Drilling Down on the New ISS “QuickScore 2.0” and Recent ISS Guidance; Companies Should Verify ISS Data No Later than February 7, 2014

February 3, 2014

On January 27, 2014, Institutional Shareholder Services, Inc. ("ISS") released information about its new version of QuickScore ("QuickScore 2.0"), which it will launch on February 18, 2014.  In addition, after Gibson Dunn submitted a series of questions to ISS about QuickScore, on January 31, 2014, ISS issued additional guidance clarifying certain information applicable to U.S. companies (the "Updated QuickScore Guidance").

As with its predecessor, QuickScore 2.0 purports to benchmark a company’s governance risk against other companies based on a number of weighted governance data points spread across four broad categories.  QuickScore 2.0 includes several new governance data points and a modified rating methodology, and ISS will now update a company’s data throughout the year based on information that the company publicly discloses.  A complete list of QuickScore 2.0 data points applicable to U.S. companies is attached to this alert as Appendix A.[1]

Background

ISS Governance QuickScore is a corporate governance benchmarking tool that ISS developed and sells to institutional investors and others (the ratings), as well as to public companies (advice on how to increase their ratings).  QuickScore ratings are not directly taken into account when ISS makes its proxy voting recommendations, and thus a favorable QuickScore rating does not guarantee that ISS will support company proposals, or vice versa.  However, QuickScore ratings are prominently displayed on ISS’s voting recommendation report for a company’s shareholders meeting.  In addition, ISS has stated that it is attempting to better correlate QuickScore ratings with its proxy voting policies, and a negative proxy voting recommendation or poor voting results can impact a company’s QuickScore ratings.  ISS also posts each covered company’s QuickScore ratings on Yahoo! Finance as of the first day of each month.   

Companies receive five QuickScore ratings:  ratings in four categories (Board Structure, Audit, Compensation and Shareholder Rights) and an overall QuickScore rating.  Each rating is on a scale of 1 to 10, with 1 being the best rating.  Ratings are relative to other U.S. companies in the company’s index.  Ratings for U.S. companies are based on assessing company practices using 87 questions,[2] or "data points," divided among the four categories.  The overall rating is based on the ratings in the four categories, with the Compensation rating historically the most heavily weighted, followed by the Shareholder Rights rating.  The possible responses to each data point are limited to a few QuickScore-prescribed alternatives, which limits the ability of QuickScore to take into account unique company circumstances.  The relative weight of each individual data point can be assessed only by subscribing to ISS’s QuickScore consulting service. 

Companies are able to review their QuickScore data (regardless of whether they subscribe to QuickScore) and request that their information be corrected or updated. 

New QuickScore Data Points That Impact Company Ratings

Under QuickScore 2.0, U.S. companies’ ratings will be impacted by several new governance data points:

1.      Director Tenure:  The Board Structure category will include a new data point on the percentage of non-management directors who have served on the board for more than nine years, reflecting a notable new ISS policy position for QuickScore purposes, under which ISS considers longer tenure as potentially compromising a director’s independence.  In the Updated QuickScore Guidance, ISS changed the wording of the new data point to replace references to "excessive" tenure with "lengthy tenure."  The addition of this data point is significant since ISS, as part of its new Benchmark Policy Consultation that closes on February 14, 2014, is soliciting comments on whether it should revise its proxy voting policy on director elections to take into account director tenure.[3]

2.      Director Election Voting Results:  The Board Structure category will include a new data point on the percentage of directors who were elected with less than 95% support.  In the Updated QuickScore Guidance, ISS clarified that the voting standard it will use in making this calculation is a "votes cast" standard (i.e., the number of shares voted "for" as a percentage of the shares voted either "for" or "against," meaning abstentions are not taken into account).

3.      Amount of Director Compensation:  The Board Structure category will include a new data point on the ratio of the average amount of non-management directors’ compensation for the prior year (based on total compensation for directors reported in the company’s proxy statement) relative to the median of such amount among the company’s ISS-determined peer group for the same period.

