On November 19, 2009, RiskMetrics Group (RMG) released its 2010 updates to its U.S. Corporate Governance Policy and a set of Frequently Asked Questions relating to executive compensation matters. The most significant changes in RMG’s updates, summarized below, relate to (i) voting policies concerning director nominees for companies that have adopted poison pills without shareholder approval, (ii) the evaluation of executive compensation practices and voting policies for companies with practices that RMG believes raise shareholder concerns, (iii) criteria for director independence, and (iv) voting policies on proposals to reduce greenhouse gas emissions. The updates also include minor changes to several other policies.
Repeated “Withhold/Against” Vote Recommendations With Respect to Non-Shareholder Approved Poison Pills
Since 2005, RMG’s policy has been to recommend withholding votes or voting against the election of a company’s entire board (other than new directors) if the board adopts or renews a shareholder-rights plan, also known as a “poison pill,” without either advance shareholder approval or a commitment to seek shareholder approval within 12 months. RMG’s policy has been to make this recommendation only once, at the shareholder meeting immediately following the adoption of the poison pill. Under the revised policy, RMG may in the future recommend “withhold/against” votes for as long as the poison pill continues in effect.
RMG will review companies without staggered boards every three years and, if the company maintains its poison pill without shareholder approval, make its “withhold/against” vote recommendation with respect to the election of the entire board (other than new directors). For companies with staggered boards, RMG will make its “withhold/against” recommendation on an annual basis. This periodic evaluation applies only to “longer-term” poison pills — those with a term of more than 12 months — and renewals of existing poison pills. With respect to “short-term” poison pills — those with a term of 12 months or less — RMG will make voting recommendations on a case-by-case basis, taking into account whether the company had time to put the pill up for shareholder ratification given the circumstances of its adoption, the company’s rationale for adoption of the pill, its governance structure and practices, and its track record of accountability to shareholders.
The new policy will be applied in 2010 only to companies adopting or renewing a pill after November 19, 2009. RMG states that it is “possible” that in future years it will apply the policy retroactively to companies that previously adopted long-term pills.
Executive Compensation
The RMG updates revise the organization and presentation of RMG’s policies concerning executive compensation practices by combining its existing Pay for Performance Policy, Poor Pay Practices Policy, and Management Say on Pay (MSOP) Guidelines to create a single Executive Compensation Evaluation Policy. While much of the substance of the Executive Compensation Evaluation policy is unchanged from previous years, there are a several notable modifications and additions:
Focus on MSOP Proposals
In prior years, if RMG felt that a particular company’s pay practices were “poor” under its guidelines, RMG’s policy was generally to recommend “withhold/against” votes with respect to that company’s compensation committee members or directors generally as the primary means to express its displeasure over compensation matters. Now, for companies that include MSOP proposals on their annual meeting ballots, RMG intends to use its voting recommendations with respect to those proposals as the primary communication avenue to address perceived deficient pay practices, reserving additional or alternative negative recommendations on compensation committee members or the full board for “egregious or continuing” situations. For companies with “problematic pay practices” under the new Executive Compensation Evaluation Policy, RMG’s general policy will be to recommend the following votes:
- “Against” MSOP proposals by such companies
- “Against/withhold” with respect to the election of compensation committee members (or, in “rare cases” in which RMG deems the entire board responsible, all directors, including the CEO) in “egregious” situations, when no MSOP proposal is on the ballot or when the board has failed to respond to concerns raised in prior MSOP evaluations
- “Against” equity-based incentive plan proposals if excessive non-performance-based equity awards are deemed to be the “major contributor” to a pay-for-performance misalignment
New Factor in Pay for Performance
As a new factor in its pay for performance evaluation, RMG will now review the alignment of the CEO’s total direct compensation with total shareholder return over a period of at least five years. RMG currently makes adverse vote recommendations with respect to equity plans and compensation committee members if it identifies a “pay for performance disconnect,” defined as an increase in CEO total compensation at a company whose one-year and three-year total shareholder returns are in the bottom half of its industry group. (CEOs who have served less than two consecutive fiscal years at their companies are exempt from this evaluation.) Under this new analysis, RMG will evaluate companies whose one-year and three-year total shareholder returns are in the bottom half of their industry groups to determine whether, in its view, the CEO’s total compensation is aligned with the company’s total shareholder return over a period of at least five years. In making this determination, RMG will consider the following factors, among others:
- Whether the CEO’s pay has increased or decreased and the magnitude of the change
- The long-term (at least five years) alignment of the CEO’s total direct compensation with the company’s total shareholder returns, with particular focus on the most recent three years
If RMG determines that there is a significant misalignment between CEO pay and performance under this measurement, it will recommend a vote “against” an MSOP proposal and/or the election of directors (“generally” the compensation committee members). If a significant portion of the pay misalignment is attributable to equity awards, as noted above, RMG will generally recommend a vote “against” any equity plan on the ballot.
