February 21, 2012
Institutional Shareholder Services ("ISS"), a leading proxy advisory firm, recently announced updates to its Governance Risk Indicators (GRId) methodology for U.S. public companies. GRId evaluates and rates public company practices across four key categories of corporate governance–Audit, Board, Compensation and Shareholder Rights. Based on answers to a series of questions about companies’ governance practices in each of these areas, GRId then identifies a level of concern (Low, Medium or High) for each of these categories.
The updates to GRId include aligning the GRId scoring system closely with ISS proxy voting policies, expanding the topics covered by GRId in analyzing company governance practices and assigning companies numerical scores (in addition to levels of concern) for each of the four categories.
The updated methodology, known as "GRId 2.0," will take effect next week. However, beginning yesterday, February 20, 2012, companies can view their new GRId information and submit corrections to ISS. Companies only have until 8 pm eastern time on Thursday, February 23, 2012, to submit any corrections in order for them to be reflected in the initial posting of GRId 2.0 scores. As discussed below, companies will have the ability to correct GRId data, and submit updated information, following the initial posting of GRId 2.0 scores. Access to the GRId data is available without charge at https://ga.isscorporateservices.com. However, companies will need their unique data verification user name and password, which can be obtained by emailing firstname.lastname@example.org or by calling ISS at (301) 556-0570. GRId 2.0 scores then will be available to ISS clients beginning on February 27, 2012.
A comprehensive discussion of the GRId updates is available in the GRId 2.0 Technical Document, available at: http://www.issgovernance.com/grid/technical_document. The GRId 2.0 Technical Document also contains a complete list of the questions for 2012 and identifies those questions that have been added or modified as part of the GRId updates.
Overview of GRId Framework
ISS launched GRId (the successor to the "Corporate Governance Quotient" or "CGQ") two years ago to provide institutional investors with information on areas of governance concern at individual companies. According to ISS, GRId is designed to provide companies with a basis for aligning their corporate governance structures and practices with shareholder interests. We are also aware of at least one insurance company that in the past referenced company scores on GRId’s predecessor during the process of renewing a company’s D&O insurance. A company’s GRId ratings also are included in the ISS report publishing its proxy voting recommendations for the company’s shareholder meeting.
The GRId ratings are designed to reference ISS-designated governance best practices, tailored to particular markets. Under the GRId system in effect until now, for each question, ISS scored companies on a ten-point scale from -5 to +5, generally awarded points where a company followed "best" practices, deducted points where a company had "problematic" governance practices, and treated "standard" practices as neutral by scoring them at zero. ISS then weighted the scores for each question based on the question’s importance and calculated a final score for each of the four categories, ranging from 1 to 100. The final score corresponded to a concern rating–Low, Medium or High–for each category. Thus, under the GRId system in effect until now, a score between 90 and 100 corresponded to a "Low" level of concern in the Audit category, while a score between 70 and 100 corresponded to a "Low" level of concern in the Board category.
Changes to GRId
The updates in GRId 2.0 relate primarily to three major areas:
1. Executive Compensation: ISS is aligning the GRId system with the new pay-for-performance test that ISS announced for 2012. As a result, ISS has reorganized the Compensation category and added new questions that draw directly from the new quantitative analysis in its pay-for-performance test. For more details on the new pay-for-performance test announced for 2012, please refer to our December 27, 2011 client alert, "ISS Issues White Paper on New Approach in Evaluating Pay for Performance Alignment."
2. Transparency: ISS added new questions and revised other questions to address particular governance practices with greater specificity.
3. Scoring: ISS has revised the way in which it calculates GRId scores "to ensure that risks connected with individual governance practices are properly reflected" in the scores. Accordingly, ISS will provide the numerical scores for each of GRId’s four key categories, in addition to publishing a level of concern for each category.
Under the GRId 2.0 methodology, ISS will assign a level of concern for each individual question, with -25 points representing moderate concern and -50 points representing significant concern. The number of points assigned will continue to correspond to what ISS views as "best," "standard" and "problematic" practices. ISS will continue to calculate a score for each of Audit, Board, Compensation and Shareholder Rights categories, and GRId 2.0 will continue to use the same 100-point scale. However, the scoring has been standardized so that the following scores will apply across all four categories:
a score of 50 or below will correspond to a "High" level of concern.
a score of 75 or below (but more than 50) will correspond to a "Medium" level of concern.
a score of more than 75 will correspond to a "Low" level of concern.
