As I noted on October 21 (“ISS Changes Stock Plan Methodology“), ISS is changing how they evaluate stock plan proposals. Just before Christmas, ISS released additional information about their new Equity Plan Scorecard, including an FAQ.  For today’s blog entry, I take a look at how the scorecard works.

What the Heck?

Historically, ISS has used a series of tests (Shareholder Value Transfer, burn rates, various plan features) to evaluate stock plan proposals.  Many of these tests were deal-breakers. For example, fail the SVT test and ISS would recommend against the plan, regardless of how low your burn rate had been in the past or that fact that all the awards granted to your CEO vest based on performance.

Under the new Equity Plan Scorecard (known as “EPSC,” because what you need in your life right now is another acronym to remember), stock plans earn points in three areas (which ISS refers to as “pillars”): plan cost, grant practices, and plan features.  Each pillar is worth a different amount of points, which vary based on how ISS categorizes your company. For example, S&P 500 and Russell 3000 companies can earn 45 points for the plan cost, 35 points for grant practices and 20 points for plan features.  Plans need to score 53 points to receive a favorable recommendation. [I’m not sure how ISS came up with 53. Why not 42—the answer to life, the universe, and everything?]  So an S&P 500 company could completely fail in the plan cost area and still squeak by with a passing score if the plan got close to 100% in both the grant practices and plan features area.

Plan Cost

Plan cost is our old friend, the SVT analysis but with a new twist.  The SVT analysis is performed once with the shares requested, shares currently available under all plans, and awards outstanding, then performed a second time excluding the awards outstanding.  Previously, ISS would carve out options that had been outstanding for longer than six years in certain circumstances.  With the new SVT calculation that excludes outstanding options, this carve out is no longer necessary (at least, in ISS’s opinion–you might feel differently).  The points awarded for the SVT analysis are scaled based on how the company scores against ISS’s benchmarks.  Points are awarded for both analyses (with and without options outstanding), but the FAQ doesn’t say how many points you can get for each.

Grant Practices

The grant practices pillar includes our old friend, the burn rate analysis. But gone are the halcyon days when burn rates didn’t really matter because companies that failed the test could just make a burn rate commitment for the future.  Now if companies fail the burn rate test, they have to hope they make the points up somewhere else. Burn rate scores are scaled, so partial credit is possible depending on how companies compare to the ISS’s benchmarks. This pillar also gives points for plan duration, which is how long the new share reserve is expected to last (full points for five years or less, no points for more than six years).   S&P 500 and Russell 3000 companies can earn further points in this pillar for certain practices, such as clawback provisions, requiring shares to be held after exercise/vest, and making at least one-third of grants to the CEO subject to performance-based vesting).

Plan Features

This seems like the easiest pillar to accrue points in. Either a company/plan has the features specified, in which case the plan receives the full points, or it doesn’t, in which case, no points for you.  There are also only four tests:

• Not having single-trigger vesting upon a CIC
• Not having liberal share counting
• Not granting the administrator broad discretionary authority to accelerate vesting
• Specifying a minimum vesting period of at least one year

That’s pretty simple. If willing to do all four of those things, S&P 500/Russell 3000 companies have an easy 20 points, non-Russell 3000 companies have an easy 30 points (more than halfway to the requisite 53 points), and IPO/bankruptcy companies have an easy 40 points (75% of the 53 points needed).

Alas, this does mean that companies no longer get a free pass on returning shares withheld for taxes on awards back to the plan.  Previously, this practice simply caused the arrangement to be treated as a full value award in the SVT analysis. Since awards were already treated as full value awards in the SVT analysis, it didn’t matter what you did with the shares withheld for taxes. Now you need to be willing to forego full points in the plan features pillar if you want to return those shares to the plan.

Dealbreakers

Lastly, there are a few practices that result in a negative recommendation regardless of how many points the plan accrues under the various pillars.  These include a liberal CIC definition, allowing repricing without shareholder approval, and a couple of catch-alls that boil down to essentially anything else that ISS doesn’t like.

For more information on the new Equity Plan Scorecard, see the NASPP alert “ISS Announces New Equity Plan Scorecard and Burn Rates.”

– Barbara