Category Equity Compensation Plan Amendments

ISS Guidance on COVID-19 Compensation Issues

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ISS first provided guidance regarding compensation issues related to COVID-19 back in April 2020 (Annual General Meetings & COVID-19: A Review of the Regulatory Landscape, April 1, 2020; and Impacts of the COVID-19 Pandemic, April 8, 2020). Since then ISS representatives have spoken on webinars about COVID-19 and compensation, and likely fielded many questions about how ISS will apply its policies and view actions taken with respect to compensation. Just last week ISS released an early set of FAQs to address the issues it sees regarding compensation actions taken regarding COVID-19 (U.S. Compensation and the COVID-19 Pandemic, Frequently Asked Questions, October 15, 2020).

Key issues and ISS positions from the FAQS:

  • Base salary reductions—temporary salary reductions will be given mitigating weight if they decrease total pay. Given more weight if targeted incentive payout opportunities are decreased to reflect the reduced salary.
  • Change to bonus/annual incentive awards—suspending program and making one-time discretionary payments may be viewed as reasonable so long as the justifications and rationale are clearly disclosed, and the resulting outcomes appear reasonable.
  • Disclosure needed if make COVID-related changes to bonus/annual incentive awards—the key disclosure items that would help investors evaluate the actions taken are:
    • specific challenges and how they rendered the original program design obsolete or the original performance targets impossible to achieve; should address how the changes are not reflective of poor management performance.
    • For mid-year changes—explain why that approach was taken and how the changes further investors’ interests.
    • One-time discretionary awards should carry performance-based considerations, with underlying criteria being disclosed.
    • How resulting payouts appropriately reflect both executive and company annual performance. Should clarify or estimate how the payouts would compare with what would have been paid under the original program design.
    • If have designed the subsequent year’s (ex. 2021) annual incentive program, encouraged to disclose information about positive changes made to the prior year design.
  • Lowered financial or operational targets below prior year’s actual levels achieved—If reflect external factors, maybe a reasonable explanation. Should be accompanied by disclosure as to how the board considered corresponding payout opportunities, especially if such payout opportunities are not commensurately reduced.
  • Changes to outstanding performance-based equity/long-term incentive awards—Such awards should be designed to smooth performance over a long-term period. Changes to in-process performance cycle awards will be viewed negatively, especially for companies that exhibit a quantitative pay-for-performance (P4P) misalignment under the ISS quantitative P4P tests.
  • Changes to outstanding equity/long-term incentive awards granted in 2020—Investors do not want to see drastic changes to awards unless the underlying business strategy has fundamentally changed. However, more modest changes to the incentive program could be viewed as reasonable. Should clearly explain any changes.
  • COVID-related retention or other one-time awards—If grant these types of awards, should clearly disclose the rationale for the award, including the magnitude and structure, and describe how the awards further investors’ interests. Vesting term should be long-term and vesting conditions should be strongly performance-based and clearly linked to the underlying concerns the awards aim to address. Such awards should also contain shareholder-friendly guardrails to avoid windfalls.
  • COVID-related retention or other one-time awards with forfeited awards—Investors do not expect such awards to be granted merely as a replacement for forfeited performance-based awards. If a one-time award is granted in the year or following year in which incentive awards are forfeited, companies must explain the specific issues driving the decision to grant the awards and how awards further investors’ interests. If a company indicates that the one-time awards were granted in consideration of forfeited performance awards, it must explain how such awards do not merely insulate executives from lower pay.
  • ISS’s board/committee responsiveness policy (when say-on-pay vote receives less than 70% support) in light of COVID-19—The ISS responsiveness policy generally requires companies in their next proxy to: (1) disclose the board’s engagement efforts, (2) disclose specific feedback from shareholders, and (3) disclose any actions or changes made to pay programs and practices to address shareholders’ concerns. In light of COVID-19, if a company is unable to implement changes, the proxy should disclose specifically how the pandemic has impeded the company’s ability to address shareholders’ concerns. If changes are delayed or do not fully address shareholders’ concerns, should disclose a longer-term plan on how the company intends to address shareholders’ concerns.
  • ISS policies unchanged by COVID-19—No changes to ISS’s equity plan scorecard (EPSC), problematic pay practices, or option repricing policies in light of the pandemic.
    However, ISS increased the passing scores (thresholds) under the EPSC model to 57 points for S&P 500 companies (was 55 points) and 55 points for Russell 3000 companies (was 53 points) and kept the score at 53 points for all other companies.

    Note: If your company is going out to shareholders to request approval of a new or amended plan in 2021, the above changes to the EPSC model likely mean that only a reduced number of shares will pass compared to 2020, everything else remaining the same. Increasing the thresholds for the S&P 500 and Russell 3000 will make it more likely that companies can request fewer shares and, thus, most likely will need to go back to shareholders sooner than they otherwise would after 2021 to request more shares.

So, if your company is even considering making changes to outstanding awards or making special one-time grants, you should also develop the proxy disclosure explaining the change(s) or one-time awards concurrently so that it is ready for your next proxy. Preparing draft proxy disclosure may also enable you to refine any changes or one-time awards to help anticipate how ISS may react.

Time to Check Your Shares!

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We are just now starting to get ready for the fall compensation committee meetings cycle for calendar-year companies. If your company’s stock price has been negatively impacted by the COVID-19 pandemic, now is a good time to look at your equity plans. You need to see how many shares are available and figure out how long those shares are likely to last given both current stock prices and potential changes in stock prices that might affect the size of your future annual equity grants.

I have already worked with several companies that undertook this exercise. Several companies have determined they have just enough shares to make it until their 2022 annual meeting, so they will continue on as normal until then. For others, they realized they might not have enough shares available after their 2021 annual grant, so they have started the process of going back to shareholders for approval of additional shares at their 2021 annual meetings.

It is better to test the waters on this before you get swamped with year-end duties. If you find you may need more shares after your 2021 annual grants, you can then calmly start the process for going to shareholders in 2021 for approval of more shares.

Questionable Equity Plan Provisions

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Drafting an equity compensation plan or reviewing your existing equity compensation plan in anticipation of taking a request to shareholders next proxy season to request additional shares? Do you know what provisions are questionable? Which will cause ISS to automatically recommend against the plan proposal (regardless of anything else)? And which provisions ISS will evaluate on a case-by-case basis, which would impact the total number of shares that might pass the ISS Equity Plan Scorecard model? If not, you might want to listen to the latest episode of the EC Minute…

 

Warning: Section 162(m) Language and Incentive Plans

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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.”