Focus on Excessive Non-Employee Director Compensation, Board Diversity and Gender Pay Gap Continues While Poison Pills Return to the Spotlight SUMMARY Yesterday, Institutional Shareholder Services published updates to its benchmark proxy voting policies applicable to meetings held on or after February 1, 2018. For U.S. companies, the key updates are: Non-Employee Director Pay: Vote recommendations against the committee members responsible for setting non-employee director (NED) compensation if there is a recurring pattern (e.g., two or more successive years) of excessive NED pay without a compelling rationale or other mitigating factors. This update, however, will not affect 2018 vote recommendations. Poison Pills: Vote recommendations against the full board at companies that maintain longterm poison pills that were not approved by shareholders. Members of annually elected boards would receive against recommendations on an annual basis, rather than every three years. Commitments to put a pill to a vote the following year would no longer be considered a mitigating factor. Boards with 10-year pills currently grandfathered from 2009 would no longer be exempt and would receive against recommendations. Shareholder Proposals on Gender Pay Gap: Vote recommendations on a case-by-case basis on shareholder proposals requesting reports, policies or goals related to gender pay inequity. This update is intended to provide more clarity on the relevant factors because ISS expects the number of gender pay gap proposals to grow. Increasing Focus on Board Diversity: Highlighting of boards with no gender diversity, although this factor will not drive adverse vote recommendations. Pay-for-Performance Evaluation: Quantitative analysis of CEO total pay and company financial performance within a peer group (each over a three-year period). This analysis was added to the qualitative review last season but will now apply as part of the quantitative Peer Group Alignment factor for companies in the Russell 3000 or Russell 3000E Indices. Board Responsiveness to Say-on-Pay: Evaluation of additional factors, including the timing and frequency of engagements, whether independent directors participated and disclosure of the specific concerns voiced by dissenting shareholders. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Brussels Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
Pledging: Vote recommendations against committee members that oversee risks related to pledging if a significant level of pledged company stock raises concerns. Although there has not previously been an explicit policy, ISS has been recommending on this basis since 2013 under its Governance Failures policy. DESCRIPTION OF 2018 U.S. POLICY UPDATES A. PROBLEMATIC COMPENSATION PRACTICES 1. Excessive Non-Employee Director Compensation The update responds to increasing investor focus on NED compensation, including shareholder challenges brought in proxy contests or legal actions. ISS will generally recommend against members of the board committee responsible for approving or setting NED compensation if there is a pattern of awarding excessive NED compensation without disclosing a compelling rationale or other mitigating factors. ISS defines a pattern as two or more years in a row. Therefore, this new policy will not impact vote recommendations in 2018 and will be triggered only after a pattern of excessive NED pay in consecutive years. The update does not define excessive, although it suggests that it will be evaluated on a basis relative to peers and, potentially, the broader market. 2. Problematic Pledging of Company Stock The update provides for an against vote recommendation for members of the committee that oversees risks related to pledging 1 if a significant level of pledged company stock by executives or directors raises concerns. ISS will consider the following factors when making its recommendation relating to problematic pledging: the presence of an anti-pledging policy disclosed in the proxy statement that prohibits future pledging activity, the magnitude of the aggregate pledged shares, the disclosure of progress (or lack thereof) in reducing the magnitude of aggregate pledged shares over time, proxy disclosure that states shares subject to stock ownership and holding requirements do not include pledged company stock and any other relevant factors. Although there has not previously been an explicit policy, ISS states that it has been recommending on this basis since 2013 under its Governance Failures policy. 3. Failure to Include Say-on-Pay Ballot Items The update provides that ISS will recommend against the compensation committee if the company fails to include a say-on-pay ballot item when required by SEC rules or under its own say-on-pay frequency or if the company fails to include a say-on-pay frequency vote when required. Historically, when companies did not have the say-on-pay on their ballot when required, ISS had been recommending against the election of the compensation committee members. The update codifies this preexisting practice. In addition, large companies who held their initial say-on-pay frequency votes in 1 As a general matter, if the full board is responsible for a decision as opposed to a committee, ISS will recommend against all members of the board. The update does not affect this policy, and we do not distinguish between these two circumstances in this memorandum. -2-
