RiskMetrics issues 2010 benchmark policy updates

RiskMetrics (ISS), the publicly traded arbiter of all things corporate governance, has released its 2010 updates to its benchmark proxy voting policies and provided an executive summary. It has also posted some FAQs regarding executive comp issues. The compensation component of the updates will be addressed in a separate email along with the FAQs.

Some of the key U.S. policy updates are summarized below:

Under the current policy, a "new nominee" is a director who would be elected by shareholders for the first time, and RM's position has been that it would not recommend withhold/against votes on new nominees because they should not be held accountable for actions taken by the board before they joined. RM is changing the definition to take into account the length of the nominee's tenure on the board before the shareholder election. Accordingly, a new nominee will be any current nominee who has not already been elected by shareholders and who joined the board after the "problematic action" in question transpired. This change contemplates a case-by-case analysis of whether the nominee has been on the board long enough to be held accountable for the board‘s decisions.

Even though companies have started to adopt more poison pills with a term of three years or less, RM is not buying the typical characterization of pills as shareholder protection measures. RM argues that institutional investors view poison pills as among the most onerous takeover defenses, entrenching management and detrimentally affecting long-term share value. Currently, RM does not take into account the duration of the pill.

To encourage companies to seek shareholder approval of poison pills and to provide flexibility with regard to short-term pills that have been adopted in response to specific circumstances that may affect the interests of shareholders, RM is updating its approach as follows:

• Generally recommend withhold or against votes on director nominees at companies that adopt long-term (greater than one year!!) pills or renews any existing pills, including short-term pills, without shareholder approval. A commitment or policy that puts a newly adopted pill to a binding shareholder vote may mitigate or counter a potential adverse vote recommendation. Companies will be reviewed at least every three years -- and those with classified boards annually -- beginning the first year following the adoption and extending until the pill has expired or been redeemed. RM will make withhold recommendations for all nominees if the company still maintains a non-shareholder-approved poison pill. This policy will apply to all companies adopting or renewing pills after the announcement of this policy (Nov. 19, 2009).
• RM will also recommend withhold or against votes if the board makes a material, adverse change to an existing poison pill without shareholder approval.
• Short-term pills adopted without shareholder approval will be considered on a case-by-case basis, taking into account the following factors:
  • The date of the pill‘s adoption relative to the date of the next meeting of shareholders, i.e., whether the company had time to put the pill on ballot for shareholder ratification under the circumstances;
  • The issuer‘s rationale;
  • The issuer's governance structure and practices; and
  • The issuer's track record of accountability to shareholders.

Because a poison pill to protect a company's net operating loss (NOL) may be intended to protect valuable NOL tax assets, RM has a separate policy for these pills that takes into account the trigger of the NOL pill, the value of the NOLs, shareholder protection provisions in the NOL pill, and the company's governance structure and track record. RM has also instituted a similar new policy evaluating NOL protective amendments.

Currently, RM recommends withhold or against votes on directors for egregious actions or failure to replace management as appropriate. The updated policy clarifies somewhat the types of egregious action contemplated. Under extraordinary circumstances, RM will now recommend a vote against or withhold from directors individually, on a committee, or the entire board, due to the following:

• Material failures of governance, stewardship or fiduciary responsibilities at the company;
• Failure to replace management as appropriate; or
• Egregious actions related to the director's 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.

RM has updated its evaluation of director independence regarding both professional and transactional services, applying an NYSE-based test for determining the materiality of transactional relationships between directors and companies listed on the NYSE and Amex exchanges, and a Nasdaq-based test for Nasdaq-listed companies. The update also defines with specificity the types of services that are deemed to be "professional services," and clarifies that professional services are

"advisory in nature, generally involve access to sensitive company information or to strategic decision-making, and typically having a commission- or fee-based payment structure."

Over the past year, RM has seen a rise in management-sponsored proposals that appear on the surface to provide shareholders with a right to call special meetings, but that, in substance, include procedural hurdles or thresholds that have the effect of limiting that right. The update specifies the factors RM takes into account in evaluating the proposal:

• Shareholders‘ current right to call special meetings;
• Minimum ownership threshold necessary to call special meetings (10% preferred);
• The inclusion of exclusionary or prohibitive language;
• Investor ownership structure; and
• Shareholder support of and management‘s response to previous shareholder proposals.

Similar updates are being made with respect to proposals to allow shareholder written consents.

RM generally votes against supermajority vote requirements. Under the new updates, however, it will now take into account an individual‘s or group‘s majority ownership in the company, which may be detrimental to minority shareholders‘ interests.

The updated policy will take into account company-specific factors (many of which might be included in proxy narrative), including, at a minimum, the following:

• Past Board performance:
• The company‘s use of authorized shares during the last three years;
• One- and three-year total shareholder return; and
• The board‘s governance structure and practices.
• The nature of the current request:
• Disclosure in the proxy statement of the specific reasons for the proposed increase;
• Dilutive impact of the request as determined through RM's "allowable cap," which takes into account the company‘s need for shares and its three-year total shareholder return; and
• Risks to shareholders of not approving the request.

With specified exceptions, RM generally supports proposals asking for reports on greenhouse gas emissions. However, it has historically generally recommended against proposals calling for actual reductions in GHG emissions by specific amounts or within a specific time frame. The updated policy analyzes reduction proposals on a case-by-case basis, taking into account factors including whether the proposal is overly prescriptive in defining specific amounts and/or timeframes for GHG reduction, the quality of company disclosure relative to industry norms, and the feasibility of GHG reduction given the company's product line and technology.

With specified exceptions, RM generally recommends in favor of proposals to obtain board diversity reports and on a case-by case basis with regard to proposals requesting action on board diversity. Here, the key change is that the updated policy spells out more clearly the concept of diversity.

RM used to recommend on a case-by-case basis with regard to proposals requesting reports on ways of linking executive compensation to non-financial criteria, such as corporate downsizings, customer or employee satisfaction, community involvement, human rights, environmental performance or predatory lending, and against proposals to actually link comp to these non-financial criteria or to analyze the pay disparity between corporate executives and other employees. Under the update, RM will now generally vote against even requesting a report on these issues. The reason given is that RM believes that there is a lack of standards or consensus over how ESG performance metrics should be linked to executive compensation and that these are matters best left to an independent comp committee.