Proxy Statements

On December 20th, ISS issued two extensive FAQs on their voting policies. This post covers the compensation items (a previous post covered the non-compensation items).

Although the compensation FAQs contain a number of items previously posted by ISS, there are a few new items worth noting, including:

• For the CEO Tally Sheet table, how the present value of all accumulated pension benefits (qualified and non-qualified) is calculated (page 7).
• The FAQs explain the methodology used in evaluating a company’s pay for performance, including how an initial quantitative analysis affects the ultimate vote recommendation for say-on-pay proposals and the factors that ISS considers when it conducts a qualitative review (such as the ratio of performance- to time-based equity awards, benchmarking processes and realizable pay vs. grant pay) and how ISS will treat CEOs who have not been in the position for three years (pages 9-11).
• The FAQs indicate that realizable pay, which is only relevant for S&P 500 companies where the company’s initial quantitative screen shows a high or medium concern, will include all amounts actually paid or realized during the specified measurement period.  ISS does not use the intrinsic value of stock options for its realizable pay calculation, because it views as important the economic value of underwater options (pages 9-10).
• In exceptional cases, an ISS peer group can contain 12 companies (page 17).
• For companies with fiscal year-ends subsequent to December 31, 2012, ISS will provide the opportunity to communicate changes made to its peer group (page 18).
• The FAQs discuss the issues surrounding problematic pay practices, including how ISS views the grant of retention awards to executives who did not receive a payout after a performance cycle ended due to failure to achieve goals (pages 19-21).
• The FAQs elaborate on ISS’ say-on-golden-parachutes policy, such as how ISS would treat: (i) a company that technically triggered a change in control but did not experience a bona fide change in control, (ii) performance measures that would not have been achieved in the absence of a decision to accelerate performance-based awards, (iii) the determination of whether specific payouts are “excessive” and (iv) existing problematic change-in-control severance features (pages 22-23).  ISS indicates that the best practice for paying out performance-based awards is pro rata vesting of the award based on current achievement.  In determining whether a golden parachute payout is excessive, ISS considers factors such as the value of the payout on an absolute basis, or one or total payouts relative to the transaction’s equity value.
• The FAQs address how ISS would determine the cost of an equity compensation plan for newly public companies and companies with limited partnership units (pages 24-25).

On December 13, the SEC declined to permit Disney to exclude a proxy access shareholder proposal submitted by Legal and General Assurance (Pensions Management), in conjunction with its client, Hermes Equity Ownership.

The proposal requested that Disney’s board adopt a bylaw that would allow a holder of 3% of its stock for at least three years to nominate up to 20% of the directors. The ownership requirements of the proposal closely resembled those of the SEC’s vacated proxy access rule and was substantially similar to two other proposals that were approved by a majority of shareholders at Chesapeake Energy and Nabors Corp. at their 2012 annual meetings.  

Disney sought to exclude the proposal as vague and indefinite under Rule 14a-8(i)(3), arguing that the proposal’s requirement that the nominating party provide Disney with information required by SEC “rules” about the nominating party and the board nominee was vague and misleading because it did not describe the substantive provisions of such rules. Disney also argued that the proposal was subject to multiple interpretations and its references to both SEC rules and to “any federal regulations” was vague and misleading.

In response, counsel to the shareholder proponent argued that the proposal “is a garden-variety ‘proxy access’ proposal” whose “central aspect” is the request of proxy access for owners of 3% of the stock for three years for up to 20% of the board. As such, the proponent argued that the language cited by Disney as vague and misleading was a secondary element of the proposal. The shareholder also disputed the claim that the wording was vague and subject to multiple interpretations. Disney then submitted a second letter to the SEC refuting the claims in the proponent’s response.

The SEC did not agree with Disney’s views, including its argument that the proposal’s reference to the SEC’s “rules” made it vague and indefinite and therefore subject to exclusion subject to Rule 14a-8(i)(3). In contrast, in the 2012 proxy season, the SEC had found that proxy access proposals which referenced “SEC Rule 14a-8(b) eligibility requirements,” without specifically describing such requirements, were subject to exclusion as vague and indefinite. In those letters, the SEC reasoned that the specific eligibility requirements were a central provision of the proxy access proposal in question.

A copy of the correspondence can be found here.

More than 18 months ago, we alerted readers about a request for information by the Department of Labor (DOL) seeking suggestions from interested parties on the possibility of using electronic media by employee benefit plan sponsors to furnish information to participants.  The current ERISA rules under the DOL prevent companies from taking full advantage of using notice and access in lieu of paper copies of proxy statements for employee benefit plan participants as a practical matter.  We wrote a comment letter to the DOL in support of moving toward easily sending plan participants electronic versions of a company’s annual proxy statement. 

However, a recent survey by the AARP, titled “Paper by Choice,” will likely retain the status quo for the time being.  In response to concerns that the financial services industry is lobbying to allow retirement plan providers to send out plan documents electronically as the default method, the survey found that of the slightly over 1,000 respondents, 75% of those over the age of 25 prefer paper over online communications and 62% currently receive only paper copies.  

Many have criticized the survey as biased, primarily because it failed to ask participants about work-related computer access, which is the touchstone the DOL uses in its electronic delivery safe harbor, and although it asked those surveyed if they read disclosures electronically, no similar question was asked of those receiving disclosures by hard copy.  Nonetheless, the survey will still likely influence the DOL’s thinking about converting plan participants from paper to electronic, holding back efforts to give companies the ability to avoid stratifying notice and access mailings and moving completely to electronic means of delivery.

We are pleased to announce the publication of Getting The Deal Through – Corporate Governance 2012. Davis Polk lawyers Arthur Golden, Thomas Reid and Sapna Dutta authored the “Global Overview” chapter. 

