Compensation Issues Dominate
RiskMetrics U.S. Policy Updates for 2009 Proxy Season

To Our Clients and Friends:

RiskMetrics Group (formerly ISS) has released the final 2009 updates to its U.S. and international proxy voting policies. The policy changes will apply to shareholder meetings held on or after February 1, 2009.

In this report, Georgeson identifies the policy changes, discusses their impact and provides practical tips for coping with some of the key U.S. policy changes. These practical tips are identified throughout this report with the text, “How This Could Impact You.”

The full description and the complete list of U.S. policy changes can be accessed from the RiskMetrics website.

Highlights

Most of the key changes to this year’s U.S. policy update relate to the issues that were included in its comment period by RiskMetrics (see Georgeson Report, dated October 21, 2008). The highlights of the changes, which are mostly compensation-related, are listed below. With the strong focus on executive pay practices, it’s important for company advisors to understand these updates.

• Pay for Performance: change of performance test from an absolute test to a relative one;
• Poor Pay Practices: expansion of the list to include excise tax gross-ups, modified single-trigger provisions, all tax gross-ups on executive perks, liberal change-in-control provisions, and dividends or dividend equivalents on unearned performance awards;
• Liberal definition of Change-in-Control: addition of a liberal definition of change-in-control as a negative factor in evaluating equity-based compensation plan proposals;
• Independent Chair Shareholder Proposals: change in the performance test that helps determine whether RiskMetrics will support management’s position; and
• Common Stock and Preferred Stock Authorizations: inclusion of new company-specific factors that may determine whether proposed increases in authorizations are appropriate.

Review of Significant Policy Changes

Executive Compensation

Pay for Performance Policy

RiskMetrics recommends WITHHOLD/AGAINST votes on compensation committee members when there is a disconnect between pay and total shareholder returns. RiskMetrics is replacing its prior absolute performance test with a relative one. Under the relative test, RiskMetrics will evaluate companies’ performance within their four-digit “Global Industry Classification Standards” (or GICS) groups. Companies that fall in the bottom half in terms of one-year and three-year total shareholder returns (TSR) are potential targets for WITHHOLD/AGAINST recommendations on their compensation committee members. (Note that RiskMetrics has now made this test uniform for all of its policies that include a TSR performance standard; therefore, failing the performance test can lead to votes against equity plan proposals as well.)

Georgeson believes the use of a relative test results in a better measure of performance. 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 would identify the true under-performers and, therefore, should result in fewer WITHHOLD/AGAINST recommendations.

How this could impact you: The use of GICS groups puts a stronger focus on how a company is performing against its industry peers. In consultation with their proxy solicitors, companies may consider seeking greater guidance from RiskMetrics about the composition of their peer groups. Finally, it should be noted that the performance test provides only an initial screen and that RiskMetrics further examines a company’s Compensation Discussion & Analysis (“CD&A”) disclosure in the company’s proxy statement. Therefore, it is crucial that companies should ensure that they provide meaningful and robust disclosure of their pay practices and their rationale for granting pay increases.

Poor Pay Practices

RiskMetrics’ current policy 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, RiskMetrics has expanded its “poor pay practices” list to include the following compensation practices:

• Excise Tax Gross-Ups and Modified Single-Trigger Provisions – Any new or materially amended severance/change-in-control (CIC) arrangement that includes a provision for the payment of excise tax gross-ups and/or modified single-trigger provisions. Under excise tax gross-up provisions, companies make executives “whole” for the taxes they would otherwise incur on the change-in-control payments that they would receive in excess of the Internal Revenue Services (IRS) limit. A modified single-trigger provision gives the executive an option to leave voluntarily for any reason after the CIC and still receive severance pay. RiskMetrics specifies that any changes that are made to comply with new regulations, such as IRS section 409A, will not be considered as a materially amended employment agreement.
• Liberal Change-in-Control Provisions – A liberal change-in-control definition in individual contracts or equity plans (discussed later under “Equity Compensation Plan Evaluation”) which could result in payments to executives without an actual change-in-control occurring.
• Executive Perquisites – Income tax reimbursement on executive perquisites. Additionally, allowances exceeding $110,000 and $100,000 for the usage of aircraft and automobiles, respectively, will be used as guidelines for its case-by-case analysis of excessive perquisites by RiskMetrics.
• Dividends or Dividend Equivalents on Unearned Performance Shares – Payment of dividends or dividend equivalents on unvested shares that have not met their performance requirements and, therefore, have not yet been earned by the executives.