4.      New ISS Pay-for-Performance Metric:  The Compensation category will include a new data point on the relative degree of alignment ("RDA") between the company’s annualized three-year pay percentile rank, relative to peers, and its three-year annualized total shareholder return ("TSR") rank, relative to peers.  This data point is the same as the new RDA metric that ISS previously announced it will use in its pay-for-performance evaluation in 2014.  ISS will now calculate RDA using a modified method focused only on a three-year period, as opposed to one- and three-year periods. 

5.      Support for Say-on-Pay Proposal:  The Compensation category will include a new data point on whether a company’s most recent say-on-pay proposal received shareholder support below the industry-index level, as calculated by ISS based on a four-digit Global Industry Classification Standard group and stock index process that ISS does not explain in the QuickScore materials. 

Note that the relative impact of these data points on company ratings will not be apparent until QuickScore 2.0 launches on February 18, 2014. 

Other New QuickScore Data Points

QuickScore 2.0 also includes several new data points where ISS will report information in response to the question, but the information will not impact a company’s ratings (at least for now), including:

1.      Board Size:  The Board Structure category will report the number of directors on the board.  Note that ISS has stated that a company should have no less than six and no more than 15 directors on a board, with nine to 12 directors "considered ideal."  

2.      Gender Diversity:  The Board Structure category will report the number and percentage of women on the board.

3.      Number of "Audit Committee Financial Experts":  The Audit category will report the number of financial experts on the audit committee.  Initially, it appeared that the QuickScore definition of "audit committee financial expert" might be narrower than the Securities and Exchange Commission ("SEC") definition.  In the Updated QuickScore Guidance, ISS confirmed that QuickScore 2.0 will count the financial expert(s) disclosed by the company using the SEC definition.

Changes To QuickScore Rating Methodology

Although ISS does not publicly disclose the weights assigned to specific data points, ISS stated that QuickScore 2.0 modifies the weights previously assigned to the data points under QuickScore 1.0 and purports to better correlate QuickScore results with ISS’s proxy voting policies, company performance and risk measures, and global governance standards and best practices.  In addition, several data points that were previously categorized under the Compensation category have been moved to the Board Structure category (the questions themselves remain unchanged).  These include questions relating to director stock ownership and stock ownership guidelines, pledging company shares by directors and executives, and company policies prohibiting hedging.  Finally, several data points that ISS carried over from QuickScore 1.0 are now identified as having no impact on a company’s ratings, including (1) the two QuickScore 1.0 data points relating to calculating RDA over one- and three-year periods, which were previously used in ISS’s pay-for-performance evaluation, (2) the percentage of directors who are immediate family members of certain affiliates, (3) the percentage of directors who are former/current employees, and (4) the length of the CEO’s employment agreement.

Changes To QuickScore Updates And The Impact On New Directors

Another significant change under QuickScore 2.0 is that company information for each QuickScore data point now will be updated by ISS on an ongoing basis using publicly available information, such as company SEC filings.  In particular, ISS says it will monitor companies’ Form 8-K filings for disclosures regarding new directors and determine whether to classify those directors as independent (based on the ISS independence definition).  If ISS is unable to make an independence determination based on a company’s disclosures, ISS will consider the director "unclassified" until it has sufficient information to make a determination.  The company’s affected QuickScore data points will not be updated until ISS has made independence classifications for all directors. 

ISS included a list of nine disclosures, listed on Appendix B to this alert, that it says are needed to classify directors.  Notably, this information is much broader than what the SEC requires on Form 8-K when reporting the election of a new director outside of a shareholders meeting.  ISS has not indicated whether providing this information on a company’s website instead of in a Form 8-K would be sufficient for QuickScore purposes. 

What Companies Should Do Now

1.      Review and Verify QuickScore Data.  Companies should review and verify their QuickScore 2.0 data by 8:00 pm EST on February 7, 2014 if they want to correct any errors or update any information before QuickScore 2.0 ratings are published on February 18, 2014.  Companies are able to preview their updated QuickScore 2.0 governance data and submit requests for changes to ISS through ISS’s data verification website, http://www.issgovernance.com/quickscore/dataverification.  Note that companies cannot yet view their estimated QuickScore 2.0 ratings.

