Note: This is an update to my post of December 19, 2106 (available here) to reflect information I learned from a discussion with ISS Research personnel on January 4, 2017. Changes have been highlighted using italics.
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, and
- Ability to transfer awards for value to a third-party (see Caution on Transferable Equity Plan Provisions)
The above issues act as complete overrides. If the plan has one of these issues/features then regardless of whether the plan scores above the ISS threshold (currently 53 points), ISS will recommend against the plan.
ISS issued new FAQs regarding equity compensation plans on 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 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. 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. At that time, after discussions with ISS Corporate Solutions, I believed that ISS Research would view such a combination of features as warranting an override and causing ISS Research to recommend against a proposed plan with both such features.
Since my initial blog post, ISS Research clarified that “amending a plan to provide for withholding above the minimum tax rate will not be considered an “equity-related problematic pay practice” egregious factor that would trigger the overriding factors policy — even if the plan in question has a liberal share recycling (LSR) feature.” The language from the Coach ISS Report was intended to convey that ISS would view amending a plan to the maximum withholding rate as a negative amendment if that plan had a LSR (if the plan did not have a LSR, then such an amendment would be viewed as administrative in nature and neutral for shareholders). While such an amendment would not be an overriding factor, it would be a factor considered under the policy framework applicable to equity plan amendments proposals (see FAQ #28 for a description of that policy framework: https://www.issgovernance.com/file/policy/1_u.s.-equity-compensation-plans-faq-dec-2016.pdf)
This is good news for companies putting equity plans to shareholders that have a LSR and want to increase the withholding rate to the maximum statutory rate, as it means that this combination of features alone will not cause ISS to recommend against the proposed plan. Rather, the proposed plan will be evaluated using the Equity Plan Scorecard policy, with significant weight placed on whether the proposed plan scores above the threshold level of points. If a plan does, and the other plan amendments are not viewed negatively and no other ISS policy is implicated (such as the pay for performance evaluation), a company should then expect ISS Research to issue a favorable vote recommendation.