How this could impact you: In light of the above policies, potentially impacted companies may need to provide additional rationale for these practices in their proxy statements, in order to avoid votes against compensation committee directors.

Equity Compensation Plan Evaluation

• Liberal Definition of Change-in-Control

  RiskMetrics’ guidelines for equity plans are mostly quantitative and focus on applying limits to the transfer of shareholder value. However, certain qualitative factors also apply, e.g., the ability to reprice without shareholder approval. RiskMetrics has now targeted change-in-control provisions that allow for accelerated vesting of awards where a “true” change-in-control has not actually occurred.

  An example of such a liberal change-in-control definition would be an acceleration of unvested awards upon the announcement or commencement of a tender offer, regardless of whether the offer is completed.

  How this could impact you: In short, any definition that deems a change-in-control to have occurred prior to an event’s actual consummation will be considered problematic and a cause for an AGAINST vote recommendation on the equity plan.

• Volatility Assumptions

  For the next year, RiskMetrics will use stock price volatility over a 400-day period for its shareholder value transfer (SVT) and burn rate policies. Given the unprecedented levels of recent volatility, extending the current 200-day period to a 400-day period should help provide better estimates of option valuations under RiskMetrics’ binominal valuation model. RiskMetrics will re-evaluate its methodology for calculating volatility at the end of 2009, with the intent of resuming its use of the 200-day period.

  How this could impact you: The use of a 400-day volatility period as opposed to a 200-day volatility period should result in a lower cost for options in RiskMetrics’ SVT analysis and, thus, should avoid unreasonably penalizing companies in their requests to make additional equity grants. As for the burn rate analysis, since the allowable limits against which a company’s burn rate is compared are calculated in a similar manner, the impact of the change from a 200-day volatility period to a 400-day volatility period is less of a factor and should have only a minimal affect on the outcome of RiskMetrics vote recommendations on equity plan proposals.

Board

Independent Chair (Separate Chair/CEO) Shareholder Proposals

RiskMetrics generally supports shareholder proposals asking companies to adopt a formal policy of maintaining an independent chairperson. However, RiskMetrics will support management’s opposition to the proposal, if the company’s total shareholder return (TSR) performance is positive and, in addition to having other good governance provisions, has a lead independent director who performs a prescribed list of duties. The TSR performance test has been changed to align it with other RiskMetrics voting guidelines that incorporate a TSR test. The change will affect the likelihood of companies passing the TSR test.
RiskMetrics also eliminated disclosure requirements related to the justification for maintaining a combined CEO/Chair role and comparison of the duties of the lead director versus chairman. RiskMetrics provided additional guidance on specific governance issues that might preclude its support for management even if other tests are met. Therefore, companies that have received RiskMetrics support on this issue in the past should re-evaluate their status under the new guideline.

How this could impact you: In 2008 thus far, RiskMetrics has issued voting recommendations on 28 such proposals, supporting 18 or 64% of them – a high level of support. Of these 28 proposals, voting results are available from 25 meetings, with the average support being 28.5% with only one company (Washington Mutual) seeing the proposal passed. Although the impact of changes will vary company to company, our view is that support levels for independent chair proposals are likely to rise in 2009.

Poor Accounting Practices

RiskMetrics added “an adverse auditor opinion” to its list of poor accounting practices. A company receiving an adverse opinion from its auditor will receive a WITHHOLD/AGAINST vote recommendation on its audit committee members. Since instances of adverse opinions are rare, this change may not result in a great number of WITHHOLD/AGAINST recommendations.

