ISS Policies

Maximum Tax Withholding and Liberal Share Counting – NOT So Deadly A Combination – UPDATE

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:

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.pdfAt 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.

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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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ISS Posts Peer Group Selection FAQs

ISS recently posted its Peer Group Selection facts on its Policy Gateway web page (https://www.issgovernance.com/policy-gateway/2017-policy-information/). These FAQs deal with questions regarding how ISS goes about establishing its peer groups used in evaluating companies, how a company’s own peer group is factored into the construction of the ISS peer group among other issues.

The full set of FAQs can be downloaded at: https://www.issgovernance.com/file/policy/uspeergroupfaq_nov2016.pdf

 

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Dividend and Dividend Equivalent Plan Provisions

One important change in the 2017 ISS policy updates with respect to ISS’ Equity Plan Scorecard (EPSC) policy is with respect to dividend and dividend equivalent provisions.  Until the 2017 policy updates, ISS policy had been to recommend against equity plans that permitted the current payment of dividends or dividend equivalents on performance-based awards prior to the vesting of such awards.  The policy permitted companies to accrue such dividends and dividend equivalents and pay them out when the performance-based award vested.

Now under the 2017 ISS policies (effective for shareholder meetings occurring on or after February 1, 2017), ISS will include a new factor under the Plan Features portion of its EPSC policy that will look to see whether dividends or dividend equivalents can be paid on any award under the plan prior to the vesting of the underlying shares/award. Companies that do not prohibit the payment of dividend and dividend equivalents on all plan awards before the awards vest, will receive no points under this factor. Companies that prohibit the payment of dividends and dividend equivalents until the awards vest (and can allow for accrual of such dividends/dividend equivalents), will receive full points under this factor. Because the ISS policy permit for the accrual of dividends and payment when the award vests, many companies will view complying with this prohibition to gain the points under the EPSC policy will make sense, and may enable them to gain a few additional shares in their request everything else being equal.

ISS has not yet released its FAQs on the new EPSC policy, but I expect that the FAQs will indicate that the old dividend/dividend equivalent policy with respect to performance-based awards has been supplanted by the new EPSC factor and anything less than a complete prohibition of the payment of dividend/dividend equivalents on all unvested awards will not provide any points under the EPSC policy.

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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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