We note this year that, as the wave of post-financial crisis corporate governance reform continues across the globe, the impact of the significant burdens on the regulators that are responsible for implementing these reforms is becoming increasingly visible. That said, we are also seeing a subtle divergence in the nature of these regulatory efforts in different parts of the world.  In the United States, regulatory efforts have focused primarily on implementation of the Dodd-Frank Act, which continues to require significant time and has resulted in delays in the rulemaking schedule. In contrast, Europe has seen more in the way of new initiatives, including the publication of the European Commission’s Green Paper on a future EU-wide corporate governance framework and the U.K. government’s significant proposals intended to curb executive compensation.

As the year goes on, we expect that U.S. and European companies will continue to experience intense pressure from regulators and shareholder advocacy groups in respect of their corporate governance practices on a number of fronts. It is inevitable that the reaction to the financial crisis of 2008 and the ongoing Eurozone crisis should provoke such severe and prolonged reaction.  What remains to be seen, if, as and when global economic conditions stabilize, is whether or not these ongoing governance reforms ultimately do anything to improve the competitiveness or actual governance of individual companies or the North American or Western European economies, or whether they are simply a series of responses – ranging in nature from remedy to retribution – that may be understandable, but perhaps not efficient in the long term. 

Read the “Global Overview” chapter >

This is the fourth in a series of posts to discuss shareholder proposals during the 2012 proxy season.

While the number of shareholder proposals on independent board chairs increased significantly this year, shareholder support for these proposals did not show a corresponding surge. As of June 30th, there was a total of 48 proposals voted on at Russell 3000 companies, as compared to 21 at the same time last year.

This increase in number of proposals is due in part to a concerted effort this year by activist investors, including AFSCME, to target companies with combined chair and CEO positions. Not all shareholders, however, followed the lead of these activist investors. Of the 48 shareholder proposals, only 3 proposals passed. The average level of shareholder support for all independent chair proposals was 36% of votes cast, which is lower than the support received this year by other governance proposals such as declassification and majority voting.

It seems that the appointment of a lead director is not enough to prevent a company from receiving a shareholder proposal for an independent chair, as a majority of the companies receiving shareholder proposals this year had a lead director in place. All but four of the remaining companies had a presiding director. In addition, there were independent lead directors at all three companies at which the proposals passed. 

According to a Spencer Stuart 2011 Board Index, only 21% of S&P 500 companies have an independent board chair.

Broadridge recently presented statistics from the 2012 proxy season, covering meetings from March 1st to June 1st. In this period of only 93 days, a staggering volume of shares, nearly 347 billion, were voted through the proxy system, representing more than half of the shares that are voted during the entire year. 

Average quorum levels stayed around 83%, with 68% of shares voted in accordance with their owners’ instructions (meaning almost 15% came from only broker votes). 95% of the voting occurs electronically, which includes telephone voting, but more than 10 billion shares are still casting ballots using paper forms. 

Technological innovation is slowly descending on proxy voting, as nearly half a million shares voted through a mobile platform. While a tiny drop in the bucket, this represents a fourfold increase from the prior year. Some issuers are also leading the effort. Six companies provided QR codes allowing shareholders to access materials and vote by scanning using a smartphone or tablet. Online meeting participation through Broadridge’s virtual shareholder platform was offered by more than 100 companies. It is unclear how many of these meetings were “virtual-only,” as debate continues over the value of holding in-person meetings at the vast majority of companies that face only routine issues and have little to no shareholder attendance. Vote confirmations are still only a discussion item in the SEC’s proxy plumbing release, but four issuers made it a reality this year.    

Interestingly, the report also noted that meetings were held later than in prior years, when the key data covered February to May instead. Perhaps as a result of say-on-pay, companies may have wanted more time to prepare and have been pushing back meeting dates. 

This is the third in a series of posts to discuss shareholder proposals during the 2012 proxy season.

The number of shareholder proposals relating to shareholder ability to call special meetings continued to decline: to 17 this year, down from 30 last year and 45 in 2010. 

This decline is due, in part, to the number of management proposals on the same topic. Management proposals relating to special meetings typically require a higher percentage (20%-25%) of share ownership to call a special meeting than do those proposed by shareholders, which generally require 10% ownership. Companies often submit management proposals to provide a basis for excluding a shareholder proposal with a lower ownership requirement under Rule 14a-8(i)(9). There have been 18 management proposals to date this year.

Close to one-third of the shareholder proposals on special meetings passed; the average level of shareholder support of votes cast was 44%. The common factor at all the companies where the shareholder proposal passed was that the shareholders of the companies in question did not have any right to call a special meeting. (At some, although not all, of the companies where the shareholder proposals failed, the shareholders of the company already had a right to call special meetings, although at a higher percentage than that sought in the shareholder proposal.) 

The SEC also permitted a number of these shareholder proposals to be excluded based on Rule 14a-8(i)(3), which allows exclusion of shareholder proposals that are “vague and indefinite.” Those proposals called for an ownership threshold of 10% “or the lowest percentage of outstanding common stock permitted by state law,” which language was found to be vague and indefinite. Interestingly, this was the same language in the proposals at most companies that chose the alternate route of seeking no-action relief  based on introducing a management proposal.

This is the second in a series of posts to discuss shareholder proposals during the 2012 proxy season.

Not surprisingly, shareholder proposals on majority voting for uncontested director elections continued to garner support this year, averaging 62.5% of votes cast at 33 companies as of early July, up slightly from 59.2% in 2011.

Of this total, 18 of the proposals voted on were at S&P 500 companies. Half of those  passed with average support of 57.5% of shares cast. Two companies – PACCAR and CF Industries – had notably high shareholder support: 97.1% and 91.7%, respectively. Management had supported the proposal at PACCAR but opposed it at CF Industries. 

At its annual shareholder meeting this year, Apple announced its intention to adopt a majority voting standard, as proposed in a shareholder proposal in its proxy statement. This followed a year of Apple’s refusal to adopt a majority vote standard, despite 73% of its shareholders having supported such a proposal in a non-binding vote in 2011. CalPERS had submitted the majority vote proposals at Apple in both 2011 and 2012.

