect, delays the annual meetings); companies targeted by these attorneys are faced with settling and paying out plaintiffs’ attorney fees in the six figures (up to $625K) to avoid a delay.
Last week, Mike Melbinger provided an update on this issue in his Compensation Blog on CompensationStandards.com. To date, 20 companies have been targeted and at least six have settled, meaning that they agreed to make additional disclosures and pay fees to the plaintiffs’ attorneys. At least one company (Brocade Communications) also had to delay the vote on their stock plan proposal (although they did hold their annual meeting on time). At least three companies (Clorox, Globecomm Systems, and Hain Celestial) got courts to reject the injunction. And Microsoft got the law firm that filed the complaint (Faruqi & Faruqi, which has initiated most of these suits) to withdraw it. The article “Insight: Lawyers Gain from Say-on-Pay” Suits Targeting U.S. Firms,” published by Reuters on November 30, has a good summary of the various suits.
This is an opportunity for you, as a stock plan administrator, to demonstrate the value that you bring to the table. Make sure that your legal department is aware of the potential for these lawsuits, so that if your company is targeted, they aren’t caught offguard. You also might want to forward the memo we’ve posted from Orrick to legal (“New Wave of Proxy Statement Injunctive Lawsuits: How to Win & Prevent Them“), which include thoughts on strengthening your disclosure so they will be more likely to withstand one of these lawsuits.
IFRS: Hot or Not? An article published on November 13 in Accounting Today (“SEC Still Has Reservations about IFRS” by Michael Cohn) reports on comments by SEC officials at FEI’s 31st Annual Current Financial Reporting Issues conference on where the SEC stands on IFRS. The upshot is that SEC researchers have identified a number of concerns with adopting IFRS in the US and that the SEC is still taking a wait and see approach. Some of the areas the researchers looked at were the cost of conversion, whether or not IFRS makes sense for US capital markets, the interpretative process, the impact on private companies, investor understanding, and what our exit strategy might be if the US adopts IFRS and it backfires. Based on this report, I’d say we still have a long ways to go before we are under IFRS (or some sort of equivalent) here in the US.
Of course, things may change now that there will be a new chair at the SEC.
Even the SEC Makes Mistakes The next time someone finds a typo in something you’ve written, you can point out that you are in good company. In his blog for Allen Matkins, Keith Bishop notes a number of errors on the Form 10-K posted to the SEC website (“The SEC’s Form 10-K: ‘In Endless Error Hurled,'” April 11, 2012), including cites to regulations that don’t exist and outdated instructions. I feel a lot better now about the myriad typos I’m sure can be found in my blogs. If the SEC isn’t perfect, how can the rest of us be expected to be error-free?
More Than You Ever Want to Know About Stock-for-Stock Exercises I spent an hour or so today drafting a 1,200-word essay in response to a question in the NASPP Discussion Forum about stock-for-stock exercises. I’m so pleased with my response that I wish I had another use for it. But I don’t, so I’m mentioning it here in the hopes that a few more people will read it. If you want to understand what a tax-free exchange of property is (and what it isn’t), check out Topic #7391.
Shout-Out Finally, a shout-out to Sara Spengler at Facebook for suggesting the Thanksgiving tie-in for today’s blog entry.
If you are an issuer that will be submitting a request for additional shares for your stock plan to a shareholder vote in the upcoming proxy season, you need to read this blog. I’m filing this under “don’t say I didn’t warn you.”
What Does Martha Stewart Have to Do With This?
A while back, a short blurb about Martha Stewart Living Omnimedia caught my eye and I put it in my back pocket for a future blog entry if I ever figured out what the heck it was about. The blurb appeared in Mark Borges’ proxy disclosure blog on CompensationStandards.com:
Martha Stewart Living Omnimedia Inc. was the target of a shareholder class action lawsuit alleging that the company’s disclosure in connection with a proposal to increase the share reserve of its omnibus stock plan was inadequate.
This intrigued me because:
In my other, non-stock compensation life, I secretly want to be Martha Stewart (but with better hair and no insider trading scandal), so I’m fascinated by anything involving her. (Don’t scoff–I’m very crafty! I make all my own window treatments, can refinish a dining room table, and can whip up some pretty tasty jams and jellies.)
It involved the company’s stock plan, which falls squarely into the category of “things I care a lot about.”
Now, thanks to Mike Melbinger’s Oct 26 blog entry on CompensationStandards.com, I’ve finally figured out the implications of the lawsuit and determined that, if you are an issuer, it should be something you care a lot about as well.
Lawsuit Over Stock Plan Disclosures Could Delay Shareholders Meeting
There have now been several similar lawsuits filed. The lawsuits allege that the company’s disclosures relating to stock plan or Say-on-Pay proposals are inadequate and seek to delay the shareholders meeting. As Mike explains it:
[Companies] are forced to decide between (a) paying the class action lawyers hundreds of thousands of dollars of attorneys’ fees and issuing enhanced disclosures or (b) fighting the matter through a preliminary injunction hearing, which may have the effect of delaying [their] shareholder meeting (and create additional legal fees).
One company has already paid $625K to plaintiff attorneys to settle a similar lawsuit and, while they didn’t have to delay their entire annual meeting, they still had to delay the vote on their stock plan and file a supplement to their proxy statement with additional disclosures about the plan.
What Can You Do?
Mike asks “Does that sound like Armageddon?” and I’d say that it sure sounds like that me. Mike says that it is too soon to panic but suggests taking extra care in drafting your disclosures relating to any stock plan proposals and your Say-on-Pay propoals. A recent memo we posted from Orrick has suggestions for fortifying both types of disclosures against attack. Here are their suggestions for disclosures relating to any stock plan proposals:
Disclose the number of shares currently available for issuance under the stock plan and explain why the existing share reserve is insufficient to meet future needs. Consider citing your current burn rate and anticipated shares needed for new grants over the next year.
Explain how the remaining shares in the reserve and the new shares will be used and how long the new share reserve is expected to last.
Describe how you determined the number of shares you are requesting approval of.