More on ISS’ Excessive Non-Employee Director Pay Policy

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ISS announced that it would not apply its excessive non-employee director (NED) pay policy until meetings on and after February 1, 2020. But in the U.S. Compensation Policies Frequently Asked Questions, Updated December 14, 2018, ISS indicated that adverse vote recommendations could be issued under this policy for meetings occurring on or after February 1, 2020 where ISS has identified excessive NED pay without compelling rationale in both 2019 and 2020.

This means that companies that might have excessive NED pay and wanted to addresses it so it would not be an issue in 2020, will need to address NED pay now. That’s because most companies are setting their director compensation for 2019, that will be disclosed in their 2020 proxy statements.

Therefore, if a company will have an issue under ISS’ NED pay policy in 2020, it will be extremely difficult to avoid that result. So, the way ISS is implementing this policy creates a real possibility that companies will be trapped into being amongst the top 3% NED pay in both their 2019 and 2020 proxy statements and have no real opportunity to address NED pay levels (since 2019 pay being set shortly) before ISS applies the policy in 2020.

Companies should therefore carefully review ISS’s new FAQ on NED pay and determine whether their director pay for any director would place him/her at the 90th percentile or higher for companies in their 2-digit GICS code in their index (S&P 500; combined S&P 400 and S&P 600; remainder of the Russell 3000 index; and, the Russell 3000-Extended). If so, then they should consider adding an explanation in their proxy explaining why their pay is higher for those directors and also consider better laying out the process used to set director pay, especially timing, so that shareholders and ISS can more easily see that the Company had very little opportunity to address NED pay levels for the 2020 proxy.

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.

ISS Issues FAQs and Burn Rate Benchmarks for 2019

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ISS released its FINAL U.S. Compensation Policies FAQs for 2019 on December 14, 2018:

https://www.issgovernance.com/file/policy/latest/americas/US-Compensation-Policies-FAQ.pdf

ISS released its U.S. Equity Compensation Plans FAQs for 2019 on December 19, 2018:

https://www.issgovernance.com/file/policy/latest/americas/US-Equity-Compensation-Plans-FAQ.pdf

The Equity Compensation FAQs also include the ISS Burn Rate Benchmarks for 2019 in the Appendix.

I will summarize the above FAQs and post an updated Equity Usage 
Calculator shortly.

ISS Issues Preliminary FAQs on Compensation Policies for 2019

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On November 21, 2018, ISS issued a set of preliminary FAQs on Compensation Policies for 2019. These FAQs are effective for shareholder meetings on and after February 1, 2019.

The key points from these preliminary FAQs are:

  • Quantitative Pay-For-Performance Screen: ISS will not make any changes to its quantitative pay-for-performance screens for 2019.
  • “Excessive” Non-Employee Director (NED) Pay: ISS will not begin to apply the “excessive pay” policy concerning NED pay until 2020 (instead of the originally announced 2019), as it intends to provide more details on the methodology it employs in identifying NED pay outliers.
  • Equity Plan Score Card (EPSC) Scoring: EPSC scoring thresholds will remain the same as 2018
  • EPSC “Overriding” Factors: ISS will now include excessive dilution (simple dilution) as an overriding factor that will cause it to recommend against equity plan proposals. For S&P 500 companies the dilution trigger is greater than 20 percent, and for other Russell 3000 companies, the dilution trigger is greater than 25 percent. ISS defines dilution for this purpose as (A + B + C) / CSO, where A = # of new shares requested, B = # shares that remain available for issuance under continuing plans; C = # unexercised/unvested outstanding equity awards; and, CSO = common shares outstanding.
  • EPSC Model’s Change-in-Control (CIC) Factor: The CIC factor under the EPSC model will be updated to evaluate the quality of disclosure of CIC vesting provisions, rather than be based on the actual vesting treatment of awards as was previously the case. Full points under the CIC factor will require the equity plan to disclose with specificity the CIC vesting treatment for both performance- and time-based awards. If the plan is silent on the CIC vesting treatment for either type of award, or if the plan provides for merely discretionary vesting of either type of award, then no points will be earned for the CIC factor.

The ISS Preliminary FAQ: US Compensation Policies, can be found at:

https://www.issgovernance.com/file/policy/latest/americas/US-Preliminary-Compensation-FAQ.pdf

See related EC Minute episode on ECMinute.com

http://www.ecminute.com/2018/12/05/episode-32-isss-2019-policy-updates/