Responding To Riskmetrics´ Updated Corporate Governance Voting Guidelines For The 2009 Proxy Season - 6 Feb 2009

United States: Responding To Riskmetrics´ Updated Corporate Governance Voting Guidelines For The 2009 Proxy Season

The 2009 Updates reflect the unprecedented volatility in the
equity markets, the ongoing credit crisis, and increased scrutiny
by investors as well as the U.S. federal government on executive
compensation and oversight of corporate risk.

RiskMetrics Group ISS Governance Services (ISS) recently
released updates (2009 Updates) to its corporate governance
policies that guide its voting recommendations to institutional
shareholders on matters submitted by companies for shareholder
approval at annual shareholder meetings. The 2009 Updates will be
used by ISS in connection with annual meetings held on or after
February 1, 2009.

The 2009 Updates reflect the unprecedented volatility in the
equity markets, the ongoing credit crisis, and increased scrutiny
by investors as well as the U.S. federal government on executive
compensation and oversight of corporate risk. Significantly, the
2009 Updates:

Given the increased focus on corporate governance and executive
compensation that will surely follow one of the worst years in the
stock market's history—and the additional attention
expected to be paid to these issues by the Obama administration and
Congress—all companies should closely consider the impact
of these 2009 Updates on their 2009 annual stockholder meetings.
This is particularly true if director withhold votes have been high
in the past or sensitive items (such as the approval of new or
modified equity compensation plans) are expected to be on the
meeting agenda.

With the changes in leadership at the U.S. Securities and
Exchange Commission (SEC), it also is anticipated that in 2009 the
SEC is likely to approve the New York Stock Exchange's
long-pending proposal to amend its broker voting rule (Rule 452) to
deny brokers the right to use their own discretion to vote
uninstructed shares in connection with the annual election of
directors. However, even if approved, it is not clear that such a
change would be effective for meetings to be held this spring. As
brokers have traditionally voted their uninstructed shares for
management's slate of directors, amendment to Rule 452 would
increase the percentage impact of withhold votes in the future.

A summary of some of the most significant 2009 Updates is set
forth below, with recommendations on actions that companies should
consider taking in response. A full description of the 2009 Updates
on ISS's website is available at
http://www.riskmetrics.com/policy/2009/policy_information.

Executive Compensation

The 2009 Updates advise that, in the current environment,
shareholders should have no patience for "pay for
failure" executive compensation programs. Companies should
consider the following as proxy season shifts into high gear:

Check All Change-in-Control Severance Arrangements

The 2009 Updates add to the list of poor pay practices that will
influence ISS's voting recommendations with respect to the
reelection of compensation committee members (and, potentially,
other board members), the approval of new or modified equity
compensation plans, and shareholder proposals relating to
independent board chairmen. These additional practices include:

A plan will not be considered to be a new change-in-control
arrangement to the extent that it is amended solely to comply with
Section 409A.

Check Your Perks Packages

The 2009 Updates also define poor pay practices to include any
tax gross-up associated with the payment or provision of
perquisites to executives, regardless of the amount being provided
to the executive. ISS has also clarified that excessive perquisites
will include personal use of a company aircraft by an executive
greater than $110,000 during a single year or an auto allowance for
an executive that exceeds $100,000 during a single year. All
aspects of perquisites are expected to receive enhanced scrutiny in
the current market environment, as investors consider them to be an
indication of how closely board members are reviewing executive
compensation practices. Consider using tables and simplifying
perquisites disclosure when practicable.

Consider Executive Compensation Clawback Provisions

Section 304 of the Sarbanes-Oxley Act of 2002 requires CEOs and
CFOs of public companies to disgorge certain bonuses and gains on
stock sales in connection with a financial restatement resulting
from both misconduct and material noncompliance with the financial
reporting requirements of the federal securities laws. Since the
adoption of SOX, the courts have held that Section 304 is only
enforceable by the SEC (and not by private plaintiffs), and the SEC
has successfully invoked Section 304 in an enforcement proceeding
on only one occasion (in a December 2007 settled enforcement
proceeding against the CEO of UnitedHealth Group). Aside from
enforcement difficulties, SOX 304 also has been viewed to have
limited usefulness due the limited scope of covered individuals and
the requirement of having an accounting restatement and
misconduct.

Institutional shareholders have pressured companies to
voluntarily adopt executive compensation recoupment policies due to
these limitations. In the past, ISS would not support a clawback
shareholder proposal if the company could show that it had adopted
a corresponding policy. Over the past few years, several public
companies have adopted clawback policies and housed them in
non-binding corporate governance guidelines or policies and have
generally tracked the terms of SOX 304.

Participating financial institutions in the Troubled Asset
Repurchase Program (TARP) must agree to amend employment contracts,
plans and arrangements to include binding clawback provisions. The
clawback provisions under the TARP program apply to all senior
executive officers and cover any bonus and incentive compensation
payments that were later found to be based on materially inaccurate
earnings, gains or other criteria (and is somewhat broader than the
coverage under SOX 304, which focuses only on "financial
results" and requires a formal accounting restatement to
trigger recoupment).

