ISS Publishes Proposed Updates to Its 2013 Proxy Voting Guidelines, Including Making Board Responsiveness Policy More Stringent and Revising Pay-for-Performance Test to Account for Company Peer Group and Realizable Compensation SEC Staff Issues Legal Bulletin on Shareholder Proposal Process SUMMARY As issuers and shareholders plan for the 2013 proxy season, they should take into account recent publications by Institutional Shareholder Services, proposing changes to its voting policies on director elections, management say-on-pay proposals and other matters, and by the SEC s Division of Corporation Finance, providing guidance under Rule 14a-8 on shareholder proposal process issues. ISS 2013 PROPOSED POLICY UPDATES ISS, the influential proxy advisory firm, published for public comment on October 16 the following proposed changes to its proxy voting guidelines for 2013: Recommending a vote against or withhold from directors who did not act to implement a shareholder proposal that received a majority of votes cast in the prior year. Under ISS s current policy, it would recommend such a vote only if the shareholder proposal had received a majority of votes outstanding in the prior year, or a majority of votes cast in the prior year and one of the two previous years; Modifying its executive compensation analysis for purposes of management say-on-pay proposals to align its peer group selection more closely with company-selected peer groups and to add realizable pay (as compared to grant date pay) and pledging of company shares by executives and directors as two new qualitative factors; Placing greater emphasis on all change-in-control arrangements (as compared to recent changes to those arrangements) in connection with say-on-golden-parachute votes now required under the Dodd-Frank Act; and New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
Changing its recommendation to vote case-by-case on shareholder proposals seeking sustainability metrics (as compared to its current recommendation of generally vote against ). The proposed change to the board responsiveness policy would not only increase the pressure on boards to implement precatory shareholder proposals but could also cause issuers to take steps to prevent such a proposal from coming to a vote and passing in the first place, such as by implementing or proposing a different form of the proposed action. Furthermore, ISS apparently contemplates that this proposed change may have retroactive effect, in that it may apply to vote recommendations in 2013 based on the outcome of a 2012 shareholder vote. The comment period for the policy changes ends on October 31, 2012, and the new policies would apply for annual meetings on or after February 1, 2013. All public companies are invited to comment on the proposal. SEC STAFF LEGAL BULLETIN NO. 14G RELATING TO RULE 14A-8 SEC Staff Legal Bulletin No. 14G, also issued on October 16, provides guidance on a number of technical issues relating to the Rule 14a-8 shareholder proposal process, including clarifications of the SEC staff s position on proof of share ownership by indirect owners, requirements for deficiency letters and the use of website references in proposals and supporting statements. ISS 2013 PROPOSED POLICY UPDATES On October 16, 2012, ISS released the 2013 draft updates to its proxy voting guidelines for comment by investors and issuers. 1 Issuers should consider the proposed updates, summarized below, including any impact they may have on the expected level of support for the directors or the company s other proposals. These policies would apply to shareholder meetings held on or after February 1, 2013. Comments on the proposed policy changes are due by October 31, 2012. BOARD RESPONSE TO MAJORITY-SUPPORTED SHAREHOLDER PROPOSALS ISS is proposing a more stringent approach to its policy regarding implementation of shareholdersupported proposals from past years. Specifically, if the proposed policy is adopted, ISS would recommend a vote against or withhold from the entire board (except new nominees, for whom its recommendation would be case-by-case) if the board failed to implement a shareholder proposal that received the support of a majority of the votes cast in the previous year. Currently, ISS employs two less strict criteria, recommending a vote against or withhold if the board failed to act on a shareholder proposal that received the majority support of either (1) the shares outstanding in the previous year or (2) the votes cast in the last year and one of the two previous years. 1 The proposed policy updates are available at http://www.issgovernance.com/policycomment2013. -2-
The adoption by ISS of such a policy would change the current approach of many issuers, which is to allow shareholder proposals to come to a vote and then, taking the voting results, shareholder feedback and market trends into account, to determine whether and how to take responsive action without the threat of impending negative recommendations on directors. Instead, an issuer would be more likely to take action to prevent a precatory shareholder proposal from coming to a vote and passing in the first place for example, by implementing, or proposing to implement, changes that address the topics raised by a proposal in a different manner than that requested by the proposal. This policy change appears to contemplate retroactive application, in that ISS would recommend against or withhold votes in 2013 based on voting results in 2012, even though those voting results occurred prior to the adoption of the new policy. Retroactive application in this manner, however, would be unfair to companies that relied on ISS s existing policies and determined to allow a shareholder proposal to come to a vote in 2012, even though there was a risk that it would pass by a majority of votes cast. These companies may have