In looking at these results, it seems that while majority voting is often referred to in the same breath as other governance stalwarts such as board declassification (which we recently discussed), shareholder support for such proposals is not nearly as high. Indeed, this season management proposals for majority voting passed at 9 companies, but failed at two companies. Nevertheless, the trend of adoption of majority voting standards, especially at large cap companies, continues apace; according to ISS, 79% of S&P 500 companies had adopted majority voting by 2011, up from 59% in 2009.

The Business Roundtable has updated its Principles of Corporate Governance, last revised in 2010.  It would be easy to dismiss the Principles as 32 pages of platitudes and conventional wisdom, but it’s actually worth a look.  The Business Roundtable is far from a thought leader, but at the same time it is not as reflexively retrograde as some other business organizations that come to mind.  The Principles may not be bold, but it is rooted in a humility—we may not know all of the answers, and different situations may call for different approaches—that is welcome in a field more often characterized by rigidity and bluster.

You can think of the Principles as providing a useful, albeit lagging, indicator of what large U.S. public companies actually do, or at least aspire to do, in corporate governance.  Put it this way: if your company is not following a practice that the Principles recommends, it should be as a result of a conscious decision at the board level.   

The general approach of the Principles is to be prescriptive as to matters that are thought to be noncontroversial (and that in many cases are already required by law or stock exchange rule), to be equivocal as to areas where the authors believe a consensus has not definitively emerged, and to be silent as to truly controversial areas.  Thus:

• Prescriptive: Items in the 2012 update that are in the “every public company should” category include: having an independent chair or lead director; having a “substantial majority” of the board be independent; having a majority vote policy under which directors who fail to receive a majority must offer their resignation; establishing a risk oversight structure (although not usually a dedicated committee); annual succession planning sessions; board oversight of political activities; and board prioritization of dialogue with “long-term” shareholders.
• Equivocal: Plenty of things that companies should “consider,” including separating the CEO and chair, using restricted stock rather than stock options for board compensation, adopting a disclosure policy with respect to political activities, board retirement age policies, and adopting a three audit committee membership limit (no reference to overboarding rules generally).
• Unaddressed: Annual election of directors, proxy access, one share/one vote, shareholder rights to act by consent or call special meetings, and audit firm rotation.

You might consider including the Principles in your next board packet.

This is the first in a series of posts to discuss shareholder proposals during the 2012 proxy season.

The march towards board declassification showed no signs of slowing down in the 2012 proxy season. Of the 45 precatory shareholder declassification proposals that had gone to a vote as of mid-June, 40 of such proposals passed with an average support of 89% of the votes cast. This shows an increase in support of shareholder declassification proposals over the previous proxy season, in which  declassification proposals passed with average support of 77% of votes cast. For the proposals that failed, the average support was 43.7% (excluding a failed proposal at Hospitality Properties Trust, which garnered the support of 90% of votes cast but failed to get the requisite 75% of outstanding shares.) 

The number of shareholder declassification proposals might have been even higher had an additional 44 companies receiving such shareholder proposals not negotiated agreements to offer management proposals to declassify their boards, according to a report by the Harvard Law School Shareholder Rights Project (SRP). All the management proposals regarding declassification received resounding support of votes cast, but some nevertheless failed at companies, such as Alcoa and Charles Schwab, which require votes of more than 80% of the outstanding shares.

According to the ISS, only one-third of all S&P 500 companies have staggered boards, as compared with over half of the mid-cap and small-cap companies. Notwithstanding this gap, the activist focus continues to be on the large-cap companies. Approximately three-quarters of the shareholder declassification proposals this season were filed at large-cap companies, many of them proposed by institutional investors who were advised by the SRP. 

Today, the SEC rules on the independence of compensation committees and advisers were published in the Federal Register. As we described in our memo, the listing exchanges have 90 days to propose implementation, and then a year from today to finalize the standards with approval from the SEC.

Since those are the outside dates, the listing exchanges can act much sooner. Depending in part on the comments received on the proposed standards, final standards may be adopted in time to apply to the 2013 annual meeting. We hope that the transition period for compensation committee independence standards will accommodate the fact that many boards evaluate director independence months before proxy statements are issued with related independence disclosure. Companies and boards will need sufficient time to modify their processes to evaluate additional independence factors required, or possibly even change the composition of their compensation committee.

In terms of compensation adviser independence, since there is no public disclosure required, the rules may not be affected by the proxy season (and proxy statement) timing. The importance in this case is for the listing exchanges to provide sufficient transition periods for companies to gather the necessary information and the compensation committee to examine the required factors. Companies will also need to consider whether their governance documents, including committee charters, should be modified to reflect the new rules.

As a reference, in a rule filing on April 2003, NYSE allowed companies 18 months following SEC approval to comply with the requirement to have a majority of independent directors (classified boards had 30 months if the affected director was not up for election). By the time the SEC approved those and other governance rules for NYSE and Nasdaq in November 2003, the implementation schedule had been revised to apply to the following year's annual meeting.

On Tuesday, I was fortunate to co-moderate a NYSE-sponsored webcast with Judy McLevey at the NYSE, as we discussed the leading proxy and governance issues for 2012 with a group of recognized experts that included Doug Chia from Johnson & Johnson, Michelle Edkins and Robert Zivnuska from BlackRock, Gordon McCoun from FTI Consulting and Pat McGurn from ISS.  An archive of the webcast is available here. Judy first informed us that while 285 companies have held annual meetings, 430 more are slated for April with another 970 currently scheduled for May.  The panelists then provided interesting perspectives and useful advice on several issues relevant to public companies today, including the following:

Proxy Statements.  Doug discussed J&J's efforts to start from scratch for this year's proxy statement with an eye toward redesigning it for the individual investor, noting that a number of companies have attempted to make their documents attention getting, almost like glossy annual reports.  Due to its large volume of holdings, Bob stated that BlackRock's starting point for proxy review are the summaries generated by proxy advisor firms, before they dive into the proxy statements themselves.  CD&A summaries with the board's perspective, clarified through tabular and graphical disclosure, has been a helpful innovation, but they are not as enthusiastic about proxy summaries that may be trying to get ahead of proxy advisors and fail to include data that BlackRock would find important, such as conflicts of interests.

