Note: The conclusions reached in this post are no longer valid given a clarification from ISS Research. See my blog post of January 5, 2017, Maximum Tax Withholding and Liberal Share Counting – NOT So Deadly A Combination – UPDATE, for full details.
This past week I learned that ISS will be issuing a set of equity compensation plan FAQs that will address a new combination of share provisions in equity plans: a plan having both liberal share counting (including the adding back of shares withheld to satisfy taxes) and permitting the withholding of shares at the maximum tax rate (as the change in accounting rules now permits).
As ISS stated in its proxy report for Coach, Inc., “Moving to a maximum withholding rate would be problematic for a plan with liberal share recycling, as this would exacerbate concerns regarding diminished transparency of share usage.” [emphasis added] So what is the consequence of this being classified as a problematic? Well, under ISS’s Equity Plan Scorecard policy, there are certain overriding features that would cause ISS to recommend against a plan proposal. These overriding features include:
- Ability to reprice underwater equity awards without shareholder approval
- Ability to conduct a cash buyout of underwater equity awards without shareholder approval
- Liberal Change-In-Control Vesting Risk (e.g., a CIC definition that could be triggered short of consummation of the deal)
- Equity-related pay-for-performance (P4P) disconnect, i.e., ISS finds a P4P disconnect to exist and it is mainly attributed to equity awards to the CEO and the proposed plan permits the CEO to participate
- Equity-related problematic pay practices, which include:
- Excise tax gross-ups in the plan
- Reload stock options permitted by the plan
- Ability to transfer awards for value to a third-party (see Caution on Transferable Equity Plan Provisions), and now
- Ability to withhold taxes at the maximum tax withholding rate coupled with liberal share counting which would add back shares withheld at the maximum tax rate to the plan’s share authorization
The odd thing is that it is a complete override. If the plan has the ability to withhold at the maximum tax rate and liberal share counting to add back shares withheld at the maximum tax rate, then regardless of whether the plan scores above the ISS threshold (currently 53 points), ISS will recommend against the plan.
So everyone that thought they could simply amend their equity plans to take advantage of the ability to withhold at the maximum tax rate and gain a little benefit from their liberal share counting provision (which would add back those shares to the plan’s share authorization) are in for a shock. Right now, without seeing what the specific ISS FAQs say, there appears to be only two alternatives for companies to address this issue:
- Completely remove the liberal share counting with respect to adding back shares withheld for taxes, or, slightly better,
- Revise the liberal share counting provision to only add back shares withheld to satisfy taxes but only up to the minimum tax withholding rate– the plan could still permit withholding at the higher rate, but the shares withheld in excess of the minimum tax withholding rate could not be added back to the share authorization.
UPDATE: ISS issued its new FAQs regarding equity compensation plans this morning (December 19, 2016). FAQ #32 deals with the issue of withholding at the maximum tax rate coupled with liberal share counting which permits shares withheld to be added back to the plan’s share authorization. The FAQ confirms the details provided above, but does not flat out state that such a combination of provisions would be viewed as a problematic pay practice that would cause ISS to recommend against a plan proposal. But, when I take FAQ #32 along with the ISS statement from its Coach proxy report (along with comments I have received from ISS Corporate Solutions), I come to the consluion that this combination will cause ISS to recommend against a plan proposal. Hopefully ISS will clarify this portion of its Equity Plan Sscorecard policy in an update to the policies and/or the Equity Compensation FAQs. The full set of the Equity Compensation Plan FAQs can be found at: https://www.issgovernance.com/file/policy/1_u.s.-equity-compensation-plans-faq-dec-2016.pdf