Category Shareholder Approval

Dilution & Equity Plan Proposals

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If you are taking an equity plan proposal to shareholders during the 2019 proxy season, you really need to know what your dilution is and will be at fiscal year-end. Why? First, it could impact the vote recommendation from ISS on your equity plan proposal. Second, it could negatively impact shareholder support for your equity plan proposal.

ISS

For 2019 shareholder meetings held on or after February 1, 2019, ISS has adopted a new “override” factor for its Equity Plan Scorecard (EPSC) model/policy. Regardless of how a proposed plan scores under the EPSC model, if the plan would cause dilution to be “excessive” ISS will recommend against it. For S&P 500 companies, excessive dilution means dilution greater than twenty percent (20%) and for other Russell 3000 companies it means dilution greater than twenty-five percent (25%). In some industries, this could be more of an issue than in others.

ISS is calculating dilution on a simple basis (as I explained in this Blog Post).

Shareholder Support

Based on prior research that I have conducted, the line in the sand for dilution that starts to see increased shareholder resistance, leading to less support for equity plan proposals, starts at about twenty percent (20%). As dilution goes above 20%, shareholder vote support starts to decline significantly, and then drops again once the 25% dilution level is passed.

Conclusion

Ensure that you have calculated your dilution currently and projected as of fiscal year-end, and also including any proposed equity plan share request. That way you will be alerted to whether dilution could cause an issue for your plan proposal. If so, it may necessitate some additional disclosures to illustrate why the request is sound and also require engaging with shareholders about the company’s need for shares in its equity compensation plans.

Overview of ISS’ Equity Plan Scorecard Model

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Is your company thinking about asking shareholders to approve more shares for your equity compensation plan? Are your shareholders influenced by ISS? Then be sure to read the latest Exequity Client Briefing I wrote. The Client Briefing provides an overview of the ISS Equity Plan Scorecard model and some of the insights I have gained running it for nearly two decades.

Exequity’s Client Briefing: An Overview of ISS’ Equity Plan Scorecard Model, can be found at:

https://www.exqty.com/newsroom/an-overview-of-iss-equity-plan-scorecard-epsc-model

 

Share Withholding at Maximum Tax Rate

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Accounting Standards Update (ASU) No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (available at: http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2 FDocumentPage&cid=1176168028584. 2) permits companies to withhold shares up to the maximum statutory tax rates (once a company is applying all the provisions of ASU 2016-09). Many existing equity compensation plans specifically limit share withholding to the minimum statutory tax rates in order to avoid potentially negative accounting consequences, i.e., liability accounting instead of fixed, grant-date accounting for equity awards. So the question has been raised whether amending an existing equity plan that limits share withholding to the minimum statutory tax rate would pose an issue under the exchanges rules.  NYSE and NASDAQ have now both issued guidance on this issue which should help companies as they consider adopting ASU 2016-09 and implementing maximum share withholding.

NYSE

The NYSE indicates that a rule to add back shares that have never been issued is not a “formula.” Consequently, amending a plan to provide for withholding of shares based on a grantee’s maximum tax rate rather than the statutory minimum tax rate is not a material revision if the withheld shares are never issued, even if the withheld shares are added back to the plan.

But the NYSE also indicates that a rule to add back shares that have actually been issued generally would be considered a formula. Furthermore, the NYSE states that a rule to add back shares that are withheld from restricted stock upon vesting to cover taxes is a formula unless the forfeited shares are immediately cancelled upon vesting. Therefore, if the plan involves a formula, it must be limited to a term of 10 years from the date of the last shareholder approval. Consequently, if a plan sets the share withholding rate at the minimum statutory rate for restricted stock (and other awards where the shares are issued), then a change to increase the share withholding to the maximum statutory rate would be considered a material amendment that would require shareholder approval.

NYSE’s FAQs, including FAQ C-1, can be found at: https://www.nyse.com/publicdocs/nyse/regulation/nyse/equitycompfaqs.pdf

NASDAQ

NASDAQ also released guidance on this issue, but failed to specifically address the issue of issued versus unissued equity awards. According to the NASDAQ guidance, an amendment to increase the withholding rate to satisfy tax obligations would not be considered a material amendment to an equity compensation plan. But the guidance then goes on to state that allowing the holder of an award to surrender unissued shares to pay tax withholdings is similar to settling the award in cash at market price, and neither creates a material increase in benefits to participants nor increase the number of shares to be issued under the plan.

The NASDAQ guidance does not specifically address what happens if such a plan amendment is made to permit the surrendering of additional issued shares to pay tax withholding (e.g., restricted stock).  I think with the use of the term “unissued” in the NASDAQ guidance that NASDAQ is more than likely taking a similar stance as the NYSE, but some additional clarification from NASDAQ regarding issued share awards would be helpful.

NASDAQ’s FAQS can be found at: https://listingcenter.nasdaq.com/Material_Search.aspx?cid=71&mcd=LQ&sub_cid=114,97,109,101,103

Final Thoughts

If you are considering amending an existing equity plan to increase the share withholding rate to permit up to the maximum statutory rate (and you will be adopting the other ASU 2016-09 requirements), it is important to analyze the plan’s equity awards to determine if there are any would have issued shares, such as restricted stock. If so, then the plan amendment might be able to be crafted so that it maintains the plan’s existing tax withholding rate for issued share awards and only permits the increased tax withholding for unissued awards and therefore would not necessarily require shareholder approval.  Needless to say, companies should check with their legal and accounting advisers before undertaking such a plan amendment to ensure that it can be done without shareholder approval. Alternatively, companies could put the amendment to shareholders for approval, but should recognize that ISS likely will apply its Equity Plan Scorecard policy to the amended plan in making its vote recommendation.

For more information about ASU 2016-09, see this Exequity Client Alert: http://www.exqty.com/uploads/6/9/9/0/69908991/fasb_update_asc_718.pdf

SEC Proposes to Eliminate Equity Compensation Plan Information Table

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According to this BNA blog (http://www.bna.com/sec-proposal-end-b73014445191/), the SEC has proposed to eliminate the Regulation S-K, Item 201(d) disclosure, i.e., the Equity Compensation Plan Information Table that is included in the proxy or annual report depending on whether a compensation plan is being put to shareholder vote.  This table provides the outstanding and available shares for shareholder approved and non-shareholder approved equity compensation plans, as well as weighted average exercise price for the outstanding equity awards.

The rationale appears to be that given current financial accounting standards, much of this information is now contained in a company’s publicly-filed financial statements.  While that is true to some extent, in my experience, the financial statements are not always the picture of clarity on such disclosure and I believe less information will ultimately be reported about equity plans if this proposal passes.

We will have to watch where this SEC proposal ends up when the final regulations gets issued.