Say-on-Pay.  Pat reiterated that ISS has changed its methodology to place more emphasis on the three-year and five-year timeframe in its initial quantitative pay-for-performance analysis, as well as review overall pay magnitude.  More companies are providing proxy disclosure that already anticipates investor (and ISS) concerns, as a preemptive strike, which has proved to be helpful in allowing ISS to get information out to their clients faster and possibly avoid the need for so many of the ancillary filings made last year.  As a result of these and other improvements, Pat predicts that there will not be a substantial increase in opposition in 2012.  There has only been one instance so far of ISS making negative recommendations against the compensation committee as a result of unresponsiveness to the prior year's low votes.  Overall, average support levels are at 91% with 9% against, and the number of ISS' negative recommendations are currently running in the low teens.

Shareholder Engagement.  According to Bob, BlackRock has seen a significant increase in shareholder engagement during the post-season period, from July through February, as companies reach out to investors to interpret their vote result in order to build in those perspectives into their compensation committees' processes.  Board members have even met directly with investors when there have been real concerns.  While triggered by compensation, BlackRock has used these engagement opportunities to also speak to companies about other governance or performance questions.  Since BlackRock and likely other investors are not looking at the proxy statements until a week or two before the vote is due, Michelle emphasized that building an existing relationship with investors is the best way to facilitate those last-minute panicked calls to try to obtain support in the face of negative proxy advisory firm recommendations.  Doug recounted J&J's broad outreach efforts in light of the company's 61% support for say-on-pay in 2011, as they devoted more time and resources to gain an understanding of the vote results and explain their story.  On his part, Gordon believes that the 2012 proxy vote will be as much about the engagement process companies have undertaken in response to the 2011 say-on-pay vote as on the compensation paid. 

Shareholder Proposals.  Shareholder engagement is also the reason that there are fewer proposals this year, as companies and proponents agree on compromises after negotiations.  After speaking with hundreds of investors, Pat stated that it continues to be difficult to predict the level of support that proxy access shareholder proposals will receive.  About a dozen proposals are likely to come to vote.  Investors have indicated that rights to access should only be available at a reasonable ownership level, but have not quite agreed upon what level is reasonable.  Interestingly, the length of the holding period seem to be less of a concern to investors.  In giving their views on several different proposals, Bob and Michelle indicated that BlackRock believes a strong lead independent director can provide sufficient independent oversight without the need for an independent chair in all instances, but that a declassified board coupled with majority voting really enhances the accountability of directors.  With respect to the popular political contributions proposals, BlackRock conducts a case-by-case analysis on the nature of the proposal and the kinds of disclosure the company is already making.  Their advice for company opposition statements in proxy statements is to avoid starting with the conclusion that the proposal is not in the best interest of the company and instead focus on how the company has already addressed the concerns raised in the proposal. 

Among the new proxy disclosure requirements under the Dodd-Frank Act is the mandate that issuers disclose in their CD&A “[w]hether, and, if so, how the registrant has considered the results of the most recent shareholder advisory vote on executive compensation… in determining compensation policies and, if so, how that consideration has affected the registrant’s executive compensation decisions and policies.”  Thus far, the vast majority of the 110 large accelerated filers who filed proxy statements in the 2012 season through February 29, 2012 have addressed this new requirement in their CD&As.  Generally, the disclosure has been fairly predictable: those that received lower shareholder approval ratings on say on pay in 2011 have provided lengthier disclosure, often addressing changes made to their compensation programs, while those that received stronger shareholder support have simply stated that they have considered the results and decided to continue their previous compensation practices in light of the support.

However, 14 large accelerated filers have failed to disclose the effect of the 2011 say on pay vote results in their CD&As.  Of these, 9 did not mention the say on pay vote in their CD&A at all.  Five companies reported last year’s vote results but did not go on to discuss whether or how the company considered the result.

Interestingly, the failure to disclose the effect of last year’s say on pay vote has not negatively affected either ISS recommendations regarding this year’s say on pay proposals or say on pay results in 2012.  Of the 14 companies discussed above, the 9 that have received a recommendation on their 2012 say on pay proposal from ISS have all received a “for” recommendation.  Of the 14 companies discussed above, the 6 that have reported their 2012 say on pay results as of February 29, 2012 have all received above 90% shareholder support.  The lack of focus on the new disclosure by ISS and shareholders may be because all of these companies received at or above 89% shareholder support in 2011.  Query whether the SEC will be as forgiving with respect to companies that do not address the new disclosure requirement.

The Oregon district court provided a ray of hope for companies fearing the possibility of shareholder say on pay litigation when it handed down its January 11, 2012 decision granting Umpqua’s motion to dismiss a shareholder derivative suit alleging directors’ breach of duty and officers’ unjust enrichment after an increase in executive compensation.  In the decision, Magistrate Judge Acosta rejected the shareholders’ arguments that demand was futile because the directors were not independent or disinterested.

In Umpqua, plaintiff-shareholders argued that, where directors were likely to be subject to liability for the challenged actions, they could not be disinterested.  The court rejected that reasoning in this context, saying that an adverse say on pay vote coupled with the award of increased compensation did not reach the necessary threshold of substantial likelihood of liability necessary to show that demand would be futile under Delaware law.  (See our October 17, 2011 blog post on the success of companies in dismissing shareholder say on pay suits under Delaware and New York law).  That reasoning had been successful in defeating dismissal under Ohio law in Cincinnati Bell, a case filed by the same firm representing the plaintiffs in Umpqua.  The Oregon court disagreed, stating that accepting the reasoning “that presuit demand is itself suggestive of impending liability [and] is sufficient to create the type of self-interest that triggers the demand futility exception. . . would permit every derivative action plaintiff to argue that demand is futile. . . because no board would be able to act objectively in evaluating presuit demand.”  This would essentially negate the purpose of the demand requirement.