How this could impact you: Companies should be aware that RiskMetrics will now 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 by any remediation efforts or corrective actions taken by the company to determine whether WITHHOLD/AGAINST vote recommendations are warranted on the audit committee members or, in certain cases, on the whole board.

Anti-takeover Defenses

Poison Pills

Under its case-by-case evaluation of management proposals to adopt or to ratify a poison pill, RiskMetrics looks for a pill to contain certain shareholder-friendly features. In its updated policy, RiskMetrics will now also look for a company to thoroughly explain its rationale for adopting its pill. Additionally, RiskMetrics will take into account the company’s existing governance structure, including any specific governance problems.

RiskMetrics also modified its policy for evaluating pills that are adopted to preserve Net Operating Losses (NOLs). For such “NOL pills”, RiskMetrics may support a pill with an ownership trigger as low as 4.9%. Additionally, to determine whether the pill is justifiable, RiskMetrics will consider the value of the NOLs, the term of the pill, the existence of shareholder protection mechanisms (such as a sunset provision) and other factors as may be applicable.

How this could impact you: Companies seeking shareholder support for pills should be prepared to provide, in its proxy statement disclosure of key factors such as industry conditions or factors unique to their businesses, in order to gain a favorable RiskMetrics recommendation.

Advance Notice Requirements for Shareholder Proposals/Nominations

RiskMetrics’ policy on advance notice for proposals is to support those proposals that allow shareholders to submit proposals as close to a company’s annual meeting date as is reasonably possible and within the broadest window possible. RiskMetrics has changed the duration of what it considers a reasonable submittal window from at least 60 days in its former policy to 30 days in its updated policy. Also, RiskMetrics will support reasonable requirements by companies for the disclosure of a proponent’s economic and voting position in the companies.

How this could impact you: The issue of proponent’s ownership has received attention in light of recent court decisions in certain proxy fights (e.g., CSX) where derivate ownership was used to enhance ownership positions without the obligation of full disclosure. Irrespective of the RiskMetrics change, companies should at this time review advance notice requirements with its legal and solicitation advisors and consider incorporating the additional disclosure requirements.

Capital Structure

Common Stock and Preferred Stock Authorizations

RiskMetrics is adding flexibility to its policy on proposals seeking to increase common stock and preferred stock authorizations. In the past, such requests were primarily analyzed by RiskMetrics using its proprietary quantitative model. The updated policy will now have RiskMetrics consider certain company-specific factors, which include the specific reasons for the proposed increase, the board’s governance structure and practices, and the resultant risks to shareholders if the proposed authorization vote does not pass. Such reasons could include proposals for the issuance of shares to the U.S. Government under the Troubled Asset Relief Program (TARP).

How this could impact you: Given this change, companies should ensure that they provide robust and specific disclosure relating to the reasons for the additional stock authorization. When companies have a critical need for a new stock authorization, prior to finalizing any new stock plans and their proxy statements, these companies should be prepared to pro-actively engage RiskMetrics’ analysts. This will give companies the opportunity to answer any probable questions regarding the rationale for the further authorizations and to discuss the companies’ stock authorization needs.

Corporate Responsibility

RiskMetrics has made changes to a number of its corporate responsibility policies, with many of the changes meant to streamline its existing policy framework. The policies that have been modified relate to the issues of:

• Genetically Modified Ingredients (GMO’s);
• Pharmaceutical Pricing and Pharmaceutical Product Importation;
• Equality of Opportunity;
• Gender Identity, Sexual Orientation, and Domestic Partner Benefits;
• Concentrated Area Feeding Operations (CAFO);
• Energy Efficiency;
• Corporate Socially Responsible (CSR) Compensation-Related Proposals;
• Labor and Human Rights Standards; and
• MacBride Principles.

Georgeson has a team of experts who are prepared to meet clients’ needs in connection with both new and ongoing RiskMetrics policies. If you have any questions, please feel free to contact your 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