Category Equity Plan Provisions

ISS Issues FAQs and Burn Rate Benchmarks for 2019

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In November, ISS issued a set of preliminary Compensation FAQs (see http://edwardhauder.com/2018/11/21/iss-issues-preliminary-faqs-on-compensation-policies-for-2019/). Then on December 14, 2018, ISS issued its final set of Compensation FAQs for 2019, U.S. Compensation Policies, Frequently Asked Questions, Updated December 14, 2018. ISS then issued a set of updated FAQs for equity plans on December 19, 2018, U.S. Equity Compensation Plans, Frequently Asked Questions, Updated December 19, 2018.U.S. Compensation FAQs

U.S. Compensation FAQs

Below are the questions and answers that were updated by ISS in this set of Compensation FAQs.

19. Any changes in the quantitative Pay-for-Performance (P4P) for 2019? No, the quantitative P4P screens will remain the same for 2019.

21. Does ISS prefer companies to use TSR as an incentive program metric? ISS does not endorse the use of TSR or any specific metric in executive incentive programs.

42. How does ISS analyze “front-loaded” awards intended to cover future years? ISS is unlikely to support grants that cover more than four (4) years (i.e., the grant year plus three future years) because such grants limit the board’s ability to meaningfully adjust future pay opportunities in the event of unforeseen events or changes in either performance or strategic focus.

47. Which problematic practices are most likely to result in an adverse recommendation? The list includes:

  • Repricing or replacing underwater stock options/SARs without shareholder approval
  • Extraordinary perquisites or tax gross-ups
  • New or materially amended agreements that provide for:
    • Excessive termination or CIC severance payments
    • CIC severance payments without involuntary job loss or substantial diminution of duties or in connection with a problematic Good Reason definition
    • Problematic “Good Reason” termination definition that present windfall risks, such as definitions triggered by potential performance failures
    • CIC excise tax gross-up entitlements
    • Multi-year guaranteed awards that re not at risk due to rigorous performance conditions
    • Liberal CIC definition combined with any single-trigger CIC benefits
  • Insufficient executive compensation disclosure by externally-managed issuers (EMIs) such that a reasonable assessment of pay programs and practices applicable to the EMI’s executives is not possible
  • Any other provision or practice deemed to be egregious and present a significant risk to investors

48. How does ISS evaluate “Good Reason” termination definitions? Such definitions should be limited to circumstances that are reasonably viewed as an adverse constructive termination, and should be tailored to preclude potential windfall risk.

50. If a company becomes a “smaller reporting company” under the SEC’s revised definition, how will ISS assess reduction in compensation disclosure? Companies with scaled compensation disclosure requirements should continue to provide sufficient disclosure to enable investors to make an informed say-on-pay vote; ISS typically wants the disclosure to be sufficient for it and investors to meaningfully assess the board’s compensation philosophy and practices.

59. How would ISS view any compensation program changes made in light of the removal of 162((m) deductions? Shifts away from performance-based compensation to discretionary or fixed pay elements will be viewed negatively.

67. How does ISS apply its policy around “excessive” levels of non-employee director pay? If a company has excessive non-employee director (NED) pay without a compelling rationale in two or more years, it could cause ISS to recommend against directors. This policy will not be applied until February 1, 2020. If ISS identifies excessive NED pay at a company it will undertake a qualitative review to determine if concerns are adequately mitigated. In evaluating a company’s disclosed rationale, the following circumstances, if within reason and adequately explained, would typically mitigate concern around high NED pay:

  • Onboarding grants for new directors that are clearly identified to be one-time in nature
  • Special payments related to corporate transactions or special circumstances, or
  • Payments made in consideration of specialized scientific expertise.

ISS will evaluate payments made in connection with separate consulting agreements on a case-by-case basis. ISS will generally not view payments to reward general performance/service as compelling rationale.

68. What is ISS’ methodology to identify NED pay outliers? ISS will compare individual NED pay total within the same index and sector. Directors will be compared to other directors within the same two-digit GICS group and within the same index grouping. Index groupings for purposes of this policy are: S&P 500, combined S&P 400 and S&P 600, remainder of the Russell 3000 index, and the Russell 3000-Extended. The methodology will also recognize board-level leadership positions, limited to non-executive chairs and lead independent directors and individuals in these roles will be compared to others in the same role in their index and sector. The methodology will also recognize cases where there is a narrow distribution of NED pay within a particular sector-index grouping, i.e., where there is not a pronounced difference between the top 2-3% and the median director, this may be considered as a mitigating factor.