done so because the directors justifiably expected to have time to take shareholder responses and market trends into consideration in deciding how to proceed without facing an immediate requirement to implement the specific proposal. An abrupt change in policy by ISS would be procedurally unfair. Recommending against or withhold votes in 2013 based on 2012 results would fail to give appropriate consideration to those directors good faith reliance on ISS s then-existing policies in deciding how to approach shareholder proposals in 2012. Sullivan & Cromwell and others have raised this concern with representatives of ISS, and our firm intends to submit a formal comment in this regard. EXECUTIVE COMPENSATION EVALUATION POLICY ISS is proposing to change three inputs, both quantitative and qualitative, to the executive compensation evaluation policy that it adopted a year ago for purposes of formulating a recommendation on the company s advisory say-on-pay proposal: incorporating information about a company s self-selected peers into ISS s methodology for selecting peer groups as part of its quantitative pay-for-performance analysis; including a comparison of realizable pay to grant date pay as part of its qualitative pay-forperformance analysis at large cap companies; and adding pledging of shares as a negative qualitative factor in assessing executive compensation. Peer group methodology. In conducting its quantitative analysis of pay-for-performance, ISS assesses a relative alignment, comparing companies within groups of 14-24 peers selected on the basis of market capitalization, revenue (or assets for financial firms), and GICS industry group. 2 2-3- ISS s construction of Global Industry Classification Standard, or GICS, is an industry taxonomy developed by Standard & Poor s and MSCI that categorizes companies based on two-digit sector codes, four-digit industry group codes within those sectors, six-digit industry codes and eight-digit sub-industry codes.
peer groups was a common subject of criticism by companies in the 2012 proxy season. 3 As ISS notes, its current focus on the subject company s GICS industry classification may not reflect multiple business lines in which the company operates, sometimes leading to the exclusion of a company s competitors from, or the inclusion of inappropriate comparisons in, the ISS peer group. ISS s draft revision would incorporate information about a company s self-selected peers to improve this relative comparison. The proposed change in methodology would draw peers from GICS classifications represented in the company s self-selected peer group, while maintaining the approximate proportions of these industries in the ISS peer group where possible. The methodology also would prioritize peers that maintain the company near the median of the peer group, that are in the subject company s peer group, and that have chosen the subject company as a peer. 4 Because many companies create peer groups based on multiple factors in addition to the GICS group, it is possible that ISS s focus on that factor may have unintended consequences. It may be useful for companies to review their current peer group from ISS s proposed perspective and evaluate the result. Realizable pay. If ISS s quantitative pay-for-performance analysis demonstrates weak alignment, then ISS conducts a further qualitative review to determine a final vote recommendation on management sayon-pay. This qualitative review takes into account a broad range of factors, including the use of performance-based awards, performance goals, peer group benchmarking, and financial performance. ISS is proposing adding realizable pay as compared to grant pay as one of these factors for large cap companies. Realizable pay would consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. In other words, it calculates performance-based pay by the final payouts made (or changes in value to ongoing awards) due to gains or losses in the company s stock price over the measurement period. In doing so, it attempts to show how executive pay has been affected by performance. ISS states that grant date pay, by contrast, shows the intent of the pay decisions of the compensation committee. Unfortunately, neither the SEC s current summary compensation table nor ISS s proposed realizable pay calculation is entirely consistent, with both including elements of both grant date pay and earned pay. Pledging of shares. ISS currently evaluates pay elements that are not based directly on performance on a case-by-case basis, but it maintains a list of problematic practices that carry significant weight in this overall consideration and may result in adverse vote recommendations. ISS is proposing adding 3 4 For a discussion of ISS s executive compensation methodology, including common criticisms thereof, see our publication, dated July 9, 2012, entitled 2012 Proxy Season Review. Additional proposed changes include focusing initially on an 8-digit GICS classification to identify comparable peers in terms of industry (as opposed to the current 2-digit GICS focus), using slightly relaxed size requirements (especially at very small and very large companies), and using revenues instead of assets for certain financial companies. -4-