ISS has announced that it will likely support any shareholder
proposal relating to clawbacks if the proposal tracks the TARP
conditions, which ISS has determined to represent the new
"best practice" in the area of clawback provisions. In
light of emerging best practices under TARP, ISS will similarly
consider shareholder proposals requesting that companies amend
equity compensation arrangements to impose mandatory holding
periods so that executives bear the risks of their decisions in a
manner similar to long-term investors.

Check The Composition of and Methodology Behind Your "Peer
Group"

Many companies benchmark their compensation to a stated level of
compensation paid by a peer group. If a company uses a benchmark to
determine executive compensation levels, SEC disclosure rules
require detailed disclosure of the peer group and the methodology
used to compose the peer group. In its 2009 Updates, ISS announced
that it has revised its own methodology for constructing the peer
groups it uses in evaluating relative performance for Russell 3000
companies. Under its revised methodology, ISS states:

In addition to modifying its peer grouping formula, ISS has
harmonized the performance measure that it will use in comparing
relative corporate performance. Previously, ISS used multiple
performance tests for different policies. In the 2009 Updates, ISS
has announced that, going forward, "poor performance" for
Russell 3000 companies will be defined as below-median Total
Shareholder Return (TSR) relative to industry peers (under the
ISS's peer grouping), or to the Russell 3000 index as a whole,
over one- and three-year performance periods.

ISS has also stated that it intends to publish in its reports
for each company a side-by-side comparison of CEO compensation
relative to the company's peer group versus CEO compensation
relative to ISS's peer group. If a company discloses that its
own CEO's compensation is set to reflect the "median"
level of compensation among the CEOs in the company's peer
group, be prepared to answer shareholder questions about why the
ISS report shows otherwise.

Consider Closely Any Proposals Relating to Your Equity
Compensation Plan

On one positive note, the ISS announced that the recent
volatility in the stock market has prompted a modification to its
basic formula used to calculate a company's equity compensation
plan share "burn rate." ISS will generally recommend
voting against a new or modified equity plan if the company's
most recent three-year average burn rate exceeds one standard
deviation in excess of the industry mean and is over 2 percent of
the common shares outstanding. (It has been possible in certain
situations to avoid a negative vote recommendation by committing to
a future three-year burn rate not to exceed these limits as
measured at the time of making such a commitment.)

ISS calculates the annual "burn rate" as the number of
shares subject to options granted plus (if applicable) the number
of full-value shares awarded times the applicable multiplier, with
the resulting sum divided by the weighted average common shares
outstanding. ISS applies a premium on "full-value
awards," or awards other than stock options and stock
appreciation rights, by counting each share subject to a full-value
award as greater than one share in the "burn rate"
calculation. The multiplier for full-value awards is based on the
company's volatility. Historically, the stock price volatility
measure was based upon changes in the stock price over the prior
200 trading days. Given the recent unprecedented disruption to the
stock markets, stock price volatility will be measured against
changes in the stock price over the prior 400 trading days for the
quarterly downloads until September 1, 2009. ISS intends to again
revert back to the 200-day period for measuring stock price
volatility as of December 1, 2009.

Corporate Governance

ISS announced the following updates to its voting policies
relating to the board and its members. Companies are advised to
take the following actions in response to these new policies:

Consider Whether Directors Up for Reelection Next Spring Are at
Risk for Withhold Votes

In evaluating management proposals to re-elect an incumbent
director at the annual shareholder meeting, ISS evaluates the
company's performance relative to its peers when determining
whether to recommend a for or withhold vote for each nominee. ISS
has adopted a single performance test based upon Total Shareholder
Return over a one-year and three-year period. If a Russell 3000
company underperforms (falls below the median of) its industry
group, ISS may recommend a withhold vote for all incumbent director
nominees if it also finds evidence of poor board oversight and lack
of shareholder accountability. Evidence of poor board oversight and
lack of shareholder accountability include the existence of
non-shareholder approved anti-takeover protections (e.g.,
poison pills), classified boards, supermajority voting
requirements, majority voting standards with no carve-out for
contested elections, the inability of shareholders to call special
meetings, the inability of shareholders to act by written consent,
and dual-class structures.

Consider an Independent Board Chairman

In previous years, ISS has recommended in favor of any
shareholder proposal requiring that the board chairman position be
filled with an independent director unless the company maintained a
counterbalancing governance structure with an independent lead
director, established corporate governance guidelines, did not
exhibit poor TSR performance relative to its peers and industry
group, and had no problematic governance issues. In its 2009
Updates, ISS clarified that problematic governance issues will
include:

It is unclear whether or which poor pay practices will
constitute "egregious compensation practices." A company
with a combined chairman/CEO position should evaluate its exposure
to an independent chairman shareholder proposal under this new
policy.

Keep Track of the Reasons for Director Non-Attendance at Board
Meetings

The SEC's proxy disclosure rules require companies to
disclose if any individual director failed to attend at least 75
percent of board and committee meetings over the course of the
year. ISS has traditionally had a policy to recommend that
shareholders withhold their vote for any director who fell below
the 75 percent attendance mark unless such director had a
"valid excuse." Valid excuses include illness, service to
the nation, work on behalf of the company and, under the 2009
Updates, attending a funeral. ISS will require companies to explain
the circumstances for any director who fails to meet the 75 percent
attendance threshold. While including such explanations in proxy
disclosures is always encouraged, if the circumstances involve
personal, sensitive information companies are not expected to
include such disclosures in their public filings.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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