2.      Check QuickScore 2.0 After Launch.  After the launch of QuickScore 2.0 on February 18, 2014, companies should review their QuickScore 2.0 ratings and verify whether any data corrections were properly processed.  In addition, new data will be added when QuickScore 2.0 is launched.  For example, companies that review their QuickScore data before the launch of QuickScore 2.0 will see that ISS reports that the new data point regarding the degree of alignment between three-year CEO pay percentile rank and three-year annualized TSR rank is "not applicable," but ISS will calculate this figure in advance of releasing QuickScore 2.0 (based on past disclosures).[4] 

3.      Consider Additional Actions Related to QuickScore 2.0.  Companies also should consider whether there are any actions related to QuickScore 2.0 they want to take in advance of filing their 2014 proxy materials.  For example, companies may be able to improve their QuickScore 2.0 rating by providing additional disclosure responding to certain data points, adopting a formal policy to document and disclose relevant governance practices that are already in place, or to take other actions to improve their practices in areas that QuickScore evaluates.  In order to ensure that the new information is reflected in the QuickScore ratings reported in the ISS proxy voting report for a shareholders meeting, a company can either submit changes via the QuickScore data verification process before filing the proxy statement (if the changes are already publicly available) or describe the changes in the proxy statement so that ISS updates QuickScore accordingly during the course of preparing the ISS proxy voting report.[5]

4.      Consider Additional New Director Disclosures.  Companies may want to include additional disclosures about new directors in future SEC filings or otherwise.  As noted above, if ISS is unable to make an independence determination based on a company’s disclosures, ISS will consider the director "unclassified" until it has sufficient information to make a determination.  Depending on the timing of their appointment, directors elected outside of a shareholders meeting may remain "unclassified" for almost a year until the next proxy statement is filed unless a company voluntarily provides certain data, since the Form 8-K disclosure requirements for new directors do not cover all of the information that ISS considers in assessing a director’s independence.  An alternative is to "furnish" the additional information under Item 7.01 on Form 8-K; it is unclear whether ISS will update QuickScore data based on information that instead is posted on the corporate governance section of the company’s public website.  

______________________________

Appendix A

QuickScore 2.0:  Governance Data Points for U.S. Companies

The chart below lists the QuickScore 2.0 data points for U.S. companies, organized by the four categories:  Audit, Board Structure, Compensation and Shareholder Rights.  QuickScore 2.0 questions that are new for U.S. companies are italicized.  Those questions that are designated as having a zero-weight impact on a company’s QuickScore ratings, and are for informational purposes only, are listed at the end of each category, and are noted as such. 

Audit Category

1. 

Non-Audit fees represent what percentage of total fees?

2.

Did the auditor issue an adverse opinion in the past year?

3. 

Has the company restated financials for any period within the past two years?

4. 

Has the company made non-timely financial disclosure filings in the past two years?

5.

Has a securities regulator taken enforcement action against the company in the past two years?

6.     

Has a securities regulator taken enforcement action against a director or officer of the company in the past two years?

7.    

Is the company, or any of its directors and officers, currently under investigation by a regulatory body?

8. 

Has the company disclosed any material weaknesses in its internal controls in the past two years?

9.     

How many financial experts serve on the audit committee? (Zero-weight impact)

Board Structure Category       

1.      

What is the independent director composition of the board?

2.      

What proportion of non-executive directors on the board has lengthy tenure?

3.      

What is the classification of the chairman of the board?

4.   

Has the company an identified senior independent director?

5.  

What percentage of nominating committee members are independent based on ISS standards?

6.      

What is the independent status of the compensation committee members?

7.     

What is the independent status of the audit committee members?

8.   
 
 

Does the CEO serve on an excessive number of outside boards?/How many boards does the CEO sit on?

9.     

How many non-executives serve on an excessive number of outside boards?

10.     