2011 were required to hold them again in 2017. Some companies inadvertently omitted the vote, and ISS states that it reached out to companies that lacked the ballot item so that they could add it to the agenda if required. For companies that were on a biennial or triennial frequency and did not have the required vote, ISS recommended against their say-on-pay resolution or, in its absence, against members of their compensation committees. There was not an adverse vote recommendation if the company failed to timely present a frequency proposal but maintained an annual say-on-pay vote. 4. Other Problematic Pay Practices The update removes two current problematic pay practices. ISS states that the first, failure to submit onetime transfers of stock options to a shareholder vote, was so rare as to no longer require a separate policy. ISS notes, however, that it will continue to recommend against compensation committee members on this basis. The second practice removed, failure to fulfill the terms of a burn rate commitment, is no longer relevant because ISS stopped considering new three-year burn commitments following the introduction of its Equity Plan Scorecard in the 2015 proxy season. B. NON-SHAREHOLDER APPROVED LONG-TERM POISON PILLS The update provides that ISS will recommend against annually elected board nominees every year (instead of every three years) at companies that maintain a long-term poison pill that was not approved by shareholders. Previously, annually elected boards would only receive an against recommendation every three years. Putting the long-term poison pill to a shareholder vote the following year will no longer be considered a mitigating factor. Boards that adopted 10-year poison pills before 2009 will no longer be grandfathered and exempt from receiving against vote recommendations; there are approximately 90 previously grandfathered companies that have adopted or renewed such pills. For adoptions of short-term poison pills (with a term of one year or less), the update provides for a caseby-case analysis with a special emphasis on the board s rationale for adopting the pill rather than the company s governance and track record. The update removes specific policies that provided for a recommendation against all board nominees every year until a dead-hand or modified-dead hand feature was removed because such poison pills would be captured under the new policy. (ISS states that only five such pills at active companies exist.) C. GENDER PAY GAP 1. ISS Policy on Shareholder Proposals The update introduces a new policy regarding shareholder proposals on gender pay inequity. ISS will make voting recommendations on a case-by-case basis for shareholder proposals requesting reports on a company s pay data by gender or on a company s policies and goals to reduce any existing gender pay gaps. Factors that will be taken into account include: -3-
the company s current policies and disclosures related to its practices and policies on diversity and inclusion; the company s compensation philosophy and use of fair and equitable compensation practices; whether the company has been the subject of recent controversy, litigation or regulatory actions related to gender pay gap issues; and whether the company s reporting regarding gender pay gap policies or initiatives is lagging behind its peers. ISS indicated that the policy was introduced in anticipation of a growing number of gender pay gap shareholder proposals. 2. U.K. Gender Pay Gap Reporting Regulations The update continues a trend of increased attention on the gender pay gap issue, and companies should be aware of the associated compliance, disclosure and optical considerations that accompany it. For example, the U.K. gender pay gap reporting regulations (part of the Equality Act 2010) came into effect in April of this year, requiring organizations in Great Britain with over 250 employees to comply with reporting obligations and publish data on the gender pay gap in their workforce. The requisite data includes: the mean and median pay gap (the difference in hourly pay of male and female full-time employees); the mean and median bonus pay gap (the difference in bonuses paid to male and female employees); the proportion of female employees who received a bonus compared to male employees; and the percentage of male and female employees in each of four quartiles when ranked by hourly rate of pay. Publication of the results must occur annually on the company s website, where it must remain for at least three years, and on a government website. D. INCREASING FOCUS ON BOARD DIVERSITY The update revises ISS s fundamental policies to include the statement that boards should be sufficiently diverse to ensure consideration of a wide range of perspectives. The policies on board composition were also updated to include a separate category for diversity, and ISS will now highlight boards that have no gender diversity. However, this factor will not drive adverse vote recommendations E. PAY-FOR-PERFORMANCE EVALUATION The update incorporates ISS s Relative Financial Performance Assessment into the quantitative pay-forperformance evaluation methodology for companies in the Russell 3000 or Russell 3000E Indices. The Relative Financial Performance Assessment compares the company's rankings to a peer group with respect to (1) CEO pay and (2) financial performance in three or four metrics (which will vary depending -4-
on industry), in each case as measured over three years. This analysis was added to the qualitative review last season but will now apply as part of the quantitative Peer Group Alignment factor. Details around the mechanics of the updated quantitative screening methodology will be provided in an updated white paper. F. BOARD RESPONSIVENESS TO SAY-ON-PAY The update refines and clarifies its approach to assessing a board s responsiveness to the say-on-pay vote, which will now be evaluated as part of Board Responsiveness rather than Board Accountability. If a company s prior say-on-pay vote received less than 70% support of votes cast, ISS will consider the timing and frequency of engagements with major institutional investors and whether independent directors participated in such engagement in forming its vote recommendation, as well as disclosure of the specific concerns voiced by dissenting shareholders along with the specific and meaningful actions taken to address such concerns in evaluating the board s responsiveness. * * * Copyright Sullivan & Cromwell LLP 2017-5-
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