Proxy advisory firm Institutional Shareholder Services has updated its U.S. and international 2006 proxy voting policies to include, among other things, a new policy on internal control reporting disclosures, performance tests for directors, and a recommendation for tally sheets for CEO pay.
Rockville, Md.-based ISS said it completed its policy formation process earlier this year in response to client and market requests. The new policies will apply for all U.S. and Canadian companies with shareholder meeting dates on or after Feb. 1, 2006.
Mueller
“The ISS voting policy updates are significant not only because they reflect stockholders' continued focus on enhancing director accountability and scrutinizing executive compensation, but also because they recognize companies' efforts to implement majority voting standards in the election of directors through resignation policies,” said Ronald Mueller, a partner with Gibson Dunn & Crutcher in Washington, D.C. “They are must reading for companies that will be proposing new stock plans or carrying stockholder proposals this coming proxy season.”
An outline of key policy changes is outlined below, and a copy of the actual ISS policy can be found in the box above, right.
Internal Control Reporting Disclosures
ISS added a new policy regarding Section 404 disclosures under which it may recommend withhold votes from audit committee members regarding problems with the company’s internal control over financial reporting. According to the policy, those circumstances might include instances where a material weakness rises to a level of serious concern, or where there are chronic internal control problems or an absence of established effective control mechanisms. ISS said vote recommendations will be on a case-by-case basis.
Performance Test for Directors
For issuers within the Russell 3000 index, ISS will adopt a case-by-case policy on director nominees at companies that are the worst performers within their industry peer group based on a weighted one-, three- and five-year average total shareholder return. ISS will consider several factors, including performance improvement in the current year; changes in management or board composition; recent transactions at the company; overall governance practices and the financial health of the company
Tally Sheets
ISS is “strongly encouraging companies to provide better and more transparent disclosure” related to CEO pay by providing a table that itemizes among other things, base salary, annual incentives, stock options, restricted stock, performance shares, deferred compensation, SERPs, perquisites, and gross-ups, severance and postretirement pay packages. Such compensation tables are often referred to as “tally sheets” (see related coverage above, right), and ISS’s 2006 Policy Update includes a sample tally sheet.
For companies that don’t meet a minimum standard of tally sheet disclosure, ISS will note the deficiency and provide cautionary language in its analysis.
SUGGESTED PRACTICES
The excerpt below is from "Institutional Shareholder Services Releases Policy Updates for 2006 Proxy Season
and Related Developments," published by the law firm of Gibson, Dunn & Crutcher, Nov. 1, 2005:
The 2006 Policy Updates and the voting policies of other proxy advisory firms and of
institutional shareholders can significantly impact the vote that companies receive on matters
presented to their shareholders. Thus, companies must carefully review the voting policies of
ISS and other proxy advisory firms and maintain open communications with shareholders
well in advance of the annual meeting. In addition, companies should consider the following
steps.
Consider the discussions and policy issues that are raised by director majority vote
proposals and the new ISS voting policy. Evaluate what approach, if any, may be
appropriate for the company to adopt. See that the board has a clearly articulated
basis for any policy that it adopts.
Consider the nature and relevance of any material financial ties or other related party
transactional relationships between the company and its director nominees, and
whether those relationships will affect the vote on a director who serves on the
company's audit, compensation or nominating committee.
Use the 2006 directors' and officer's questionnaire to address all issues of interest to
proxy advisory firms. For example, determine if any director will be considered
"overboarded" by ISS and, if relevant, discuss the situation with the director (and the
nominating committee) before finalizing proxy materials.
The compensation committee should carefully review and make sure that the proxy
discloses all elements of compensation. If applicable, the committee should explicitly
describe the manner in which compensation payouts have been tied to company
performance, including how that performance was measured. Clarity and precision in
the compensation committee report is increasingly important.
Companies should highlight in their proxy statements or governance policies steps
that have been taken or are being implemented to respond to poor corporate
performance or the perception of poor governance or compensation practices.
Reevaluate how ISS will view the company's equity compensation plans in light of the
new SVT and burn rate calculations. Also, reconsider whether ISS will recommend
"Withhold" votes from compensation committee members because of the "pay for
performance" criteria that ISS adopted in 2005 or the "poor"
compensation practices
standard included in the 2006 Policy Updates.
Source:
ISS Releases Policy Updates For 2006 Proxy Season And Related Developments (Gibson, Dunn & Crutcher)
ISS said it generally won’t withhold votes from compensation committee members for providing rules-based disclosure and boilerplate language in the compensation committee report; however, in 2007, ISS will consider such votes, potentially recommending votes against proposed or amended equity plans if compensation disclosure isn’t improved and enhanced proxy disclosure in the form of a tally sheet is not provided.
Poor Pay Practices
ISS said it will recommend withhold votes on compensation committee members at companies with poor pay practices, including egregious employment contracts such as:
Excessive severance provisions;
Excessive perks that dominate compensation;
Huge bonus payouts without justifiable performance linkage;
Performance metrics that are changed during the performance period;
Egregious SERP payouts; and
New CEO with overly generous new hire package; internal pay disparity.
ISS may also recommend a vote against equity plan proposals that are considered a vehicle for poor pay practices.
The proxy firm also fine-tuned its policies related to majority voting for director elections and stock option burn rates.
Majority Vote Standard
ISS said it will generally recommend for reasonably crafted shareholders proposals calling for a majority vote standard for electing directors in uncontested elections. But, ISS will consider recommending against such shareholder proposal “if the company has adopted formal corporate governance principles that present a meaningful alternative to the majority voting standard and provide an adequate response to both new nominees as well as incumbent nominees who fail to receive a majority of votes cast.” ISS noted that the policies should address the specific circumstances of each company.
Overboarding
ISS will continue to recommend withhold votes from directors who are CEOs of a publicly traded company and who serve on more than three public boards, but will only make that recommendation at their outside directorships and not at the company where they serve as CEO. ISS will continue to recommend withhold votes for non-CEO director nominees who serve on more than six public company boards.
The complete ISS policy update is available from the box above, right, as is related coverage.
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