Did any directors attend less than 75% of the aggregate board and committee meetings without a valid excuse?

11.   

How many directors received withhold/against votes of 50% or greater at the last annual meeting?

12. 

What percentage of directors received shareholder approval rates below the industry-index level?

13. 
 

What is the average size of outside directors’ compensation as a multiple of the median of company peers?

14.   

Are directors subject to stock ownership guidelines?[6]

15.   

Do all directors with more than one year of service own stock?[6]

16.   

Did any executive or director pledge company shares?[6]

17. 

Does the company have a robust policy prohibiting hedging of company shares by employees?[6]

18.   

Does the company disclose board/governance guidelines?

19.   

What percent of the directors were involved in material RPTs?

20.  

Do the directors with RPTs sit on key board committees?

21.   

Are there material related-party transactions involving the CEO?

22.   

How many directors serve on the board? (Zero-weight impact)

23.   

What is the number / proportion of women on the board? (Zero-weight impact)

24. 
 
 

What percentage of the board consists of immediate family members of majority shareholders, executives, and former executives (within the past five years)? (Zero-weight impact)

25. 
 
 

What percentage of the board are former or current employees of the company? (Zero-weight impact)

Compensation Category

1.   
 
 

What is the size of the CEO’s 1-year cumulative pay, as a multiple of the median pay for company peers?

2.    

What is the degree of alignment between the company’s TSR and change in CEO pay over the past five years?

3.      

What is the ratio of the CEO’s total compensation to the next highest paid executive?

4.   
 

What is the degree of alignment between the company’s annualized 3-year pay percentile rank, relative to peers, and its 3-year annualized TSR rank, relative to peers?

5.      

Are any of the NEOs eligible for multiyear guaranteed bonuses?

6.   
 

What is the ratio of the CEO’s non-performance-based compensation (All Other Compensation) to Base Salary?

7.     

Do the company’s active equity plans prohibit share recycling for options/SARs?

8.      

Do the company’s active equity plans prohibit option/SAR repricing?

9.      

Does the company’s active equity plans prohibit option/SAR cash buyouts?

10.  

Do the company’s active equity plans have an evergreen provision?

11.   

Do the company’s active equity plans have a liberal CIC definition?

12. 

Has the company repriced options or exchanged them for shares, options or cash without shareholder approval in the last three years?

13.   

Does the company grant equity awards at an excessive rate, according to ISS policy?

14.   

Did the company disclose a claw back or malus provision?

15.
 

What are the minimum vesting periods mandated in the plan documents for executives’ stock options or SARs in the equity plans adopted/amended in the last 3 years?

16. 
 

What are the minimum vesting periods mandated in the plan documents, adopted/amended in the last three years, for executives’ restricted stock/stock awards?

17. 

What is the holding/retention period for stock options (for executives)?

18.   

What is the holding/retention period for restricted shares/stock awards (for executives)?

19. 
 

What proportion of the salary is subject to stock ownership requirements/guidelines for the CEO?

20.
 

Does the company disclose a performance measure for the short-term incentive plan (for executives)?

21. 
 

What is the level of disclosure on performance measures for the latest active or proposed long-term incentive plan?

22.
 

Did the most recent say-on-pay proposal receive shareholders’ support below the industry-index level?

23. 

What’s the trigger under the change-in-control agreements?

24.   

Do equity based plans or other long-term plans vest completely upon a change-in-control?

25. 
 

What is the multiple of the change-in-control/severance payment for the CEO (upon a change-in-control)?

26.   

What is the basis for the change-in-control or severance payment for the CEO?

27.   

Does the company provide excise tax gross-ups for change-in-control payments?

28.  

Has ISS’ qualitative review identified a pay-for-performance misalignment?

29.   

Has ISS identified a problematic pay practice or policy that raises concerns?

30.

What is the degree of alignment between the company’s cumulative 3-year pay percentile rank, relative to peers, and its 3-year cumulative TSR rank, relative to peers? (Zero-weight impact)

31.

