Key ISS Updates For Companies Seeking Shareholder Approval of an Equity Plan in 2019

Public companies seeking shareholder approval of a new or amended equity plan on or after February 1, 2019 should consider some key updates by Institutional Shareholder Services (“ISS”) to its Equity Compensation Plans FAQs.

Although the updates leave ISS’s general equity plan scorecard (“EPSC”) methodology framework intact, there are some noteworthy changes:

  1. CIC Vesting Factor. The change in control (CIC) vesting factor has been revised to provide EPSC points based on whether the company discloses the vesting treatment of awards, regardless of the actual vesting treatment that the company elects to apply. Under the pre-2019 ISS policies, companies were allocated points for the CIC vesting factor if equity awards did not vest automatically upon a change in control (unless the awards were not assumed) or, in the case of performance awards, vested pro-rata based on the actual performance attainment level and/or the time elapsed in the performance period as of the change in control.Under the ISS policy for 2019, full EPSC points will be awarded where an equity plan discloses the CIC vesting treatment for both time-based and performance-based awards. However, if the plan is silent on the vesting treatment or if the plan provides the company with discretion to determine the vesting treatment, the company will not be allocated any points. Historically, many companies have elected to forego the points attributable to the CIC vesting factor because they prefer to retain flexibility to determine the CIC vesting treatment at the time of a change in control. Therefore, the change to this factor may not influence companies to comply with it.
  2. Excessive Share Capital Dilution. An additional negative overriding factor has been added for the S&P 500 and Russell 3000 EPSC models, triggered when the company’s equity compensation program is estimated to dilute shareholders’ holdings by more than 20% for the S&P 500 model or 25% for the Russell 3000 model. Note that this policy appears to focus on share capital dilution rather than voting power dilution. As a negative overriding factor, it may result in an “against” recommendation from ISS on an equity plan proposal regardless of the EPSC score.
  3. 162(m)-Related Plan Amendments. Many companies and their advisors have been awaiting ISS’s view on plan amendments to reflect the elimination of Code Section 162(m)’s performance-based compensation exception to the $1 million limit on the deductibility of compensation paid to public company “covered employees.” As most have anticipated, ISS’s policies for 2019 confirm that ISS will not look favorably on plan amendments that remove good governance provisions, such as individual award limits. Eliminating such provisions will not result in a reduction of points under the EPSC, but doing so may be considered a problematic pay practice that could influence ISS’s recommendation with respect to a company’s say-on-pay vote or under ISS’s executive pay evaluation policy. However, ISS has no issue with removal of general references to 162(m) qualification, including the metrics to be used for performance awards.
  4. Plan Duration Factor. Recognizing that companies will no longer need to bring their equity plans to shareholders every five years for Code Section 162(m) purposes, the updated EPSC places increased weight on the estimated plan duration factor in an effort to encourage plan resubmission to shareholders more often than stock exchanges require. The factor itself is not changed, under which full points are awarded for a plan with an estimated duration (based on three-year average burn rate) of five years or less, half points are awarded if the estimated duration is between five and six years and no points are awarded if it exceeds six years.

If your company is taking a plan to shareholders this proxy season, it should consider these ISS policy changes and other required or advisable plan updates from a tax and legal perspective. In particular, companies need to carefully consider their approach to performance-based awards under their plans following the changes to Code Section 162(m).

Sinead Kelly is a partner in Baker McKenzie’s Compensation practice in San Francisco. She advises on U.S. executive compensation and global equity and has practiced in the compensation field since 2005. In her practice, Sinead counsels U.S. and non-U.S. public and private companies on all aspects of equity and executive compensation plans and arrangements, including plan design, drafting, administration and governance. In this regard, Sinead advises on and assists companies with compliance with U.S. federal and state securities and tax laws relating to compensation arrangements, as well as with preparing SEC disclosures, complying with stock exchange rules and addressing non-U.S. tax and regulatory requirements. She has been repeatedly recognized by Legal 500 as a leading lawyer for Executive Compensation and Employee Benefits.
Victor Flores is a partner in Baker McKenzie’s Employment & Compensation Practice, with a focus on Executive Compensation and Employee Benefits. Victor advises global US and non-US companies – both public and private – on all aspects of executive compensation and benefits matters, including the corporate, securities and tax law, and ERISA issues arising in the implementation and administration of compensation programs. He regularly helps clients with the design and implementation of equity and non-equity based incentive compensation programs and nonqualified deferred compensation programs. Victor also has extensive experience advising on compensations and benefits issues in mergers and acquisitions, corporate reorganizations, private equity and other corporate transactions.