RiskMetrics Group ISS Governance Services (ISS) Releases Policy Updates for 2009 Proxy Season and Related Developments

December 1, 2008

On November 25, 2008, RiskMetrics Group ISS Governance Services (ISS), a leading proxy advisory firm, released its U.S. and international corporate governance policy updates for the 2009 proxy season.  The ISS U.S. Corporate Governance Policy 2009 Updates (2009 Policy Updates) can be accessed at http://www.riskmetrics.com/sites/default/files/RMG2009PolicyUpdateUnitedStates.pdf.  The 2009 Policy Updates apply to annual meetings held on or after February 1, 2009.  This client alert reviews the most significant policy updates and sets forth suggested practices.


The most significant ISS policy changes in the 2009 Policy Updates relate to:

  • The expansion of the types of "poor" pay practices that will cause ISS to recommend that shareholders vote "Against" or "Withhold" voting authority from compensation committee members and/or the full board;
  • Increased instances in which ISS will recommend votes "For" "clawback" shareholder proposals;
  • Revised methods for determining and reporting compensation peer groups and the introduction of a single performance test based on relative performance; and
  • The addition of an adverse opinion from the company’s auditors as a "poor" accounting practice that will cause ISS to recommend that shareholders vote "Against" or "Withhold" voting authority from audit committee members and/or the full board. 

Overview of ISS 2009 Policy Updates

Executive Compensation

1. Recent Market Volatility and Legislation.  ISS has aligned its policies on compensation-related shareholder proposals to the practices outlined in the U.S. Treasury’s Rules under the Emergency Economic Stabilization Act of 2008 (EESA).  In the past, ISS generally reviewed shareholder proposals requesting "clawbacks" or recoupment of bonus or other incentive compensation on a case-by-case basis, considering such factors as whether the company had adopted a robust and formal bonus/equity recoupment policy.  Under the 2009 Policy Updates, proposals on "clawbacks" of incentive pay may receive ISS support if existing company policy does not meet the practices outlined by Treasury.  In addition, shareholder proposals seeking holding requirements for stock-based incentives will be evaluated with a view to the risk-incentivizing behavior associated with the company’s incentive compensation program.  Moreover, ISS will not view market deterioration, in and of itself, as an acceptable reason to reprice stock options or reset goals under performance plans. 

2. Compensation Peer Groups and Harmonization of Performance Tests.  Several ISS policies include an evaluation of company performance (for example, the performance/governance evaluation of directors, the pay for performance policy and the policy for evaluating independent chair (separate chair/CEO) shareholder proposals).  The 2009 Policy Updates harmonize the measure of performance across these policies, and introduce a relative basis for assessing performance.  The 2009 Policy Updates define poor performance for Russell 3000 companies as below-median total shareholder returns (TSR), relative to industry peers or the index as a whole, for one- and three-year periods (Harmonized TSR).  ISS also changed and made uniform throughout its policies the methodology that it will use for constructing peer groups. Under the new methodology, company size will be a key determinant in constructing these peer groups, with peers falling between 0.5 and 2.0 times the company’s size, measured by revenue, assets or market capitalization as appropriate.  The minimum number of companies in the peer group has been reduced to eight, and for very large companies, peers may be drawn from a wider industry-sector or index pool, in order to create a group of reasonably similar companies.  ISS will display the pay of CEOs relative to their peers in the new peer groups.  ISS also plans to add to its reports a comparison of CEO pay under both ISS peer group methodology and the peer group selected by the company.  The updated peer group methodology will be released in 2009 and the report modification that will compare the ISS peer group to the company’s peer group will be released at a later date.

3.  "Poor" Pay Practices.  ISS updated its "poor compensation practices" standard which it uses as a guide in recommending that shareholders vote "Against" or "Withhold" voting authority from some compensation committee members and/or entire boards) by making the following additions/clarifications.  Pursuant to the 2009 Policy Updates, "poor" pay practices will include:

  • Any new or materially amended severance or change-in-control arrangements that include provisions for the payment of excise tax gross-ups or modified single-triggers;
  • Liberal change of control definitions in individual contracts or plans that could result in payments to executives without an actual change-in-control occurring;
  • Tax reimbursements of any executive perquisites or other payments; and
  • Payment of dividends or dividend equivalents on unearned performance awards.

ISS also provided updated examples of what it considers to be best pay practices regarding employment agreements, severance agreements, change-in-control agreements, supplemental executive retirement plans, deferred compensation and disclosure practices.