ISS consolidated existing subcategories of questions into six subcategories that correspond to its principles for evaluating say-on-pay:
the use of equity
equity risk mitigation
communication and disclosure
termination and severance
As noted above, ISS has added a number of new questions that correspond to the factors that ISS will use in conducting its updated "pay-for-performance" analysis. These questions evaluate two measures: relative performance and absolute performance. The relative performance questions evaluate the degree of alignment between CEO pay and total shareholder return ("TSR"), as measured against an ISS-created "peer group." Relative performance is measured over one- and three-year periods. Absolute performance measures the trend in CEO pay against the company’s annualized TSR over the past five fiscal years.
Other key updates include the following:
1. Non-Performance-Based Pay: ISS evaluates whether companies have pay practices that ISS believes erode the link between pay and performance. Thus, for example, GRId 2.0 includes questions about paying dividends on unvested performance shares and the ratio between the CEO’s salary and other compensation paid to the CEO.
2. Use of Equity: ISS evaluates how companies use equity as part of their long-term compensation programs, including the effect of equity grants on shareholders and whether equity plans contain provisions that ISS views as "shareholder-friendly." Thus, GRId 2.0 includes new and modified questions regarding whether equity plans: (a) have "liberal" change-in-control provisions that would allow for accelerated vesting of equity grants; (b) affirmatively prohibit option/SAR repricing, share recycling and/or cash buyouts; and (c) have evergreen provisions that allow for automatic replenishment of shares available under the plan without a shareholder vote. Practices adopted more recently are likely to raise greater concern than those adopted in prior years.
3. Equity Pay Risk Mitigation: This subcategory examines whether a company’s equity pay programs include provisions that ISS considers to mitigate equity pay risks and potential executive-shareholder misalignment. New questions were added in GRId 2.0 on whether executives or directors have pledged company shares and whether companies have a policy prohibiting hedging. In addition, ISS combined several questions on disclosure of performance measures for different long-term pay instruments into a single question that looks at whether performance conditions for the latest long-term incentive plans are appropriately disclosed and measured.
4. Change in Control Payments: The termination subcategory has been updated in GRId 2.0 to include additional questions relating to change-in-control payment for CEOs and other executives. New questions consider how companies calculate change in control payments and whether these payments are based on actual, target or maximum bonus. Other new questions examine the amount of the CEO’s estimated non-change-in-control severance as a multiple of the executives’ average salary and bonus and whether the CEO’s outstanding equity awards vest on a change in control.
ISS has reorganized the Board Practices category in GRId 2.0 into two separate subcategories, one that focuses on behaviors of board members, such as "overboarding" and attendance ("Board Practices") and the other that focuses on governance policies ("Board Policies"). In addition, ISS has added a number of new questions designed to focus on specific areas:
1. Board Leadership: ISS divided what was previously a single question on board leadership into three separate questions: (a) whether the roles of chairman and CEO are separate; (b) whether the board has an independent chairman; and (c) whether the board has a lead director with "clearly delineated and comprehensive duties."
2. Related Party Transactions: ISS added a new question that deals specifically with related party transactions involving the CEO.
3. Director Hiring of Advisors: ISS added a question on whether directors can hire their own advisors without management approval. According to ISS, in order to answer "yes" to this question, this authority should apply to "the entire board or each individual director" and not just certain committees or specific functions (e.g., compensation consulting).
4. Board Independence: New questions seek to provide more detail about the level of board independence by considering what percentage of the board consists of former employees and what percentage of board members are related to executive officers or significant shareholders.
D. Shareholder Rights
The changes in GRId 2.0 relating to shareholder rights include the following:
1. Approval of Poison Pill: ISS divided the previous question about whether companies had a shareholder-approved poison pill into two questions: whether or not companies have a poison pill and, if so, whether shareholders have approved it.