Despite the positive nature of the Umpqua decision for potential defendant-companies and the fact that, as the Umpqua decision points out, the holding in Cincinnati Bell has recently been called into question by jurisdictional defects, Cincinnati Bell Inc.’s December 20, 2011 decision to settle one of the say on pay shareholder suits may continue to fuel the plaintiffs’ bar’s desire to bring further suits.  For example, suit was filed against Navigant Consulting, Inc. on January 19, 2012 in the Northern District of Illinois alleging breach of fiduciary duty on the part of the board and executive officers for increasing executive compensation during a period of decreasing shareholder value.

It remains to be seen if court decisions such as that in Umpqua will quell the lawsuits.

NOTE: Umpqua was dismissed without prejudice.

Contact Kyoko Takahashi Lin. Contact Gillian Emmett Moldowan.

In December, ISS issued a whitepaper providing further guidance on its new pay-for-performance review framework first introduced in its 2012 proxy voting guidelines update (effective for meetings on or after February 1, 2012).  As described in our memo New ISS Policies Overhaul Say-on-Pay Analysis (November 29, 2011), the revised pay-for-performance methodology includes both a three-part quantitative analysis and a qualitative analysis.  The quantitative analysis is made up of two relative measures (“Relative Degree of Alignment,” comparing CEO pay and TSR performance against a comparison group over 1- and 3-year periods, and “Multiple of Median,” comparing the prior year’s CEO pay to the median pay of a comparison group for the same period) and one absolute measure (“Pay-TSR Alignment,” comparing trends in CEO annual pay and the value of an investment in the company over the prior 5-year period).

The whitepaper provides extensive detail on ISS’s pay-for-performance evaluation methodology, which continues to analyze pay based on award opportunity (and not realized pay) with a focus on Total Compensation as reflected in a company’s Summary Compensation Table.  Of particular interest, the whitepaper provides insight into (1) how ISS will construct a company’s relative alignment comparison group and (2) how the results of a company’s quantitative analysis will determine whether ISS considers the company to be at risk of having a pay-for-performance disconnect.

Comparison Group.  Comparison groups will consist of 14 to 24 companies selected from a database of more than 4000 companies (the Russell 3000 index, together with publicly traded peers disclosed by Russell 3000 companies in their proxy statements).  Comparison groups will be constructed twice per year, and will be selected from a group of companies within the same 2-digit GICS category, between 0.45 times and 2.1 times annual revenues (assets for financial companies) and with market capitalizations between 0.2 times and 5 times.  In constructing a comparison group, ISS will start with companies within the same 6-digit GICS category and those closest in revenue and market capitalization.  Approximately 25 unidentified “super-mega” non-financial companies (over $50 billion in revenue and at least $30 billion market capitalization) will make up their own comparison group.

Impact of Quantitative Analysis. The quantitative analysis is intended to identify companies with a likely pay-for-performance disconnect by identifying companies that are (1) high concern with respect to a single evaluation measure or (2) medium concern with respect to two or three evaluation measures.  The whitepaper includes the following table showing where results would trigger concern:

Measure	Medium Concern		High concern
Relative Degree of Alignment	-30	~25th percentile	-50	~10th percentile
Multiple of Median	2.33x	~92nd percentile	3.33x	~97th percentile
Pay-TSR Alignment	-30%	~10th percentile	-45%	~5th percentile

ISS’s new approach to evaluating pay-for-performance alignment is complex and may be difficult for companies to model on their own.  Despite this challenge, there are a number of actions companies can take to ready themselves for the second year of say-on-pay as described in our Say-on-Pay Year Two: a Planning Primer (December 13, 2011) memo.

Contact Kyoko Takahashi Lin. Contact Gillian Emmett Moldowan.

Proxy season 2012 has begun and we’re beginning to see disclosure on the impact of last year’s say on pay voting results.  As of December 16, 2011, 14 large accelerated filer companies have filed proxy statements for the 2012 season.  These proxy statements disclose whether, and to what extent, the companies considered the results of their 2011 management say on pay proposal and how that affected their compensation decisions and practices.  Unsurprisingly, the ten companies with high shareholder approval ratings (83% and higher) have provided simple and unremarkable disclosure.  These companies generally acknowledge their high ratings and cite them as support for continuing their compensation practices.

In contrast, disclosure varied among the four companies with lower shareholder approval ratings.  Mueller Water Products, Inc., who received approximately 78% approval from its shareholders in 2011, kept its disclosure short, indicating that the results were taken into account in determining the amounts of annual cash incentive awards for 2011 and in setting bonus targets for executive officers for 2012.  Johnson Controls, Inc., Jacobs Engineering Group, Inc., and Monsanto, Co., who had 60%, 45%, and 65% approval ratings respectively, all provided lengthy disclosure regarding how say on pay results were considered, and two companies disclosed changes in their compensation practices. 

Johnson Controls and Jacob Engineering both stated that feedback from investors was a factor in their decisions to modify their practices, with Johnson Controls changing annual and long-term incentive performance plan targets and Jacobs Engineering changing the form of awards and adding a performance condition to its long-term equity based incentive program.  In contrast, Monsanto did not alter its compensation practices in light of its results from say on pay.  Monsanto said that discussions with shareholders suggested no common reason for the negative votes and hypothesized that the results stemmed from poor fiscal performance in 2010.  Monsanto said it believes its compensation practices are sound and, based on improved performance in 2011, it thinks it will have improved say on pay results in 2012.