4.  Company Compensation Proposals. 

  • The ISS case-by-case assessment of whether to recommend votes "Against" a company’s equity-based compensation plan will also consider as a factor whether a company has a liberal definition of change-in-control. 
  • With respect to calculations of volatility under the Shareholder Value Transfer (SVT) and burn rate policies, ISS will use a 400-day volatility rather than a 200-day volatility for December 1, 2008, March 1, June 1 and September 1, 2009 quarterly downloads in an effort to adjust for recent market volatility. 
  • ISS updated the burn rate percentages for 2009, as it does annually, and the methodology by which it will calculate allowable burn rate percentages for companies.
  • With respect to incentive bonus plans and tax deductibility proposals, ISS amended its policy to specify that it will recommend a vote "Against" Section 162(m) related plans if the compensation committee does not consist of only independent directors (based on the ISS definition of independence).

Board Issues

5.  "Valid Excuses" for Low Director Attendance.  ISS expanded, and provided additional detail, regarding what constitutes a valid excuse with respect to its policy to recommend that shareholders vote "Against" or "Withhold" voting authority from directors who attend less than 75 percent of their board and committee meetings.  "Valid excuses" include illness, service to the nation, work on behalf of the company and funeral obligations.  If a company provides ISS with meaningful disclosure explaining the director’s absences, ISS will evaluate the information on a case-by-case basis taking into account (a) the degree to which absences were due to an unavoidable conflict, (b) a pattern of absenteeism, and (c) other extraordinary circumstances underlying the director’s absence.  While these disclosures increasingly are included in public filings, ISS acknowledged that some excuses are of personal nature, so ISS invited companies to contact it with information related to directors who fall below the 75 percent attendance threshold.

6.  Shareholder Proposals Calling for Independent Chair.  ISS generally will recommend votes "For" shareholder proposals asking that an independent director serve as chairman of the board unless a company maintains a counterbalancing governance structure (including a lead independent director with specified responsibilities), satisfies a corporate performance standard and has no problematic governance or management issues.  The 2009 Policy Updates eliminated two of the disclosure requirements added in 2008 relating to a comparison of the independent lead director and chairman duties and a "sufficient explanation" of why a company combines the chairman and CEO positions.  In addition, the 2009 Policy Updates replace the existing performance standard with the Harmonized TSR standard discussed above.  Finally, the 2009 Policy Updates broadened the previous "no problematic governance issues" criterion to also include management issues and provided examples of these issues.

7. Performance/Governance Evaluation for Directors.  The 2009 Policy Updates revised the circumstances pursuant to which ISS will recommend that shareholders vote "Against" or "Withhold" voting authority from all director nominees at a Russell 3000 company that has sustained poor performance relative to its peers (now based on Harmonized TSR, as discussed above).  Beginning in 2009, ISS will also examine whether the company has a governance structure that promotes entrenchment in making its voting recommendation (e.g., the existence of several anti-takeover provisions, including a classified board, supermajority voting requirements, majority voting with no carve out for contested elections, non-shareholder approved poison pill and inability of shareholders to call special meetings).  In addition, ISS may consider a company’s five-year TSR and five-year operational metrics in making its voting recommendation. 

8.  Shareholder Proposals Requesting the Establishment of Board Committees.  ISS adopted a new policy to generally recommend votes "Against" shareholder proposals to establish a new standing board committee.  This policy is in response to shareholder proposals that, for example, request the formation of board committees to address compliance matters or  sustainability and human rights issues.  In making its voting recommendation, ISS will consider (a) the existing oversight mechanism regarding the issue for which board oversight is sought, (b) the level of disclosure regarding the issue, (c) company performance related to the issue, (d) board committee structure compared to that of other companies in its industry, and/or (e) the scope and structure of the proposal.

Anti-takeover Defenses

9.   Net Operating Loss (NOL) Poison Pills. Rather than apply its general policy with respect to poison pills,[1] ISS will evaluate management proposals to adopt a poison pill for the stated purpose of preserving a company’s NOLs on a case-by-case basis considering  (a) the trigger (typically slightly below five percent), (b) the value of the NOLs, (c) the term, and (d) shareholder protection mechanisms (such as sunset provision or expiration of the pill upon exhaustion or expiration of NOLs), as well as other factors that ISS determines to be applicable.  The new framework takes into account the unique purpose of NOL pills, i.e., to preserve a tax benefit, and not as an anti-takeover defense.

