RiskMetrics Issues Policy Updates for 2010 Proxy Season

On November 19, 2009, RiskMetrics Group issued updates to its proxy voting policy that will be applicable to shareholder meetings held on or after February 1, 2010. The policy updates that are applicable to US companies are available at here. This briefing summarizes those policy updates that affect US companies and discusses implications for voting recommendations and results in uncontested elections of directors. [1] Notably, RiskMetrics’ updated policy expands the circumstances that will lead it to recommend that its clients vote against or withhold votes for directors who are up for re-election in 2010. As outlined in Appendix A, there will now be more than 40 categories of practices that could lead to a negative vote recommendation.

RiskMetrics voting recommendations are influential: The voting results at Russell 3000 companies for the 2009 proxy season indicate that the vast majority of directors who received a majority “against” or “withhold” vote also received an adverse RiskMetrics vote recommendation. The impact of negative vote recommendations is likely to be even greater for the 2010 proxy season because of the increase in companies adopting majority voting for the election of directors and/or director resignation policies, coupled with the elimination of brokers’ ability to vote in director elections in the absence of customer instructions.

In preparing for their companies’ 2010 annual meetings, corporate counsel, corporate secretaries and directors (particularly those serving on compensation or nominating and governance committees) should review the updated policy and consider areas of potential vulnerability.

Summary of Key Changes for the 2010 Proxy Season

1. Executive Compensation Evaluation and Equity Plan Proposals

RiskMetrics has updated its policy on evaluation of executive compensation so that management proposals to approve executive compensation that have been included on the ballot at companies that have implemented a “say-on-pay” will become the primary communications vehicle for shareholders to initially address problematic pay practices. In determining its recommendation with respect to a management proposal to approve executive compensation, RiskMetrics will:

• Consider whether the company has “problematic pay practices,” including policies and practices that could incentivize excessive risk-taking and
• Assess pay-for-performance, which will now include an assessment of CEO pay relative to a company’s total shareholder return over five years in addition to its current tests.

RiskMetrics will generally recommend a negative vote on the re-election of compensation committee members (or, in rare cases where it deems the full board to be responsible, all directors) if, in its view:

• There is a misalignment between CEO pay and performance with regard to shareholder value, in accordance with the broader tests discussed above or
• The company maintains problematic pay practices (including policies and practices that could incentivize excessive risk taking) and one of the following three factors is present:
  • RiskMetrics considers the situation to be “egregious”
  • No management proposal to approve executive compensation is on the ballot or
  • The board has failed to respond to concerns raised in prior management proposals to approve executive compensation.

In emphasizing its new focus on potential incentives for inappropriate risk-taking, RiskMetrics spotlighted guaranteed bonuses, the use of a single performance metric for short- and long-term plans, “lucrative” severance packages, “high pay opportunities” relative to industry peers, “disproportionate” supplemental pensions and “mega” annual equity grants that provide “unlimited upside with no downside risk.”

RiskMetrics will also assess pay-for-performance when determining its recommendation with respect to proposals to approve equity-based incentive plans and will recommend a negative vote if in its view, excessive non-performance-based equity awards are the major contributor to a payfor- performance misalignment. RiskMetrics has also updated its volatility and stock price assumptions and burn rate tables for 2010, which it uses to determine recommendations with respect to equity compensation plans that are up for shareholder approval.

Note that on November 19, 2009, RiskMetrics released a set of frequently asked questions in relation to its evaluation of compensation practices for US companies, which is available here.

2. Adoption or Renewal of Non-Shareholder Approved Poison Pills

RiskMetrics has amended its policy with respect to voting on directors at companies where a shareholder rights plan (poison pill) has been instituted by the board but not approved by shareholders. RiskMetrics will now recommend on a “case-by-case” basis where a board has adopted a pill with a term of 12 months or less without shareholder approval. However, RiskMetrics will recommend a negative vote with respect to all continuing directors where a board has, without shareholder approval:

• Adopted a pill with a term of more than 12 months
• Renewed any pill
• Made any “material, adverse change” to an existing pill or
• Maintained an existing pill that has not been previously approved by shareholders. RiskMetrics will review companies that have a pill in place every year if the company has a classified board or at least once every three years if the company does not have a classified board.

Note that RiskMetrics has a separate updated policy regarding pills adopted to protect a company’s net operating losses.

3. Shareholder Ability to Call a Special Meeting and Action by Written Consent

RiskMetrics has amended its policies relating to recommendations on proposals that either restrict or permit shareholders to call special meetings or act by written consent. RiskMetrics will now consider the following factors:

• Whether shareholders currently have the right to call special meetings or act by written consent
• The ownership threshold necessary to call special meetings (10% is preferred) or the threshold at which shareholders can act by written consent, as applicable
• The inclusion of exclusionary or prohibitive language
• The ownership structure of investors and
• The level of shareholder support of and management’s response to previous shareholder proposals.