pledging of company stock by executives or directors to this list of problematic practices. 5 In ISS s view, pledging stock for margin accounts or other loans may adversely affect shareholders or the company by, among other possibilities, forcing the executive or director to sell a significant amount of company stock to satisfy a margin call, which could impact the company s stock price or violate company insider trading policies, as well as allowing the executive or director to hedge economic exposure to the company s stock, even while maintaining voting rights. Although, as ISS notes, pledging policies are not tied to compensation, it believes say-on-pay proposals are a reasonable mechanism for shareholders to voice concern with companies pledging policies because most executives and directors receive a substantial portion of their company shares through compensation programs. Details not yet published. The proposed executive compensation policy changes generally omit significant details, especially as to the realizable pay and pledging of shares revisions. For example, ISS expressly seeks comments regarding the appropriate measurement period for realizable pay and how to define a significant level of pledging of company stock that causes concern for investors. Accordingly, it may be difficult for companies to assess how ISS will evaluate particular compensation decisions under the proposed policy changes. SAY-ON-GOLDEN-PARACHUTE PROPOSALS Under SEC rules adopted in January 2011 pursuant to the Dodd-Frank Act, companies are required to hold a separate advisory vote on potential severance and change-in-control payments when seeking shareholder approval for mergers and other similar transactions. ISS s proposed policy change regarding these so-called say-on-golden-parachute votes would continue to evaluate proposals on a case-by-case basis and take into account the factors set forth in ISS s existing policies, adopted by ISS a year ago, such as single-trigger acceleration of unvested equity awards, excessive severance payments, and a company s assertion that the proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. The proposed 2013 policy, however, includes a focus on all existing change-incontrol arrangements with executive officers, rather than focusing only on new or extended arrangements as under the current policy. Thus, for example, where the current policy considers factors such as recently adopted or materially amended agreements that include modified single triggers or excise tax gross-up provisions, the proposed 2013 policy would consider factors such as, simply, Single- or modified-single-trigger cash severance and Excessive golden parachute payments (on an absolute basis or as a percentage of transaction equity value). It also offers a specific definition for excessive cash severance: greater than three times base salary and bonus. The proposal states that recent amendments that incorporate problematic features will tend to carry more weight on the overall analysis, but that the presence of multiple legacy problematic features also will be closely scrutinized. 5 Companies are required to disclose shares pledged by executive officers and directors in the proxy statement pursuant to Item 402(b) of Regulation S-K. -5-
ISS indicated that these proposed policy changes will likely increase the number of ISS negative vote recommendations. ENVIRONMENTAL, SOCIAL, AND GOVERNANCE METRICS FOR COMPENSATION ISS is proposing to modify its general position on shareholder proposals urging the company to link executive compensation to environmental and social non-financial performance (often referred to as sustainability metrics ) from generally vote against to vote case-by-case. Additionally, the policy would delete the illustrative list of specific social and environmental criteria to which a shareholder proposal might seek to link compensation, 6 thus employing only the general term sustainability criteria, and would clarify that sustainability refers equally to environmental and social issues. Finally, in evaluating any particular proposal, ISS would change the existing factor of whether the company has significant and persistent controversies or violations regarding sustainability issues to whether the company has significant and/or persistent controversies or violations. These changes are intended to provide ISS with greater flexibility to incorporate developments in evolving environmental and social issues, particularly for certain industries such as the extractive industry sector or other sectors where companies have greater exposure to environmental issues. SEC STAFF LEGAL BULLETIN NO. 14G RELATING TO RULE 14A-8 Staff Legal Bulletin No. 14G ( SLB 14G ) 7 provides further guidance on a number of process issues that have caused significant confusion, and thus been the subject of past Staff Legal Bulletins and no-action requests, relating to Rule 14a-8 shareholder proposals. PROOF OF BENEFICIAL OWNERSHIP Rule 14a-8(b) provides that, to be eligible to submit a shareholder proposal for inclusion in the company s proxy materials, a shareholder must provide documentation proving that the shareholder has continuously held at least $2,000 in market value or 1% of the company s securities entitled to vote at the shareholder meeting for at least one year as of the date the shareholder submits the proposal. If the shareholder is a beneficial owner of the securities, Rule 14a-8(b)(2)(i) provides that this documentation can be in the form of a written statement from the record holder of the securities. In October 2011, the SEC s Division of Corporation Finance published Staff Legal Bulletin No. 14F, which provided guidance on the definition of record holder for purposes of the proof of ownership requirement, 6 7 Under the existing policy, those specified criteria are corporate downsizings, customer or employee satisfaction, community involvement, human rights, environmental performance, or predatory lending. SLB 14G is available on the SEC website at http://www.sec.gov/interps/legal.shtml. -6-