It appears that companies with solid support for their compensation practices are not providing extensive disclosure on the impact of say on pay results, while those who did not fare so well are taking steps to demonstrate they take say on pay seriously—even if they aren’t changing their compensation practices.  This bifurcated approach aligns with what we are hearing in discussions with other companies regarding disclosure for the 2012 proxy season.

Contact . Contact .

During its 2012 North American Proxy Season review, proxy advisory services firm Glass Lewis looked back to the 2011 proxy season and also gave insights as to what we can expect from them in 2012.  Highlights included:

Say-on-Pay.  Glass Lewis recommended against 17.5% of say-on-pay proposals in 2011.  They use a proprietary model to evaluate companies and come up with "A" to "F" grades.  10% of companies that they reviewed received "F"s in 2011, with the average say-on-pay results at those companies at 73%.  While, like ISS, they cite pay for performance issues as the primary reasons for causing negative recommendations, Glass Lewis also tends to cast an unusual focus on CD&A disclosure that sometimes surprises companies.  According to Glass Lewis, they find it problematic when companies disclose performance measures but not the rationale for the selection or the weighting of the measures, or when they perceive inadequate discussion of a compensation committee's exercise of discretion.  Glass Lewis grades CD&A disclosure as "poor, fair and good," and 5% of companies received "poor" citations in 2011.  They mentioned Amazon as an example of a company that, in their view, both performs and has appropriate executive compensation, but has poor CD&A disclosure.  In terms of evaluating company responses to prior year say-on-pay votes, Glass Lewis will examine those companies that received at least 75% negative votes for whether to recommend against either the chairman of the compensation committee or the entire committee, depending on companies' engagement efforts with shareholders and then the level of responses. 

Shareholder Proposals, Including Proxy Access.  Glass Lewis data shows that there were 443 shareholder proposals in 2011, a decrease from 591 in 2012, mainly attributable to the absence of compensation proposals in light of mandatory say-on-pay.  This year's most popular proposal, given the election year, will likely be on political contributions and related topics.  As for proxy access shareholder proposals, similar to ISS, Glass Lewis will review those on a case-by-case basis before making recommendations, including the percentage ownership requested and holding period requirement.  Their list of factors that they will consider is much longer than the ISS policy, including an analysis of the company's shareholder base in both percentage of ownership and type of shareholders, responsiveness of board and management to shareholders as evidenced by "progressive shareholder rights policies" such as annual elections and majority voting, and company performance and steps taken to improve bad performance. 

Exclusive Forum Provisions.  Glass Lewis discussed the selection of Delaware as an exclusive forum for shareholder derivative suits by 80 companies as of November, adopted either after seeking shareholder approval or by board action alone.  We recently blogged about ISS policies on this matter.  Like ISS, Glass Lewis generally recommends against an exclusive forum provision and a company will need to demonstrate that it has a long history of suffering from frivolous lawsuits to justify the proposal.  But Glass Lewis also takes it a step further and will recommend against the chairman of the governance committee if the company adopts exclusive forum provisions either without shareholder approval or pursuant to a bundled bylaw or charter amendment (where exclusive forum is coupled with other changes).  If a company adopts an exclusive forum provision before a company's IPO, Glass Lewis will recommend against the chairman of the governance committee or the board chairman if there is not a governance committee chairman. 

Talk to Us Now.  Glass Lewis reiterated that they do not engage with companies during the proxy season, long a frustrating policy for companies after they receive negative Glass Lewis reports, but they are available for discussions during the off-season.  At times during the proxy season, they will sponsor "proxy talks" involving a specific company and invited clients. 

Contact .

In what would appear to be the first filing of proxy access proposals by an institutional investor, Norges Bank Investment Management (NBIM), manager of the Norwegian Government Pension Fund, has recently filed proxy access shareholder proposals at six U.S. companies. The Norwegian Government Pension Fund held approximately $98 billion in U.S. equities and $63 billion in U.S. bonds as of the end of November.

According to its press release, NBIM filed shareholder proposals at Wells Fargo, Charles Schwab, Western Union, Staples, Pioneer Natural Resources and CME Group, asking each of the companies to establish procedures for shareholders to nominate candidates to the company’s boards of directors.  The NBIM proposal would require that shareholders own a minimum of 1% of the company’s stock for at least one year in order to nominate directors.  Under the proposal, up to 25 percent of the board may be nominated by shareholders. These proposals provide a lower threshold of stock ownership required for nomination than that of  the SEC’s vacated Rule 14a-11, which required ownership of 3% of a company’s shares for a period of three years in order to nominate a director.

All but one of the companies targeted by NBIM has seen a drop in its stock price over the last year.  In its press release, a spokesperson for NBIM said that it “will continue to identify companies with unsatisfactory performance.” According to an article in the Wall Street Journal today, NBIM selected the six targeted companies after a review more than 2000 of the fund’s U.S. holdings.  A spokesperson also said in the article that NBIM is “not planning [on nominating directors] now; we would much rather have a good dialogue with the board.”

Contact . Contact .

ISS has asked that we encourage interested parties to register for its free webinar to discuss its new proxy voting guidelines, which we recently summarized in a client publication.  The session focused on U.S. policies will take place on Wednesday, December 7, at 11:00 a.m. EST and will feature Martha Carter, Head of Governance Research; Carol Bowie, Head of U.S. Compensation Research; and Pat McGurn, Special Counsel. 

Having been on panels with Carol and Pat, both frequent speakers about ISS, it is always helpful to hear them discuss ISS' recent experiences and the background and application of ISS guidelines.  They may explain and further elaborate on some of the seeming complexities of the new pay for performance criteria that will be used to evaluate say-on-pay in 2012, and may provide indications of their upcoming guidance to be issued on the topic, likely in mid-December.  They may also give a sense of the latest status of proxy access proposals.  While many are critical of it, no one disputes the reality of ISS' influence on proxy voting, so this is a welcome opportunity for education as a key step toward being prepared. 

A separate discussion of the European policies will take place a day earlier, and you can find registration for that session on the same site as noted above.   