4. Egregious Actions

For 2010, RiskMetrics will define more broadly the “egregious actions” for which it will recommend negative votes for individual directors, for a specific committee or for the entire board. In addition to its existing criteria, which relate to failure to replace management as appropriate, RiskMetrics will consider:

• “Material failures of governance, stewardship or fiduciary responsibilities at the company” and
• Actions related to the directors’ service on other boards that “raise substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders” at any company.

5. Director Independence Classification

RiskMetrics has amended its classification of directors to, among other things, broaden the transactional relationships and professional services that may impair independence under its bright-line rules. In relation to transactional relationships, RiskMetrics will employ a NYSEbased test for companies listed on the NYSE or Amex and a Nasdaq-based test for all other companies. While RiskMetrics removed related party transactional relationships from the bright-line impediments to a finding of independence, such relationships will continue to be examined under the general tests of “material relationship.”

For a detailed comparison of the classification for 2010 against the 2009 classification, see Appendix B.

6. Other Amendments

Appendix C summarizes the other changes and clarifications made by RiskMetrics that are applicable to the 2010 proxy season, including amendment of the policy relating to greenhouse gas emissions.

Expected Impact of these Changes in 2010

Looking back at uncontested elections during the first nine months of 2009, RiskMetrics recommended a negative vote with respect to 2,147 directors in the Russell 3000. Notably, the vast majority of directors who received a majority “against” or “withhold” vote received an adverse vote recommendation from RiskMetrics – out of 93 directors at 50 companies who received such a vote, RiskMetrics recommended adversely with respect to 89 of those directors, at 48 companies. [2] According to RiskMetrics, the following key factors led to high negative votes during the 2009 proxy season:

• Tax gross-up payments and other pay concerns
• Failure to implement a majority-supported shareholder resolution
• Failure to seek shareholder approval for a poison pill
• Service of management-affiliated directors on key board committees and

• Poor attendance at board and committee meetings. [3]

Notwithstanding the record numbers of “against” and “withhold” votes in 2009, few directors failed to be seated. Most companies at which a director received a majority negative vote had a plurality standard in place for director elections and no director resignation policy. [4]

It is likely that RiskMetrics’ policy updates will result in an increased number of recommendations in 2010 to vote “against” or “withhold” votes from director nominees in uncontested elections. It is also likely that these negative vote recommendations will have a greater impact than in the past because of other significant changes in the director election process – the increase in companies adopting majority voting for the election of directors (which is also the subject of several pending Congressional bills) [5] and/or director resignation policies, coupled with the elimination of brokers’ ability to vote in director elections in the absence of customer instructions.

What You Should Do Now

RiskMetrics typically provides companies that are in the S&P 500 with prior warning if it intends to issue a recommendation to vote “against” or “withhold” from a director and companies are given a very narrow time window (48 hours) in which they can respond and engage with RiskMetrics on the issue. Companies that are not in the S&P 500 generally do not receive such prior warning. We encourage all companies to become familiar with the circumstances in which RiskMetrics may recommended a vote “against” or “withhold” from directors (set forth in Appendix A) so that companies are better prepared to engage with RiskMetrics within a tight time frame. Companies may also wish to proactively contact their analyst at RiskMetrics in anticipation of or shortly after proxy statement filing to talk through any issues that could cause RiskMetrics to recommend a vote “against” or “withhold” from a director. [6]

Endnotes

[1] On November 19, 2009, RiskMetrics also issued updates to its proxy voting policies that are applicable to European, Canadian and other international companies, which are available at http://www.riskmetrics.com/policy/2010/policy_information.
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[2] Data relates to director elections where the voting results were available as of October 5, 2009 and was derived from the Governance Analytics section of the RiskMetrics website (www.riskmetrics.com) (log-in required). See also RiskMetrics Group, Postseason Review: Withhold Votes, RISK & GOVERNANCE WEEKLY (October 2, 2009).
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[3] RiskMetrics Group, Postseason Report (October 15, 2009) at 10.
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[4] Id.; SharkRepellent, Withheld: The Director’s Cut (October 1, 2009).
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[5] See, e.g., the Restoring American Financial Stability Act of 2009, 111th Cong. (2009), the Shareholder Bill of Rights Act of 2009, S. 1074, 111th Cong. (2009) and the Shareholder Empowerment Act of 2009, H.R. 2861, 111th Cong. (2009).
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[6] RiskMetrics recently issued guidelines with respect to engaging with RiskMetrics on proxy voting matters, which is available at http://www.riskmetrics.com/sites/default/files/ProcessForEngagingOnProxyVoting20090130.pdf.
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