Review of RiskMetrics U.S. Draft Policy Updates
for 2009 Proxy Season

To Our Clients and Friends:

On October 14, 2008, RiskMetrics Group (formerly ISS) opened its annual comment period for the 2009 updates to its U.S. and international proxy voting policies. The comment period, which runs through October 31, provides an opportunity for corporate issuers, institutional investors and governance constituents to provide feedback on RiskMetrics’ proposed policy updates while they are still in a draft stage.

While RiskMetrics will consider comments, we expect that the proposed U.S. policy updates will be finalized on November 20 in mostly the form in which they have been proposed (the proposed updates can be found at http://www.riskmetrics.com/policy/2009comment). We will send out a separate e-mail update once the final policy updates are released. 

Of the 13 proposed updates, only seven apply to U.S. issuers. Some of the key issues that RiskMetrics is considering for its U.S. policy updates are driven by the downturn in the stock market and the crisis at large financial firms.  None, however, represents a significant change in RiskMetrics policies. All proposed changes should be read in the context of the existing framework of RiskMetrics policies.

Pay for Performance
Of the changes being considered, the one with the most potential impact relates to RiskMetrics “Pay for Performance” Policy. Under the current RiskMetrics policy, companies that increase CEO pay when they have absolute negative one-year and three-year total shareholder returns (TSR) are likely candidates for WITHHOLD/AGAINST recommendations on the compensation committee members.

The proposed change would replace the absolute TSR test with a relative one.  Under the relative test, RiskMetrics would evaluate companies’ performance within their “Global Industry Classification Standards” (or GICS) groups, with the companies that fall at the bottom quartile in terms of one-year and three-year TSR as potential targets for WITHHOLD/AGAINST recommendations. As RiskMetrics notes, in the current bear market where many companies would fail the absolute test of negative one-year and three-year TSR, a relative test should result in fewer WITHHOLD/AGAINST recommendations.

The use of GICS groups would put a stronger focus on how a company is performing against its industry peers.  If your company’s performance would likely make it a target of this policy, it becomes important that you focus on the appropriateness of your GICS grouping. In consultation with their proxy solicitors, companies may consider seeking greater guidance from RiskMetrics about the composition of their peer groups.

Independent Chair
Another meaningful proposed change concerns shareholder proposals for an Independent Chair. Under its current policy, RiskMetrics applies a performance test in addition to requiring a counterbalancing governance structure at the company for determining its recommendation on the proposal. The existing performance test looks to see if the company has underperformed both its a) peers and b) benchmark index in both one-year and three-year TSR. In short, if the company has outperformed on any of these four data points, it will pass the existing performance test.

The proposed change will make it harder for a company to pass the performance test and, therefore, more likely that RiskMetrics will support an Independent Chair proposal, notwithstanding an acceptable counterbalancing governance structure at the company. RiskMetrics is proposing that the company outperform both its peer and its index in both one-year and three-year TSR, i.e., on all four data points in order to pass its new performance test. This will make companies in certain sectors that have underperformed their benchmark indices virtually certain to see RiskMetrics support for Independent Chair proposals at their meetings.

To put this issue and the proposed change in perspective, year-to-date RiskMetrics has issued voting recommendations on 28 such proposals, supporting 18 or 64% of them -- already a high level of support. Of these 28 proposals, voting results are available from 23 meetings, with the average support being 29% with only one company (Washington Mutual) seeing the proposal passed. Nonetheless, the proposed RiskMetrics change would provide additional support for the Independent Chair issue, which saw renewed traction in 2008.

Poor Pay Practices
The third notable proposed change is in the area of Poor Compensation Practices. RiskMetrics already lists a number of poor pay practices that may cause it to recommend WITHHOLD/AGAINST votes, primarily on compensation committee members (and in some cases, on the full board). As executive compensation continues to be closely scrutinized (helped by enhanced disclosure requirements), RiskMetrics is considering expanding its “poor pay practices” list to include the following compensation practices as additional reasons for WITHHOLD/AGAINST recommendation:

• Modified Single Trigger – A change-in-control (CIC) package with a modified single trigger gives the executive an option to leave voluntarily for any reason after the CIC and receive severance pay.  RiskMetrics is concerned with extended “windows” (i.e. longer than one year) during which an executive may voluntary leave and still receive the CIC severance package. As a mitigating factor to making a WITHHOLD/AGAINST vote recommendation, RiskMetrics would consider a company’s public commitment not to enter into such modified single-trigger agreements in the future.
• Dividends or Dividend Equivalents on Unvested Performance Shares – In RiskMetrics’ view, a company is considered to have disconnected its pay from its performance when it pays dividends or dividend equivalents on unvested shares that have not met their performance requirements and, therefore, have not yet been earned by executives. As a mitigating factor to the WITHHOLD/AGAINST vote recommendations, RiskMetrics would consider a company’s public commitment not to pay dividends or dividend equivalents on newly granted performance shares until the performance goals have been achieved and the shares are earned.
• Excise Tax Gross-Ups – Under excise tax gross-up provisions, companies make executives “whole” for the taxes they would incur on the change-in-control payments they receive in excess of the IRS limit. RiskMetrics’ institutional investor clients generally consider this practice to be problematic due to the already lucrative nature of the change-in-control payments. RiskMetrics is considering whether to recommend WITHHOLD/AGAINST vote on the compensation committee members when two criteria are met: (i) an S&P 500 company is involved and (ii) such company enters into new or substantially amended change-in-control agreements that provide for excise tax gross-ups.
• Excessive Perquisites – RiskMetrics is considering whether two specific perquisites should result in WITHHOLD/AGAINST vote recommendations on the compensation committee members, based on their value (including tax gross-ups) and prevalence among “Named Executive Officers” (NEOs). These are (i) an automobile allowance exceeding $100,000 for multiple NEOs and (ii) the personal use of company aircraft having a value in excess of $110,000, without an appropriate justification.

In light of the proposed changes, possibly impacted companies should consider providing additional rationale for the use of such practices in their proxy statements. With the help of their proxy solicitors, they should also look to engage with RiskMetrics and their institutional investors to discuss these provisions and the possibility, where applicable, of making the desired future commitments.

Other Proposed Changes
The four other proposed changes are likely to have minimal impact on companies.

Under its “Poison Pills” Policy, RiskMetrics is considering adding tax-related provisions for pills that are adopted to preserve Net Operating Losses (NOLs). For such “NOL pills”, RiskMetrics would continue to substantially apply its current policy with slight changes. One change would be allowing for a lower ownership trigger of 4.9%, down from the current 20%. Additionally, RiskMetrics would consider the value of the NOLs and likelihood of an NOL-limiting event, to determine whether the pill can be justified.

Under its “Poor Accounting Practices” Policy, RiskMetrics may provide a more detailed analysis of the factors that it considers in its case-by-case evaluation of accounting issues at a company. The purpose is not to change its current policy but to provide more detail and transparency in its reports to its institutional clients. In its analysis, RiskMetrics considers the severity, breadth, chronological sequence and duration of the poor practice, counterbalanced against any remediation efforts or corrective actions by the company in determining whether WITHHOLD/AGAINST vote recommendations are warranted on the audit committee members or, in certain cases, on the whole board. Additionally, as a change, RiskMetrics is considering whether to generally recommend WITHHOLD/AGAINST votes on the audit committee members if the company receives an adverse opinion from its auditor. However, since instances of adverse opinions are rare, RiskMetrics does not expect this proposed change to materially increase its adverse recommendations.

Another proposed policy change relates to Corporate Social Responsibility (CSR) Compensation Related Proposals. RiskMetrics is considering adopting a policy to generally recommend AGAINST proposals that seek to link executive compensation to non-financial criteria, such as corporate downsizings, customer and employee satisfaction, community involvement, human rights, and environmental performance. The purpose of the proposed policy is to clearly differentiate between (i) those proposals that seek a review and disclosure of the role that non-financial criteria may have in determining executive compensation and (ii) those proposals that seek to formally link such non-financial performance criteria to executive compensation. Note that this is consistent with RiskMetrics overall approach on CSR issues to distinguish between proposals that ask companies to make business changes from those that merely ask for additional disclosure.

The seventh or the last proposed change does not trigger any voting recommendation under RiskMetrics existing policies but may contribute to overall case-by-case decisions made under policies such as Pay for Performance. RiskMetrics is seeking comment on “Peer Group Selection for Executive Compensation Comparisons” that it includes in its research report for Russell 3000 companies to compare the CEO’s last fiscal year compensation to the median CEO compensation of 12 peer companies.  RiskMetrics is considering an approach that would better link a company’s revenue range and its peer industry group by limiting the revenue range of the peer group to between 0.5 times and two times the company’s revenue, and changing the required number of peer companies to a minimum of eight and up to a maximum of 12 firms. 

Georgeson has a team of experts who are prepared to meet clients’ needs in connection with both proposed and ongoing RiskMetrics policies. If you have any questions, please feel free to contact your regular Account Executive or any of the following Georgeson executives:

David Drake, President 212-440-9861
Rajeev Kumar, Senior Managing Director, Research 212-440-9812
Rhonda Brauer, Senior Managing Director, Corporate Governance 212-805-7168

Please also visit our web site at http://www.georgeson.com.

About Georgeson
Georgeson Inc. is the world’s leading provider of strategic proxy and corporate governance advisory services to corporations and shareholder groups working to influence corporate strategy. For over half a century, Georgeson has specialized in complex solicitations such as hostile and friendly acquisitions, proxy contests and takeover defenses. In 2007, Georgeson was ranked the No. 1 proxy solicitor for M&A transactions in the US. The firm also provides issuers with expertise in corporate events solutions such as post-merger unexchanged holder programs and information agent services. Georgeson is a Computershare company. For more information, visit www.georgeson.com.

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