ISS Seeks Comment on Draft Proxy Voting Policies

As a critical component of ISS’ annual policy formulation process, ISS is seeking comment from institutional investors, corporate issuers, and other governance market participants on its proxy voting policy updates while they are still in draft stage. ISS is requesting comments on both its U.S. and international policies.

In response to a number of requests from investors, issuers and market intermediaries, ISS has extended the deadline for commenting on its 2012 draft proxy voting policies through Nov. 7.

The comments received on ISS’ 2012 draft policies from all market participants are invaluable to ISS as they help ensure that ISS’ draft policies reflect the perspectives of the corporate governance community and the best practices in corporate governance. ISS gathers broad input each year from institutional clients and market constituents through policy surveys, issue-specific roundtables, and this unique open comment period. During this year’s policy survey, more than 300 respondents weighed in on issues that included executive compensation, board independence, engagement triggers, and social and environmental issues. The full results from the survey are posted on the ISS Policy Gateway.

ISS will release its final 2012 U.S. and international policy updates during the week of Nov. 14 and its Global Policy Summary and Concise Guidelines in December. To participate in ISS’ comment period and learn more about its policy formulation process, please visit the ISS Policy Gateway.

Key Changes Under Consideration

The proposed 2012 policy changes include a more robust pay-for-performance policy for the U.S. and Canada with a longer-term focus on trends in total CEO compensation and shareholder return. The proposed policies also address the responsiveness of boards to significant shareholder opposition during say-on-pay votes and to investor preferences during say-on-pay frequency votes.

ISS also is seeking comment on draft policy changes on: Proxy Access Proposals (U.S.), Election of Censors (France), Board Independence (Brazil), Equity Plans Related to Section 162(m) (U.S.), Equity-Based Compensation (France), Increase in Director Compensation Ceiling Proposals (Japan), Hydraulic Fracturing Proposals (U.S.), and Political Contribution Proposals (U.S.).

The following are excerpts from some of the key ISS policy changes:

Evaluation of Executive Pay (U.S.): ISS currently identifies pay-for-performance disconnects by scrutinizing underperforming companies (i.e., those with 1- and 3-year total shareholder returns (TSRs) below the median of their 4-digit GICS industry group), and then applying a qualitative examination of other factors, including the year-over-year change in the CEO’s total pay and a view of the five-year trends in company TSR and CEO pay, to determine whether pay and performance are misaligned. Beginning in 2012, ISS proposes to use a new methodology to evaluate pay-for-performance alignment, which will identify companies that have demonstrated strong, satisfactory, or weak alignment between TSR and CEO pay over an extended period. The new methodology incorporates a quantitative analysis, followed as applicable by further qualitative analysis.

The quantitative pay-for-performance analysis utilizes three factors; together they provide a useful signal to pay-for-performance alignment over sustained periods (one, three, and five years), including both high and low performing companies that provide proportionate (or disproportionate) pay and pay opportunities to the CEO. The analysis measures three factors in two categories:

Relative Alignment– Two factors are analyzed to determine the pay-performance alignment within a group of companies similar to the company in market cap, revenue (or assets), and industry:

• The peer group is generally comprised of 14-24 companies that are selected on the basis of market cap, revenue (or assets for financial firms), and GICS industry group, via a process designed to select peers that are closest to the subject company in terms of revenue/assets and industry and also within a market cap range that is reflective of the company’s life cycle maturity phase
• The degree of alignment between the company’s TSR rank and the CEO’s total pay rank within the peer group, as measured over one-year and three-year periods (weighted 40/60, to put more emphasis on the longer term);
• The multiple of the CEO’s total pay relative to the peer group median, which may identify cases where a high performing company may nevertheless be overpaying.

Absolute Alignment– this factor measures long-term alignment between pay and company performance, as:

• Alignment between the trend in the CEO’s pay and the company’s TSRs over the prior five fiscal years – i.e., the difference between the slope of annual pay changes and the slope of annualized TSR changes during the prior 5-year period.

Peer Alignment and Absolute Alignment may be weighted 50/50 in this portion of the analysis. Companies that demonstrate strong or satisfactory alignment will generally receive a positive recommendation (in the absence of other pay-related issues), while companies demonstrating weak alignment will receive further qualitative review to determine a final vote recommendation.

The qualitative review considers the ratio of performance- to time-based equity awards; the overall ratio of performance-based compensation; the robustness of disclosure and rigor of performance goals; the company’s peer group benchmarking practices; actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers; special circumstances related to, for example, a new CEO in the prior FY or equity grant practices (e.g., biannual awards); and any other factors deemed relevant.

Board Response to Management Say-on-Pay (MSOP) Vote (U.S.): This policy update clarifies that ISS will recommend CASE-BY-CASE on Compensation Committee members (or in rare cases where the full board is deemed responsible, all directors) and the current MSOP proposal if the company’s prior say-on-pay proposal received significant opposition from votes cast, taking into account:

• The level of opposition;
• The company’s ownership structure;
• Disclosure of engagement efforts with major institutional investors regarding the compensation issue(s);
• The company’s response;
• Specific actions taken to address the issue(s) that appear to have caused the significant level of against votes;
• Other recent compensation actions taken by the company; and
• ISS’ current analysis of the company’s executive compensation and whether any prior issues of concern are recurring or one-time.

A higher level of scrutiny will be placed on companies where the MSOP proposal received less than 50 percent support from all votes cast. Further, the recurrence of previously identified compensation issues or newly identified compensation concerns, depending on the severity, may result in an AGAINST vote on Management Say on Pay and the Compensation Committee members.

Proxy Access Proposals (U.S.): ISS’ current policy on shareholder proposals asking for open or proxy access is to recommend on a Case-by-Case basis, taking into account the ownership threshold proposed in the resolution and the proponent’s rationale for the proposal at the targeted company in terms of board and director conduct.

Under the proposed policy for 2012, ISS would continue to evaluate these proposals on a Case-by-Case basis in determining a vote recommendation, and would take into account additional factors. The proposed policy update is as follows:

Vote CASE-BY-CASE on shareholder proposals seeking proxy access, taking into account, among other factors:

• The proponent’s rationale for the proposal at the targeted company;
• The ownership thresholds proposed in the resolution (e.g., percentage and duration);
• The maximum number of directors that shareholders may nominate each year; and
• The method of determining which nominations should appear on the ballot if multiple shareholders submit nominations.