U.S. Equity Compensation Plans FAQs

Below are the questions and answers that ISS has updated with respect to this set of Equity Compensation Plans FAQs:

26. How will ISS treat plan proposals that are only seeking approval in order to qualify grants as “performance-based” under IRC Section 162(m)? Proposals that only seek approval to ensure tax deductibility of awards pursuant to Section 162(m) – now under the “grandfather rule” – and that do not seek additional shares for grants or approval of any plan amendments, will generally receive a favorable recommendation regardless of Equity Plan Scorecard (EPSC) factors (“positive override”), provided that the board’s Compensation Committee or other administering committee is 100% independent according to ISS standards.

27. How will ISS consider plan revisions relating to the 162(m) tax code changes? Plan amendments that involve the removal of general references to 162(m) qualification will be viewed as administrative/neutral. But, if a plan contains provisions representing good governance practices, even if no longer required under the revised 162(m) code, their removal may be viewed as a negative change in a plan amendment evaluation.

34. What changes were made to the EPSC policy for 2019? Beginning February 1, 2019, the following updates will apply:

  • The change-in-control vesting factor is updated to provide points based on the quality of disclosure of CIC vesting provisions, rather than based on the actual vesting treatment of awards. Full points will be earned if the plan discloses with specificity the CIC vesting treatment for both time- and performance-based awards. But no points will apply if the plan is silent on the CIC vesting treatment for either type of award or if the plan provides for merely discretionary vesting for either type of awards.
  • There is a new negative overriding factor for excessive dilution–greater than 20% for S&P 500 companies and greater than 25% for the Russell 3000 companies (other than the S&P 500).
  • Certain factor scores have been adjusted in accordance with ISS’ proprietary (black box) scoring model.

45. When will excessive dilution have an adverse recommendation implication for the equity plan proposal? Excessive dilution is an overriding factor that can be applied to S&P 500 and Russell 3000 companies. For S&P 500 companies, this override will be applied if dilution is greater than 20%. For Russell 3000 companies (excluding S&P 500), this override will be applied if dilution is greater than 25%. For this policy, ISS defines “dilution” as (A + B + C) / CSO, where A = number of new shares requested; B= number of shares that remain available for grant; C = number of unexercised/unvested outstanding equity awards; and CSO = common shares outstanding.

2019 Burn Rate Benchmarks

See Appendix A of the U.S. Equity Compensation Plans FAQs for a full list of ISS’ 2019 burn rate benchmarks for the S&P 500, Russell 3000 (excluding the S&P 500), and the Non-Russell 3000.

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…

 

ISS Posts Final FAQs and Other Policy Document for 2018

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On December 14, 2017, ISS issued several important updated documents concerning its policies and methodologies for the upcoming 2018 proxy season:

These are all available on ISS’s Latest Voting Policies: 2018 webpage on its website: https://www.issgovernance.com/policy-gateway/latest-policies/

This page also includes information ISS released on its European Pay-for-Performance Alignment and Methodology.

U.S. Compensation Policies: FAQs

This supersedes the preliminary FAQs on this topic issued in November 2017.  These FAQs make changes to or introduce ISS policies:

  • How ISS Assesses Board’s Actions Taken in Response to Low Support (<70%) on a Say-on-Pay (SOP) Vote
    • Same as last year’s policy except now ISS will expect companies to address in their proxy statements: (1) the breadth of the engagement with shareholders, including the frequency and timing of engagements, number of institutional investors and the company participants including whether independent directors participated as well; (2) disclosure of specific feedback received from investors; and, (3) specific and meaningful actions taken to address shareholder concerns.
  • Lay out the four measures now used in ISS’ quantitative Pay-for-Performance (P4P) screen
    • Relative Degree of Alignment (RDA) – relative measure
    • Multiple of Median (MOM) – relative measure
    • Pay-TSR Alignment (PTA) – absolute measure
    • Financial Performance Assessment (FPA) – relative measure – assesses CEO pay rank and financial performance rank over a two- or three-year period using up to four financial metrics which vary by industry
  • Explain how the new Financial Performance Assessment (FPA) measure operates
    • Compares a company’s financial and operational performance over the long-term versus ISS peer group. Note: ISS has historical taken the position that you need a performance period of at least 3 years for it to consider the program long-term performance and yet, somehow it characterizes a two-year period of financial performance as long-term. FPA uses three or four financial metrics that are selected and weighted based on industry. The financial metrics that could be used include: return on invested capital (ROIC); return on assets (ROA); return on equity (ROE); EBITDA growth; and, cash flow (from operations) growth.
  • Explain how the FPA result will impact the final quantitative P4P concern level
    • FPA may affect the overall quantitative P4P concern level only if:
      • a Medium concern under any of the three initial tests (RDA, MOM, PTA), or
      • a Low concern but bordering the Medium concern threshold under any of the three initial tests
    • FPA can modify the overall concern up to Medium or down to low in the above cases. If the concern level under any of three initial tests is a High concern or the three initial tests result in a Low concern not bordering on Medium concern, then FPA modification is not be available.
  • Explain the time period used for TSR calculations for RDA
    • ISS uses a three-year period for measuring TSR ending closest to the fiscal year-end of the subject company. The TSR of the ISS peers will be measured over that same period. However, ISS will begin to average the closing prices across all trading days contained in the beginning and months of the TSR measurement period.
  • Explain which problematic practices are most likely to result in an adverse ISS vote recommendation
    • Repricing or replacing underwater stock options/SARs without prior shareholder approval (including cash outs)
    • Extraordinary perquisites or tax gross-ups
    • New or extended executive agreements that provide for:
      • Excessive CIC payments (exceeding 3 times base salary and average/target/most recent bonus)
      • CIC severance payments without involuntary job loss or substantial diminution of duties
      • CIC payments with excise tax gross-ups
      • Multi-year guaranteed awards that are no at-risk due to rigorous performance conditions, or
      • Liberal CIC definition combined with any single-trigger CIC benefits
    • Any other provision or practice deemed to be egregious and present a significant risk to investors
  • Explain how ISS will identify “excessive” levels of non-employee director pay and the impact it will have on its analysis
    • ISS is looking for extreme “outliers” in NED pay, which historically has represented pay figures above the top 5% of all comparable directors
    • If ISS finds excessive NED pay levels to exist, it may issue adverse vote recommendation for those board members responsible for approving/setting NED pay if no compelling rationale is provided
  • Explain how ISS will consider the new CEO Pay Ratio disclosure
    • ISS will display in its research reports: (1) the median employee pay figure; and, (2) the CEO pay ratio.
    • ISS will continue to assess the CEO pay ratio data as it becomes available and seek feedback from investors on the usefulness of this information and what should be done with it

 

U.S. Equity Compensation Plans: FAQs

This supersedes the preliminary FAQs issued in November 2017 about ISS’ Equity Plan Scorecard (EPSC) policy. These updated FAQs