What is the degree of alignment between the company’s cumulative 1-year pay percentile rank, relative to peers, and its 1-year cumulative TSR rank, relative to peers? (Zero-weight impact)

32.  

What is the length of employment agreement with the CEO? (Zero-weight impact)

Shareholder Rights Category

1.   

Does the company have classes of stock with different voting rights?

2.  
 

Are there any directors on the board who are not up for election by all classes of common shareholders?

3.      

Are all directors elected annually?

4.      

Is the board authorized to issue blank check preferred stock?

5.      

Does the company have a poison pill (shareholder rights plan) in effect?

6.      

What is the trigger threshold for the poison pill?

7.    

Does the poison pill have a sunset provision?

8.      

Does the poison pill have a TIDE provision?

9.     

Does the poison pill have a qualified offer clause?

10.   

What is the expiration date of the poison pill?

11.   

Is the poison pill designed to preserve tax assets (NOL pill)?

12.  

When was the poison pill implemented or renewed?

13.   

Does the company’s poison pill include a modified slow-hand or dead-hand provision?

14.  

Does the company have a majority vote standard in uncontested elections?

15. 
 

If the company has a majority voting standard, is there a plurality carve-out in the case of contested elections?

16. 

Does the company require a super-majority vote to approve amendments to the charter and bylaws?

17.

Does the company require a super-majority vote to approve mergers/business combinations?

18.  

What is the percentage of share capital needed to convene a special meeting?

19.   

Can shareholders act by written consent?

20. 
 

Has the board adequately addressed a shareholder resolution supported by a majority vote?

21. 
 

Are there material restrictions as to timing or topics to be discussed, or ownership levels required to call the meeting?

Appendix B

QuickScore 2.0:  Director Classification Guidelines

In the QuickScore updates, ISS "outlined the following guidelines for director classification." 

1.      Disclose whether the board has made any determination regarding the independence of the director in accordance with Item 407(a) of Regulation S-K.

2.      Disclose all transactions between the company and:  (a) the director, (b) the director’s employer, (c) an immediate family member, or (d) an immediate family member’s employer in the last three years that exceed $10,000.  State the percentage that the amount represents of the recipient’s revenues.[7] 

3.      Disclose family relationships, as required under Item 401 of Regulation S-K.

4.      Disclose compensatory arrangements, as required under Item 402 of Regulation S-K.

5.      Disclose beneficial stock ownership, as required under Item 403 of Regulation S-K.

6.      Disclose any previous employment with the company, a former parent company, or an acquired company.

7.      Is the director party to a voting agreement to vote in line with management on proposals being brought to shareholder vote?  If so, please provide a brief summary of the agreement.

8.      Does the director (or an immediate family member) have an interlocking relationship, as defined by the SEC, involving members of the board or its compensation committee?

9.      Is the director a founder of the company, but not currently an employee?  If so, what was the extent of the director’s operational involvement with the company?


   [1]   More information, including the Updated QuickScore Guidance, is available at http://www.issgovernance.com/quickscore. 

   [2]   In the original appendix to the QuickScore 2.0 technical document, ISS listed 88 data points applicable to U.S. companies, including a data point relating to the "aggregate level of stock ownership of the officers and directors, as a percentage of shares outstanding."  In the Updated QuickScore Guidance, ISS clarified that this was an error and that this data point does not apply to U.S. companies.

   [3]   More information about ISS’s Benchmark Policy Consultation is available at http://www.issgovernance.com/benchmarkpolicyconsultation. 

   [4]   ISS will again calculate it after a company discloses updated compensation information in a proxy statement and use that new RDA metric both in the pay-for-performance analysis and for this data point in QuickScore.

   [5]   Note that companies are not able to use the QuickScore 2.0 data verification process during the period between the filing of a company’s proxy statement and the publication of ISS’s proxy analysis for the company’s annual meeting. 

   [6]   This data point was formerly listed under the Compensation category.

   [7]   Note that this appears to be a "catchall" request as the ISS director independence definition in the ISS proxy voting policies includes higher thresholds for most transactions (other than those involving professional services). 

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