Contact .

Exclusive forum provisions in charters and bylaws, under which derivative suits and other shareholder litigation must be brought in the courts of the company's state of incorporation, drew some attention during the 2011 proxy season.  My recent piece summarizing the state of the law and the practice on this subject is here.  No consensus on this topic has yet emerged among institutional investors, and the 2011 votes were close and had mixed results.

ISS's position on these provisions in the 2011 season ignored the merits of exclusive forum requirements and instead looked to a set of largely unrelated governance "best practices":

• annual election of directors
• majority voting for directors in uncontested elections
• 10% shareholders having the right to call special meetings
• the absence of a poison pill unless approved by shareholders

Only companies that had adopted all four of these practices would receive an ISS recommendation in support of an exclusive forum provision.

ISS has revisited this policy in connection with its overall policy review for the 2012 season and, as often seems to be the case with ISS, has taken a step or two forward and a step back.  Instead of the checklist approach used in 2011, ISS says that this issue will now receive "case-by-case" analysis, taking into consideration most of the same factors that were in the checklist.  The weighting of these factors is unclear.

A step forward is the deletion of the 10% shareholder special meeting requirement from the list of best practices.  ISS acknowledges that "this governance feature is less relevant to exclusive venue than it is to other proposals".  (The same could of course be said about the other items on the list, but never mind.)

The step backward is the addition of a new factor that ISS says it will consider: "[w]hether the company has been materially harmed by shareholder litigation outside its jurisdiction of incorporation, based on disclosure in the company's proxy statement."  It's hard to make sense of this one, since exclusive forum provisions are by their nature prophylactic and not retrospective.  If avoidance of potentially duplicative litigation is a legitimate goal, it hardly becomes less legitimate if the company has not yet been a victim of the practice.  This would be akin to saying that you shouldn't buy fire insurance unless your house has burned down at least once in the past.

The new guidelines make ISS's position on any particular company's proposal less predictable than before, and to that extent further complicate the decision tree for companies considering whether to adopt an exclusive forum provision and, if so, whether to submit it for shareholder approval.  We may need to see another proxy season's results before this becomes more clear.

Contact Bill Kelly.

Last week, the U.S. Proxy Exchange, an organization supporting retail shareholder activists, released its Model Proxy Access Proposal. According to an ISS blog, two proxy access proposals which closely resemble the U.S. Proxy Exchange’s model proposal were filed by retail shareholder activist Ken Steiner at MEMC Electronic Materials, Inc. and Textron Inc. on November 11th and November 15th, respectively.  The model proposal provides a lower threshold of stock ownership for shareholder nomination of directors than that contemplated by the SEC’s vacated Rule 14a-11, which required ownership of 3% of a company’s outstanding shares in order to nominate a director.  The model proposal recommends that the company’s proxy include nominees of: “any party of one or more shareholders that held continuously, for two years, 1% of the Company’s securities eligible to vote for the election of directors” or any party of 100 or more shareholders that satisfy SEC rule’s 14a-8(b) eligibility requirements ($2000, or 1% of company’s securities eligible to vote, continuously held for at least 1 year). In addition, the model proposal provides that any one party may make one nomination to the board or, if greater, a number of nominations equal to 12% of the current board members.  In its comments to the proposal, U.S. Proxy Exchange noted that the 12% provision is intended to dissuade boards from growing beyond 16 members in response to proxy access provisions.

These targeted companies are not obvious choices to receive shareholder access proposals. MEMC Electronic Materials and Textron both received relatively strong support in their 2011 say-on-pay votes: 81% and 82%, respectively. In addition, both companies’ GRId profiles are low concern on board and medium concern on both compensation and shareholder rights.  Nonetheless, both proposals do focus on executive compensation.  The MEMC Electronic Materials proposal states that the company’s CEO was awarded “options worth over $14 million in 2009 without performance-contingent criteria” and the “CEO’s 2011 annual awards will be 20%-based on a subjective analysis of personal metrics.” In addition, MEMC Electronic Materials has seen a 63% drop in its stock price over the last 52-week period.  The Textron shareholder proposal notes that “[e]xecutive compensation is a particular concern” and refers to a “potential $39 million payout to our CEO.” Textron’s shares had declined 11.8% over the previous 52-week period.

One wonders whether these proposals will prove beneficial to the proponents of proxy access.  We would expect that even if these proposals survive no-action challenges by the company, they will most likely fail to obtain shareholder approval and may set a precedent that shareholders are not in favor of proxy access. In addition, any proxy access proposal submitted first by a retail shareholder could be used by a company as a basis for exclusion of a proposal received later from an activist institution.

The head of the U.S Proxy Exchange has indicated that their members plan to file at least four more proposals.  The filing of two shareholder proposals right on the heels of the U.S. Proxy Exchange’s Model Proxy Access Proposal, combined with the fact that a number of companies have proxy filing deadlines in December, may indicate that there will be more proxy access proposals than initially expected this season. 

Contact . Contact .

Section 951(b)(2) of Dodd-Frank requires companies to hold a non-binding shareholder vote on executive severance packages (golden parachutes) in connection with M&A transactions that are presented for shareholder approval.  Shareholder votes on golden parachutes have been required since April 25, 2011.  Pearl Meyer & Partners recently completed a study on the outcomes of such shareholder votes held between April 25, 2011 and September 26, 2011. 

According to the Pearl Meyer study, during this period, 37 companies included golden parachute disclosure and votes in their merger proxies, 24 of which to date have publicly disclosed the results of the golden parachute vote.  Each golden parachute vote received support of a majority of shareholders, with the median vote equal to 91% approval.  Interestingly, Pearl Meyer noted that the median support for the related merger transactions was 99%.  The study shows that shareholders are generally voting in favor of golden parachutes where the shareholders approve of the related merger transaction, but at slightly lower rates.