  • Explain how ISS will treat the grant of time-vested restricted shares as consideration for an acquisition for purposes of its burn rate calculation
    • Generally, ISS factors all equity grants into its burn rate calculation. However, if companies grant time-vested restricted shares as part of an acquisition, they may request that such shares be excluded from the ISS burn rate calculation, but must provide tabular disclosure to enable ISS to determine the shares used in each of the three most recent years. Only time-vested restricted stock can be excluded under this policy; performance-based awards issued in an acquisition context will continue to be included. See the FAQs for a sample of the table that must be provided. Once companies make this initial disclosure, they should continue to provide it, even if they did not issue any time-vested restricted shares for acquisitions during the most recent year covered.
  • Clarified that all previous ISS burn rate commitments are now dead and of no force and that ISS no longer gives any special treatment to such commitments
  • Lay out the definition of “liberal change in control” and its impact on a plan with contains such a term
    • Means vesting triggers linked to: shareholder approval of the transaction, rather than its consummation; and/or an unapproved change in less than a majority of the board; and/or acquisition of a low percentage of outstanding common stock (15% or less); and/or announcement or commencement of a tender or exchange offer; or any other trigger that could result in windfall compensation without the occurrence of an actual change in control of the company.
  • Explain how ISS evaluates an equity plan proposal seeking approval of one or more amendments
    • Evaluated on a case-by-case basis
    • ISS will generally base its vote recommendation on the EPSC evaluation/score if any of the following apply:
      • the proposal includes a material request for additional shares;
      • the proposal represents the first time shareholders have had an opportunity to vote on the plan;
      • the amendments include an extension of the plan’s term; or
      • the amendments include the addition of full value awards as an award type when the current plan authorizes only stock option/SAR grants
    • If none of the four scenarios above apply, then ISS’ vote recommendation will depend on the overall impact of the proposed amendments, i.e. whether deemed beneficial or contrary to shareholders’ interests
  • Explain the factors ISS considers in its qualitative review of director pay for the purpose of a proposal seeking approval of a director equity plan
    • The relative magnitude of director compensation compared to companies of a similar profile
    • The presence of problematic pay practices relating to director compensation
    • Director stock ownership guidelines and holding requirements
    • Equity award vesting schedules
    • The mix of cash and equity-based compensation
    • Meaningful limits on director compensation
    • The availability of retirement benefits or perquisites
    • The quality of disclosure surrounding director compensation
  • Lay out the changes to the EPSC policy for 2018
    • Passing score for S&P 500 companies was raised from 53 to 55 points
    • The CIC vesting factor was made binary – either full or no points are no earned depending on whether plan complies with the ISS CIC vesting requirements:
      • For performance-based awards: acceleration is limited to actual performance achieved, pro-rata of target based on the elapsed portion of the performance period, a combination of both actual & pro-rata, or the performance awards are forfeited or terminated upon a CIC, and
      • For time-based awards: acceleration cannot be automatic single-trigger or discretionary
    • The holding requirement factor was made binary – either full or no points are earned depending on whether all awards require a holding period of at least 12-months. No points are given if the holding period is less or the holding requirement applies until stock ownership guidelines are met.
    • The CEO vesting requirement factors were made binary – either full points or no points depending on whether the vesting period is at least 3 years from the date of grant
    • The broad discretion to accelerate vesting factor was updated so that full points are earned only if discretion is limited to cases of death and disability. Discretion to accelerate vesting upon a CIC will cause no points to be awarded under this factor unlike current policy which would give full  points. The ability to use discretion to accelerate vesting in any other situation would cause the plan to lose all points under this factor.
    • ISS adjusted certain factor scores, per ISS’ proprietary scoring model.
  • Explain how the EPSC models differ now
    • Generally the same as current policy, except that the maximum points for S&P 500 and Russell 3000 companies under the Plan Features and Grant Practices pillars have been revised to be: 19 and 36 points, respectively.
  • Explain the EPSC points required to receive a positive ISS vote recommendation
    • S&P 500 companies now must score 55 or more points under the EPSC model to receive a positive ISS vote recommendation for their equity plan proposals
    • All other companies must still score 53 or more points under the EPSC model to receive a positive ISS vote recommendation for their equity plan proposals
  • Explain the ESPC factors, whether they are binary and if weighted equally
    • See chart in the FAQs on this. But note that ISS does not give out the actual points attributed to each factor
  • Lay out when repricing provisions will constitute and overriding factor that would cause ISS to recommend against a plan proposal regardless of EPSC model score and other analysis
    • If the plan would permit repricing of stock options/SARs without shareholder approval it would constitute an overriding factor.
  • Explain how ISS evaluates whether a plan meets the minimum vesting requirement
    • The plan must mandate a vesting period of at least one year for all equity award types grantable under the plan, which applies to no less than 95% of the shares authorized for grant. Exceptions to the minimum vesting beyond 5% will prevent a company from getting points under this factor. Also if the plan permits individual award agreements or other mechanisms to reduce or eliminate the minimum vesting requirement, the plan receives no points under this factor.
  • Explain how ISS determines the treatment of performance-based awards that may vest upon a change in control
    • ISS will consider whether the amount of the performance award that would be payable/vested upon a CIC is (a) at target level, (b) above target level, (c) prorated based on actual performance as of the CIC date and/or the time elapsed in the performance period as of the CIC date, or (d) based on board discretion. Of the plan is silent, it will be treated as discretionary.
  • Explain how ISS determines the vesting period for a CEO’s most recent equity grants
    • For time-vested awards, full vesting should not occur until three years from the date of grant
    • For performance-based awards, ISS will give credit for a vesting period of slightly less than three years from the grant date so long as the performance measurement period is three years, if the reason is due to the grant date being within the performance measurement period. For performance-based awards that are subject to subsequent time-based vesting, only the performance-contingent portion of the vesting period is counted.
  • Explain how ISS will evaluate an equity plan amendment proposal when the company does not disclose the updated plan document
    • ISS may recommend against the plan amendment proposal because the company has not provided sufficient information to enable shareholders to fully evaluate the revised plan
  • Lay out the new 2018 Burn Rate Benchmarks
    • See the Appendix to this FAQ

 

Pay-for-Performance Mechanics (U.S.)

