Equity Compensation Plan Amendments

Warning: Section 162(m) Language and Incentive Plans

Just a quick word of warning to executive compensation professionals to take a long, hard look at both short-term incentive and long-term/equity incentive plans (and their associated proxy proposals ) that include Section 162(m) language. The reason is not so much the question of whether such Section 162(m) language is still needed (it might be if your company is putting forward a plan amendment and there are outstanding awards that may qualify for the Section 162(m) transition relief under the Tax Cuts and Jobs Act), but rather what justifications are given for seeking shareholder approval of the proposed plan.

If the proxy proposal indicates that one reason for requesting shareholder approval due to qualifying compensation paid under the plan under Section 162(m), then the plaintiff’s bar is ready to file suit.  I have been working with one company that filed its proxy early in 2018 and was requesting shareholder approval for both its annual and equity plans.  The company was on a fiscal year and the changes in Section 162(m) wrought by the Tax Cuts and Jobs Act will not fully apply until later in calendar 2018–after the company’s annual meeting. But, the proposals did not indicate this and the plaintiff claimed that the disclosures were misleading and sought an injunction.

So, practitioners should carefully evaluate the rationale given for seeking shareholder approval of any incentive plan being proposed in a company’s proxy statement.  If Section 162(m) is mentioned, then be sure to address the changes wrought by the Tax Cuts and Jobs Act and explain how the changes will impact the plan and awards under the plan going forward, as well as why shareholder approval would be needed in light of the changes to Section 162(m).

Finally, if the proposal is for a completely new plan, and there is no possibility that any of the Section 162(m) transition relief will apply to awards under the proposed plan, you may be tempted to eliminate all references to Section 162(m). Of course, even though certain elements of equity plans are no longer needed by Section 162(m), ISS has already said that it will be reviewing the elements included in plan documents. So it may not make complete sense right now to eliminate things like annual (or other period) limits on awards, especially to directors, or a list of potential performance metrics, and other elements that used to be included solely for Section 162(m) compliance reasons.

As they always said in Hill Street Blues, “Let’s be careful out there.”

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Is it Better to Propose a New Omnibus Plan or to Amend an Existing Omnibus Plan?

I am often asked whether it is better to ask shareholders to approve an amendment of an existing omnibus plan or a completely new omnibus plan. Generally, there is not too much difference since you can make the amendments ensure that the existing omnibus plan complies with current corporate governance best practices.  But, in point of fact, there is a slight difference when I look at the voting for proposals to amend an existing plan versus to approve a new plan.

Mind you, the difference is not all that much.  But for companies that are looking to do everything possible to ensure a favorable vote outcome, then serious thought should be given to adopting a new omnibus plan since such proposals receive higher levels of voting support.  That said, the median level of vote support for proposals to amend an existing omnibus plan are slightly higher than the median support for proposals to approve a new omnibus plan.  But this is offset by the fact that proposals to approve new omnibus plans have more votes coming in at or above the 90% level.

The charts below look at the vote support at median and average and by support level for both of these proposals using data from the ISS Voting Analytics database for S&P 500 companies with such proposals in 2015, 2016 and in 2017 so far.

Source: ISS Voting Analytics database

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Maximum Tax Withholding and Liberal Share Counting – A Deadly Combination

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

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Caution on Transferable Equity Award Provisions

As companies begin to get their equity plan proposals ready for the 2017 proxy season, it is an appropriate time to review those equity plan proposals to see if they contain or permit the transfer of equity awards to third parties for value, e.g., the ability of participants to sell stock options to an unrelated investor, such as was done at Microsoft in 2003. If companies review ISS’s Equity Plan Scorecard Policy, there is not a specific mention of any concern over transferable stock awards.  Instead, companies need to review the ISS policy on Transferable Stock Option (TSO) Programs.  Under that policy, ISS indicates that it will recommend against equity plan proposals if the details of an ongoing TSO program are not provided to shareholders.

This is significant because the specific criteria that ISS expects companies to detail are not those ordinarily include in a typical equity plan proposal seeking shareholder approval of a new or amended equity plan, and include, but are not limited to, the following:

  • Eligibility
  • Vesting
  • Bid-price
  • Term of options
  • Cost of the program and impact of the TSOs on a company’s total option expense, and
  • Option repricing policy.

If a company’s equity plan provides for the transferability of equity awards to third parties, and the above TSO disclosure are not made (which ISS will then evaluate on a case-by-case basis), then the company can expect a negative ISS vote recommendation on their equity plan proposal even if they have run the ISS Equity Plan Scorecard model and believe the plan will pass muster.

Source: ISS United States Proxy Voting Manual, 2016 Benchmark Policy Recommendations, Effective for Meetings on or after February 1, 2016, Published February 23, 2016,  p. 187

This very scenario just played out at Thor Industries, Inc. Thor had an equity plan proposal in its proxy filed October 27, 2016 (https://www.sec.gov/Archives/edgar/data/730263/000119312516748833/d251706ddef14a.htm#tx251706_29 ) that provided for transferability of equity awards to third parties (see Section 6.6 of the Thor Industries, Inc. 2016 Equity and Incentive Plan). “A Nonstatutory Stock Option may, in the sole discretion of the Administrator, be transferable to a permitted transferee, as hereinafter defined, upon written approval by the Administrator to the extent provided in the Option Agreement.” The plan goes on to define permitted transferree to include “(b) third parties designated by the Administrator in connection with a program established and approved by the Administrator pursuant to which Participants may receive a cash payment or other consideration in consideration for the transfer of such Nonstatutory Stock Option.” [emphasis added]

As a result of this language, ISS found that the proposed plan permitted the transfer of stock options to financial institutions without prior shareholder approval.  ISS classified this as a problematic equity-related provision under its list of overriding features and practices.  As a result, even though the plan scored sufficient points under the ISS Equity Plan Scorecard to warrant ISS support, ISS nevertheless recommended against the proposed plan in its November 22, 2016 report. Thor announced it would amend its proposed equity plan to remove this transferability feature (https://www.sec.gov/Archives/edgar/data/730263/000114420416136370/v453873_defa14a.htm) and then filed the updated proxy with the amended proposed plan that had removed this transferability feature on November 28, 2016 (https://www.sec.gov/Archives/edgar/data/730263/000119312516777872/d301535ddefa14a.htm). Then on November 29, 2016, ISS released an updated Proxy Report Alert in which it changed it recommendation to support Thor’s proposed equity plan.

The odd thing in all this? None of Thor’s current named executive officers hold any stock options and stock options are not part of the long-term incentive program disclosed for fiscal 2016. This case serves as a good reminder to check equity plans being taken to shareholders to ensure that they do not permit such TSO programs without shareholder approval.

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