10.  Advance Notice Requirements for Shareholder Proposals/Nominations.  For companies whose bylaw amendments are subject to a shareholder vote, ISS will recommend votes on proposed amendments to advance notice provisions on a case-by-case basis.  It will support those proposals permitting shareholders to submit proposals/nominations as close to the meeting as reasonably possible and within the broadest window possible, recognizing the need to allow for sufficient company, regulatory and shareholder review.  For example, ISS indicated that a reasonable time for submissions would be no later than 60 days before the meeting with a submission window of at least 30 days.

Capital Structure

11.  Proposals to Increase Common Stock and Preferred Stock Authorizations.  The 2009 Policy Updates replace the 300 percent allowable cap and other criteria considered (e.g., whether the company has a non-shareholder approved poison pill or any non-shareholder approved compensation plans) when ISS analyzes company proposals to increase the number of shares of common or preferred stock authorized for issuance.  The 2009 Policy Updates indicate that recommendations on proposals to increase the number of authorized shares will be determined on a case-by-case basis after considering company-specific factors, including (a) the specific reasons for the proposed increase, (b) the dilutive impact (which continues to be measured by a proprietary ISS quantitative model), (c) board governance structure and practices, and (d) risk to shareholders of not approving the request. 

Accounting Issues

12.  "Poor" Accounting Practices.  As a result of the 2009 Policy Updates, ISS will no longer automatically recommend that shareholders vote "Against" or "Withhold" voting authority from audit committee members and/or the full board if "poor" accounting practices are present.  Instead, ISS will make its recommendations on a case-by-case basis after examining the accounting practice’s severity, breadth, chronological sequence and duration, as well as the company’s efforts at remediation.  In addition, ISS expanded the circumstances in which it will recommend that shareholders vote "Against" or "Withhold" voting authority from audit committee members to include where the company received an adverse opinion from its auditor.

Corporate Responsibility

13.  ISS issued a number of policies with respect to shareholder proposals that address corporate responsibility, including proposals regarding:

  • Genetically modified ingredients;
  • Pharmaceutical pricing and pharmaceutical reimportation;
  • Diversity and equal opportunity programs and policies;
  • Farming operations;
  • Energy efficiency;
  • Linking executive compensation to corporate responsibility; and
  • Labor and human rights standards, including vendor standards, codes of conduct and the MacBride Principles.

What Companies Should Do Now

In light of the ISS 2009 Policy Updates, companies should consider the following steps.

1.  Examine the Harmonized Performance Test – that is, whether one-year and three-year total shareholder returns are in the bottom half of the company’s four-digit Global Industry Classification Group – to determine if ISS considers your company to have poor performance.

2.   Examine whether ISS is likely to make an "Against" or "Withhold" recommendation regarding a director’s election, and in particular, members of committees (especially the compensation committee) due to a governance issue and what steps, if any, should be taken with regard to the director(s). 

3.  Evaluate whether your company engages in any of the practices ISS has enumerated as "poor" pay practices and determine if the practices remain appropriate.  In addition, if applicable, confirm your company is complying with the Treasury’s rules under the EESA.[2]

4.  Evaluate whether your company engages in any of the practices or is subject to any of the actions that ISS has enumerated as "poor" accounting practices and take steps to remediate the issues.

5.   Consider providing additional disclosure (e.g., on your company’s website or through other public documents) regarding your company’s policies and procedures that relate to the corporate governance issues identified by the ISS 2009 Policy Updates.   

6.   Review last year’s reports proxy advisory reports on the company, particularly in light of the 2009 Policy Updates, to determine if there are any issues that should be addressed.

   [1]   NOL pills would not typically receive ISS support under the general ISS policy with respect to poison pills due to the low triggers, which may discourage companies from seeking shareholder approval for such pills. 

  [2]   On October 21, 2008, John W. White, Director, Division of Corporation Finance, Securities and Exchange Commission gave a speech titled "Executive Compensation Disclosure: Observations on Year Two and a Look Forward to the Changing Landscape for 2009," in which he suggested that it might be appropriate for companies not subject to EESA consider some of the risks an executive might be incentivized to take to meet compensation targets and disclose this in the company’s CD&A.  The speech is available at http://www.sec.gov/news/speech/2008/spch102108jww.htm.

Gibson, Dunn & Crutcher LLP  

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or

John F. Olson (202-955-8522, [email protected]),
Brian J. Lane (202-887-3646, [email protected]),
Ronald O. Mueller (202-955-8671, [email protected]),
Amy L. Goodman (202-955-8653, [email protected]),
Gillian McPhee (202-955-8230, [email protected]) or
Elizabeth Ising (202-955-8287, [email protected])

in the firm’s Washington, D.C. office. 

© 2008 Gibson, Dunn & Crutcher LLP

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