2. Poison Pill Features: ISS added questions designed to focus on: (a) specific features of a poison pill, such as the trigger threshold; (b) whether a poison pill is designed to preserve net operating losses (a so-called NOL pill); and (c) how long ago the board last took action on the poison pill.
3. Right of Shareholders to Call Special Meetings: ISS added a question on the right of shareholders to call special meetings, and specifically, whether there are "material restrictions as to timing or topics to be discussed, or ownership levels required" to call a meeting. According to the GRId 2.0 Technical Document, material restrictions include those that: (a) prohibit special meetings more than 90 days from the annual meeting date; (b) may be interpreted to preclude director elections or other significant business; or (c) effectively raise the ownership threshold necessary to call the meeting.
4. Plurality Carve-Out for Contested Elections: ISS added a new question on whether companies with majority voting in director elections have a carve-out for plurality voting in contested elections, since the absence of a carve-out may favor incumbents in a proxy contest.
The Audit category continues to focus on the role of the outside auditor and the presence of audit or accounting "controversies." ISS added two new questions to GRId 2.0 that evaluate whether directors or officers have been under investigation by a regulatory body or subject to a securities enforcement action during the last two fiscal years.
Transition to GRId 2.0
ISS has been assessing each covered public company under the GRId 2.0 criteria based on publicly available information. ISS will make the GRId 2.0 scores available to GRId subscribers on Monday, February 27, 2012. Before then, companies can review and submit corrections regarding their updated GRId data until Thursday, February 23, 2012, at 8 pm eastern time. A company’s GRId scores also are posted on its "Profile" page on Yahoo! Finance. ISS will provide the updated scores to Yahoo! Finance on March 1, 2012.
Note that the GRId 2.0 data may include out-of-date information because most companies have not yet filed their 2011 Form 10-Ks and 2012 proxy statements and may not have otherwise publicly disclosed updated information relevant to their GRId scores. For example, ISS calculated the "pay-for-performance" assessments in the Compensation category using the most recently available data for each company and ISS-designated peers known at the time of the GRId 2.0 launch, which for most companies was their 2011 proxy statement. However, ISS will not allow companies to update or correct these metrics (absent an error) to reflect information that will be disclosed in soon-to-be filed Form 10-Ks and proxy statements. Instead, ISS will update the information when it publishes its proxy analysis for the company’s next shareholder meeting.
Companies will be able to make changes to the GRId data after ISS publishes GRId 2.0 scores on February 27, 2012, but no changes can be made during the time between when a company files its proxy materials with the Securities and Exchange Commission and when ISS issues its proxy voting recommendations for that meeting.
Actions to Take Now
Companies should review their GRId 2.0 data in advance of the February 23, 2012, deadline in order to correct any errors before GRId 2.0 scores are published. Reviewing this data may also identify actions that companies will want to consider in advance of filing their 2012 proxy materials.
Companies also may find it helpful to review the ISS "pay-for-performance" assessments in the Compensation category as those calculations, while in many cases based on 2010 compensation data in the 2011 proxy statement, may provide insight into how ISS will assess "pay-for-performance" in 2012. In addition, companies should revisit their GRId data once ISS publishes its proxy analysis for the company’s 2012 shareholder meeting to confirm that their GRId 2.0 scores accurately capture the information in the 2012 proxy statement, including executive compensation information.
For more background on the ISS voting policy updates for 2012, please refer to our November 23, 2011, client alert, "ISS Releases Policy Updates for 2012 Proxy Season."
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you work, or any of the following:
John F. Olson – Washington, D.C. (202-955-8522, email@example.com)
Brian J. Lane - Washington, D.C. (202-887-3646, firstname.lastname@example.org)
Ronald O. Mueller – Washington, D.C. (202-955-8671, email@example.com)
Amy L. Goodman – Washington, D.C. (202-955-8653, firstname.lastname@example.org)
Stephen W. Fackler - Palo Alto, CA (650-849-5385, email@example.com)
James J. Moloney - Orange County, CA (949-451-4343, firstname.lastname@example.org)
Elizabeth Ising – Washington, D.C. (202-955-8287, email@example.com)
Sean C. Feller - Los Angeles, CA (213-229-7579, firstname.lastname@example.org)
Gillian McPhee – Washington, D.C. (202-955-8201, email@example.com)
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