stating that only securities intermediaries that are participants in The Depository Trust Company ( DTC ) system should be viewed as record holders of securities that are deposited at DTC. 8 This year, in SLB 14G, the Division noted that, during the 2012 proxy season, some companies questioned the sufficiency of proof of ownership letters from entities that were affiliates of DTC participants, but were not themselves DTC participants. The Division formalized the position it took in several no-action letter responses during the 2012 proxy season, stating that a proof of ownership letter from an affiliate of a DTC participant 9 will satisfy the requirement to provide proof of ownership for purposes of Rule 14a-8(b)(2)(i). The Division also indicated that it will require greater specificity from issuers in their deficiency letters to shareholders before allowing the exclusion of a proposal for failure to provide proof of ownership for the specific one-year period required. In submitting proof of ownership, shareholders must verify that they own the requisite amount of shares for the one-year period preceding and including the date on which the shareholder submits the proposal. If an ownership letter refers to a date before the proposal is submitted, or if it refers to a date after the proposal was submitted but covers a period of only one year, then the letter fails to provide proof of beneficial ownership over the full one-year period. In either case, under Rule 14a-8(f), the company may exclude the proposal only if the company notifies the shareholder of the defect and the shareholder fails to correct it. In SLB 14G, the Division takes the position that it will not allow a proposal to be excluded under Rules 14a-8(b) and 14a-8(f) unless the company s deficiency letter identifies the specific date on which the proposal was submitted and explains that the proponent must obtain a new proof of ownership letter covering the full one-year period to cure the defect. According to the Division, identifying the specific submission date in the deficiency letter will aid shareholders in instances when it is difficult for them to determine the submission date on their own, such as when the proposal is postmarked with a different date than when the shareholder placed it in the mail. Additionally, the Division states that companies should include copies of the postmark or evidence of electronic transmission with their no-action requests. USE OF WEBSITES IN PROPOSALS AND SUPPORTING STATEMENTS The Division also formalized its no-action position that shareholders may include references to websites within a proposal or supporting statement, and that the website will continue to count as only one word for purposes of the 500-word limitation, subject to the following three qualifications: 8 9 For a detailed discussion of SLB 14F, see our publication, dated October 28, 2011, entitled 2012 Proxy Season Developments. According to SLB 14G, an entity is an affiliate of a DTC participant if the entity directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the DTC participant. -7-
First, under Rule 14a-8(i)(3), a company may exclude a proposal as vague and indefinite if neither the shareholders voting on the proposal, nor the company in implementing it (if adopted), would be able to determine with reasonable certainty exactly what actions or measures the proposal requires. Where the shareholder proposal or supporting statement refers to a website, the Division takes the position that the proposal and supporting statements themselves nevertheless still must contain the information necessary to satisfy this definiteness requirement. That is, even if information available on the website supplements the proposal, shareholders and the company must be able to discern exactly what the proposal requires without reviewing the information provided on the website. Second, a proposal cannot be excluded solely because the referenced website is not yet operational. To benefit from this position, however, the shareholder must provide the company, at the time when the proposal is submitted, with the materials intended for publication on the website and a representation that the website will be operational when the company files its definitive proxy. Third, because a shareholder easily may change website content after submission of a proposal, the Division takes the position that a company may seek SEC staff approval to exclude a website reference if later revisions to the website render it excludable for any reason. Furthermore, although Rule 14a-8(j) requires a company to submit reasons for exclusion no later than 80 days before filing its definitive proxy materials, the Division indicated that we may concur that the changes to the referenced website constitute good cause for a company to request and receive a waiver of the 80-day deadline. * * * Copyright Sullivan & Cromwell LLP 2012-8-
ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Jay Plum (+1-212-558-4049; plumj@sullcrom.com) in our New York office. CONTACTS New York Robert Buckholz +1-212-558-3876 buckholzr@sullcrom.com Catherine M. Clarkin +1-212-558-4175 clarkinc@sullcrom.com Jay Clayton +1-212-558-3445 claytonwj@sullcrom.com Audra D. Cohen +1-212-558-3275 cohena@sullcrom.com H. Rodgin Cohen +1-212-558-3534 cohenhr@sullcrom.com Donald R. Crawshaw +1-212-558-4016 crawshawd@sullcrom.com Robert W. Downes +1-212-558-4312 downesr@sullcrom.com Matthew M. Friestedt +1-212-558-3370 friestedtm@sullcrom.com Joseph B. Frumkin +1-212-558-4101 frumkinj@sullcrom.com David B. Harms +1-212-558-3882 harmsd@sullcrom.com Alexandra D. Korry +1-212-558-4370 korrya@sullcrom.com Stephen M. Kotran +1-212-558-4963 kotrans@sullcrom.com John P. Mead +1-212-558-3764 meadj@sullcrom.com Scott D. Miller +1-212-558-3109 millersc@sullcrom.com James C. Morphy +1-212-558-3988 morphyj@sullcrom.com Robert W. Reeder III +1-212-558-3755 reederr@sullcrom.com Robert M. Schlein +1-212-558-4848 schleinr@sullcrom.com Glen T. Schleyer +1-212-558-7284 schleyerg@sullcrom.com Max J. Schwartz +1-212-558-3936 schwartzmax@sullcrom.com Andrew D. Soussloff +1-212-558-3681 soussloffa@sullcrom.com Marc Trevino +1-212-558-4239 trevinom@sullcrom.com -9-
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