Those that were hoping that ISS would go into more sufficient detail so that they might be able to determine how they will fare under ISS’ quantitative P4P assessment are likely to be a bit disappointed.  While ISS does give some direction on how it will the P4P quantitative test will work, it stops short of giving sufficient details for a company to calculate these on its own. So much for transparency. But, I guess too much transparency is bad for the bottom line and if companies could calculate how they would fare under the ISS quantitative P4P tests they might need to purchase P4P simulation modeling from ISS Corporate Solutions (ISS corporate services arm).

However, this document does lay out a change in the concern thresholds under the Multiple of Median (MOM) test for S&P 500 companies. For S&P companies, the level that triggers a medium concern level has decreased from 2.33x to 2.00x. For non-S&P 500 companies, the medium concern threshold under the MOM test remain at 2.33x.

While this document does lay out the metrics that will be used for FPA for each GICS group, it does not specify the weighting of those metrics.

 

 

ISS Posts Preliminary U.S. Compensation FAQs – Buckle Up!

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On November 21, 2017, ISS issued preliminary U.S. Compensation FAQs These can be found at the bottom of the ISS Latest Voting Policies page:

https://www.issgovernance.com/policy-gateway/latest-policies/

At first I thought it was a bit odd that ISS was issuing preliminary Compensation FAQs. Then, I read through the FAQs and understand why they did so.  The FAQs make a number of changes to ISS policies that likely will leave a few companies scrambling to figure out how these will impact them going forward.

First, with respect to the Quantitative P4P tests:

  • ISS is dropping the medium threshold for the Multiple of Median test from 2.33x to 2.00x for S&P 500 constituents covered by ISS’s U.S. Policies. All other thresholds remain the same for 2018.
  • Total Shareholder Return will now be calculated using a “smoothing” method by ISS for both the beginning-of-period and end-of-period stock prices by averaging the beginning and ending stock price for the month closest to the fiscal year-end of a company. Stock splits and dividends occurring during such averaging periods will be factored into the TSR calculations. If a company’s FYE is on/after the 15th of the month, then that monthly stock price average will be used; otherwise, the monthly average of the prior month will be used.
  • Financial Performance Assessment (FPA) will be applied as a secondary measure after the traditional three quantitative tests (MOM, RDA, and PTA) are calculated. FPA will then could be used to assess how well companies performed on relative financial metrics and may cause ISS to score the overall quantitative P4P concern level as low concern when the traditional quantitative tests indicate a medium concern, and, likewise, could cause ISS to score the overall quantitative P4P concern as medium concern when the traditional quantitative tests indicate a low concern.
  • Preliminary FAQs include a chart showing which metrics will be used for the various GICS groups – no word on the weightings of these metrics is provided.

Second, with respect to the Equity Plan Scorecard (EPSC), ISS appears to making a couple of significant changes :

  • The minimum points necessary to pass the EPSC model is being increased from 53 points to 55 points for all S&P 500 companies; for all other companies, the minimum points remains at 53 points.
  • Change in Control (CIC) Vesting Factor under the EPSC will now only give full or no points. Full points will be awarded when an equity plan contains both of the following provisions:
    • For performance-based awards, acceleration is limited to actual performance achieved, pro-rata of target based on the elapsed portion of the performance period, a combination of both actual & pro-rata, or the performance awards are forfeited or terminated upon a change in control. If no performance awards, points for this factor will be based solely on the treatment of time-based awards.
    • For time-based awards, acceleration upon a CIC cannot be automatic single-trigger or discretionary.

Any other provision for CIC treatment results in no points under this factor.

  • Holding Requirements Factor is being “simplified” for 2018 and ISS will either award full or no points. To receive full points, awards must be subject to a minimum 12-month holding period, or holding through the end of employment. A holding period of less than 12 months or only until stock ownership guidelines are met will result in no points under this factor.
  • CEO Vesting Requirement Factor is also being “simplified” for 2018 and there will either be full or no points under this factor. To receive full points, time-based options, time-based restricted stock, and performance-based equity compensation for the CEO must all have a vesting requirement of at least 3 years from the date of grant until all shares from the award vest.
  • Broad Discretion to Accelerate Vesting Factor is being revised so that full credit under this factor will only be awarded if the discretion to accelerate vesting is limited to cases of death and disability.  If discretion extends to CIC, retirement, or other terminations, the plan would not receive any points under this factor.