Pearl Meyer also noted that ISS issued reports on 32 of the 37 transactions.  Four of ISS’s reports contained a negative recommendation for the golden parachute votes.  Of the golden parachute votes that did not receive ISS support, according to the Form 8-Ks filed reporting the results of such votes, a majority of shareholders still approved each golden parachute vote (albeit by a percentage somewhat below the median – approval votes ranged from 57% to 95%).  Based on this early data, it appears that while ISS may have the ability to sway shareholder votes to some extent, the shareholders’ votes on golden parachutes are closely linked with shareholders’ views regarding the related merger transaction.  The “say on golden parachutes” vote therefore may not greatly affect a company’s decision(s) with respect to the golden parachute payments offered to executives and officers.

Contact .

Section 953(b) of Dodd-Frank requires companies to disclose the internal pay ratio between the total annual compensation of their CEO and the median total annual compensation of their employees.  Effectiveness of the requirement has been delayed until the SEC promulgates implementing rules.  Meanwhile, companies have complained that the calculations required to comply with the disclosure requirement are burdensome and unfeasible, and proposals for Section 953(b)’s repeal have been introduced in Congress. 

Against this background, it is somewhat surprising that shareholder proposals seeking disclosure of the internal pay ratio decreased in 2011, and average shareholder support for this disclosure has remained low (although it increased slightly in 2011).  According to an executive compensation bulletin published by Towers Watson in June 2011, shareholder proposals with respect to internal pay ratio disclosure dropped from 9 in 2010 to 3 in 2011 (through mid-June), while average shareholder support increased from 6.2% to 9.1%.

One such example of a failed shareholder proposal is the 2011 proposal by the International Brotherhood of DuPont Workers calling for the board of directors of E. I. du Pont De Nemours to compare the “compensation packages for senior executives with that provided to the lowest paid employees.”  The proposal received just 5.8% in shareholder support.

Some companies already address concerns regarding internal pay equity.  Examples of such “proactive” companies include Whole Foods Market, which places a cap (expressed as a multiple of the company’s average wage) on executive cash compensation, NorthWestern Corporation, which voluntarily disclosed in its 2011 proxy that its targeted compensation for its CEO in 2010, excluding benefits, was 18 times the median pay of all its employees, and Goldman Sachs, which released supplemental proxy materials dedicated exclusively to its compensation practices.

A possible reason for this lack of activism may be that shareholders as a whole are less concerned with internal pay ratio disclosure than with other areas of compensation policy, such as linking pay to performance and requiring executives to retain a significant percentage of their equity.

As we wait to see where the SEC and Congress will come out on mandatory internal pay ratio disclosure, it is difficult to predict where we will end up, but one thing looks certain – shareholder proposals are not currently leading the charge. 

Contact .

A unanimous D.C. Circuit panel this morning invalidated Rule 14a-11 as "arbitrary and capricious", ruling that the SEC had failed to consider the potential costs and other impacts of the rule.  This outcome was fairly predictable given the composition of the panel that decided the case, but even so the scathing and dismissive tone of the opinion is remarkable.  The panel essentially swallowed the Business Roundtable and Chamber of Commerce arguments hook, line and sinker, even to the point of second guessing which academic studies the Commission should have relied upon and which it should have disregarded.

Where do we go from here?  Barring intervention from the Supreme Court, the decision sends the SEC back to square one: a dispiriting prospect, given that the subtext of the opinion is that this panel at least would have thrown out pretty much anything that the SEC might have put forth.  It's also hard to imagine the current Congress coming up with a statutory solution.  This means that the initiative on this subject may be back with companies and shareholders, where it arguably should have been all along.

Contact .

It has been frustrating for companies who want to benefit from the substantial cost-savings provided by the SEC notice and access rules to discover that they must also comply with the Department of Labor (DOL) ERISA rules regarding electronic communications to employees, if for example the employee shareholders hold company stock through a 401(k) plan that is registered on a Form S-8.  As a practical matter, using notice and access for employee benefit plan participants has proved prohibitively difficult.  The ERISA rules permit electronic delivery of documents only to participants who have the ability to access them at their regular place of work, and who have access to the company's electronic information system as an integral part of their duties.  Even for those participants, administrators must try to ensure actual receipt of the documents and provide notice about the documents' significance.  For participants who do not meet this test (e.g., former employees and current employees who do not work at computers) an affirmative consent, with specific content requirements, is required.

The DOL recently published a request for information (RIF) soliciting "views, suggestions and comments" from interested parties on the use of electronic media by employee benefit plans to furnish information to participants.  The rules have not been updated since 2002, a lifetime ago in terms of technological changes.  The deadline is June 6th.  This may be an opportunity to alert the DOL of the important need to finally align the ERISA rules with notice and access.  One suggestion might be to permit plans to send plan participants and beneficiaries a paper notice/election stating that, unless a participant affirmatively elects otherwise, electronic access will be the default mode of access for certain items (such as proxy statements and cards).  For other items, such as plan benefit statements, the notice could provide that the default will be a paper mailing, unless a participant affirmatively elects electronic access in lieu of paper.  This notice/election could also be provided to new participants when they join a plan.

Contact .  Contact . 

The SEC staff issued a surprising CDI recently.  Seems that the biographies of directors who are not standing for re-election are required to be disclosed under both Item 401(a) and Item 401(e) of Regulation S-K, if not technically in the proxy statement, then in the Form 10-K.  Why investors would be interested in the bios of directors who won’t be continuing is a bit of a mystery.  And for those of you who have asked – Item 401(a) only applies to your current directors.  If they resigned before your published your proxy statement, you don’t have to worry about their biographies.

Contact Ning Chiu.

The SEC has stayed implementation of its newly-adopted proxy access rules, including the amendments to Rule 14a-8, pending resolution of a legal challenge to the rule brought by the Business Roundtable and the US Chamber of Commerce.  These controversial rules will likely not be applicable before the 2012 proxy season, at the earliest. Click here to view the SEC order.

Contact Phillip Mills.