Risk Assessment
RMG’s new assessment of company policies and practices that could incentivize excessive risk-taking will include consideration of (i) guaranteed bonuses; (ii) single performance metrics used for short- and long-term plans; (iii) lucrative severance packages; (iv) high-pay opportunities relative to industry peers; (v) disproportionate supplemental pensions; and (vi) “mega” annual equity grants that provide unlimited upside with no downside risk. In previous years, RMG’s policies have not included a separate assessment of such policies and practices for their potential to incentivize excessive risk-taking.
Primary Problematic Pay Practices
RMG has identified the following pay practices as most significant in its determination that a company maintains problematic pay practices:
- Multi-year guaranteed salary increases and equity compensation and bonuses that are not performance-based
- Bonus payouts that it deems “abnormally large” without sufficient ties to performance or satisfactory disclosure
- Crediting additional years of service under benefit plans that result in significant additional benefits without sufficient justification or including long-term equity awards in the pension calculation
- Perquisites for former or retired executives and extraordinary relocation benefits, including home buyouts, for current executives
- Change-in-control payments exceeding three times base salary and target bonus
- Single-trigger change-in-control payments and new or materially amended agreements that provide for modified single triggers under which an executive may voluntarily leave for any reason and still receive the change-in-control severance package
- New or materially amended agreements that provide for an excise tax gross-up
- Tax gross-ups for perquisites and similar benefits
- Dividends or dividend equivalents paid on unvested performance shares or units
- Use by executives of company stock in hedging activities such as cashless collars, forward sales, equity swaps, or other similar arrangements
- Repricing or replacement of underwater stock options/stock appreciation rights without prior shareholder approval, including cash buyouts and the voluntary surrender of options followed by a subsequent re-grant
Other Problematic Pay Practices
RMG also has identified other problematic pay practices that it considers less weighty than those listed above, including (i) excessive severance and/or change in control provisions, such as payments upon an executive’s termination in connection with a deemed performance failure; (ii) overly generous perquisites; (iii) an excessive difference between the CEO’s total pay and that of the next highest paid named executive officer; and (iv) voluntary surrender of underwater options by executive officers that may be viewed as an indirect repricing or exchange program.
Director Independence
Changes to Evaluation of Professional Services
RMG’s updates codify several of its practices with respect to professional services that, if provided by a director or certain affiliates of a director, may result in RMG treating the director as an “affiliated outside director.”
Determination of “Inside” Director Status
The updates change one of the criteria for inside directors from “non-employee officer of the company if among the five most highly paid” to “among the five most highly paid individuals.” A non-employee director serving as an officer due to a statutory requirement will not be deemed an “insider” if the company expressly discloses that he or she does not receive compensation in excess of $10,000 for such service.
Evaluation of “Material Transactions”
The updates modify RMG’s threshold for a “material transactional relationship” under its director independence standards for NYSE-listed companies to conform the transaction to the NYSE standard (i.e., greater of $1 million or two percent of the recipient’s gross annual revenues). NASDAQ-listed companies will continue to be subject to the NASDAQ test of the greater of $200,000 or five percent of the recipient’s gross annual revenues. RMG will examine transactional relationships for materiality if the director or an immediate family member has the transactional relationship directly, or if the director or an immediate family member is a partner in, or a controlling shareholder or an executive officer of, an organization that has the transactional relationship.
Proposals to Reduce Greenhouse-Gas (GHG) Emissions
RMG will evaluate shareholder proposals seeking reductions in GHG emissions on a “case-by-case” basis, taking into account factors including whether the company provides meaningful disclosure on GHG emissions from its products and operations, feasibility of GHG-emission reduction in light of the company’s product line and current technology, and how prescriptive the proposal is in defining specific amounts and timeframes for GHG-emission reduction.
Since RMG is among the most influential shareholder advisory firms in the institutional investor community, its corporate governance policies and changes to those policies should be noted and considered by boards of directors when designing and evaluating corporate governance policies and practices. The complete updates are available at RMG’s Web site: http://www.riskmetrics.com/policy/2010/policy_information. In addition, on November 18, 2009, Patrick McGurn, Special Counsel to RMG, gave a presentation on RMG’s 2010 institutional investor issues by Web conference as part of Foley’s National Directors Institute. You can listen to that presentation and review Mr. McGurn’s presentation materials at Foley.com/ndi.
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If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:
Peter C. Underwood
Milwaukee, Wisconsin
414.297.5630
[email protected]
Steven R. Barth
Milwaukee, Wisconsin
414.297.5662
[email protected]
Joshua A. Agen
Milwaukee, Wisconsin
414.297.5535
[email protected]
