Introduction

RiskMetrics Group, the proxy advisory firm formerly known as Institutional Shareholder Services ("RMG"), has released its annual US Corporate Governance Policy Update for the 2009 proxy season (the "2009 Policy Update"). The 2009 Policy Update is effective for shareholder meetings occurring on or after February 1, 2009. To view the full text of the 2009 Policy Update, please click here.

RMG's update outlines changes to the policies RMG utilizes in making voting recommendations to clients regarding various corporate ballot measures during the proxy season. Companies should take note of the policy update because RMG's recommendations continue to hold sway with institutional investors. RMG's update also contains RMG's positions on various corporate responsibility proposals, many of which involve changes to RMG's policies from prior years. In particular, RMG will now recommend voting "against" incumbent directors who are members of a board that exhibits sustained poor performance relative to its peers (i.e., in the bottom 50% of its peer group on a one- and three-year basis) and, in the view of RMG, lacks both accountability and oversight.

Companies with majority voting standards in director elections should be particularly mindful of RMG's policy update. Plurality voting used to be the default standard in most director elections. A director subject to plurality voting standards could be elected to office by virtue of having received the most votes cast in his or her election. In contrast, a director nominee subject to a majority voting standard can only be elected to a board if he or she secures a majority of votes cast in the election. Accordingly, a "withhold" recommendation from RMG could prevent reelection in a majority vote election.

The 2009 Policy Update addresses the following matters:

  • Board of Directors
    • Voting on director nominees
    • Classification of directors
  • Shareholder and Management Proposals
    • Corporate governance
    • Anti-takeover defenses
    • M&A/Capital restructuring
    • Corporate responsibility
  • Executive Compensation

RMG has not taken a definitive position on a number of matters, including director attendance at board and committee meetings, advance notice requirements, anti-takeover defenses, SPAC M&A and capital restructuring, and will instead make its recommendations to clients on a case-by-case basis. For such matters, companies should examine the list of criteria that RMG has included in the 2009 Policy Update when developing their portfolio of shareholder and governance provisions. The adoption by a company of even one provision that RMG has determined constitutes "bad corporate governance" could result in a "withhold" or "against" vote, even if the company is otherwise in compliance with RMG's policies. In particular, RMG discourages provisions that could lead to board and management entrenchment, such as a classified board, dual-class structure and the existence of a non-shareholder approved poison pill. It should be noted that companies may want to disclose in their proxy statements a detailed rationale for their corporate governance and other provisions analyzed by RMG in order to increase the likelihood of obtaining RMG's recommendation.

Set forth below is a summary of RMG's policy update regarding a company's board of directors and shareholder and management proposals. For an in-depth analysis of RMG's policy update regarding executive compensation, please see Fried Frank Memorandum " What You Need to Know About RiskMetric's Updated Compensation Guidelines for the 2009 Proxy Season."

Board of Directors

Voting on Director Nominees

Audit Committee's Poor Accounting Practices

In an uncontested election, RMG will oppose the reelection of audit committee members if the company has received an adverse opinion from the auditors on its financial statements. An "adverse opinion" is issued when the auditors determine that a company's financial statements, taken as a whole, do not conform to GAAP and that the information contained within is materially incorrect, unreliable and/or inaccurate.

In addition, RMG will, on a case-by-case basis, oppose the reelection of individual members of the audit committee, and potentially the full board, if the company has additional poor accounting practices. RMG defines "poor accounting practices" as practices that rise to a level of serious concern, such as fraud, misapplication of GAAP and material weaknesses. In its determination, RMG will consider the severity and duration of the poor practice as well as the company's efforts at remediation. Accordingly, companies facing such issues may want to go beyond what may be required disclosure and include additional information on their remediation efforts to control material weaknesses.

Attendance at Board and Committee Meetings

In an uncontested election, RMG will recommend that its clients "withhold" their votes or vote "against" individual directors who attend fewer than 75% of the board and committee meetings without a valid excuse. A "valid excuse" may include illness, service to the nation, work on behalf of the company or funeral obligations.

RMG will recommend voting on a case-by-case basis for individual directors if the company provides RMG with meaningful disclosure to explain the director's absence. In its determination, RMG will consider the existence of an unavoidable conflict, a pattern of absenteeism and other extraordinary circumstances. RMG recognizes that reasons for missing meetings may be highly personal and not relevant to a director's qualifications. Accordingly, RMG recommends that companies contact it for guidance before publicly disclosing highly personal explanations to investors.

Performance of the Board

In an uncontested election, RMG will oppose all director nominees if the board exhibits sustained poor performance relative to its peers and lacks accountability and oversight. RMG will find "sustained poor performance" where a company's one- and three-year total shareholder returns ("TSR") is in the bottom half of the company's four-digit GICS industry group. This same standard is utilized in evaluating shareholder proposals calling for the appointment of an independent Chairman as discussed below, as well as pay for performance, as discussed under "Executive Compensation." This constitutes a change from RMG's policy for 2008, which provided that RMG would oppose a board's director nominees if the company's TSR was in the bottom five percent within its GICS group for 2007 and/or 2008.

Once RMG has identified a company with sustained poor performance, it will then evaluate the board's accountability and oversight. In its determination, RMG will consider problematic provisions that may lead to board and management entrenchment, such as a classified board, dual-class structure and the existence of a non-shareholder approved poison pill. After RMG has identified a company that exhibits sustained poor performance and lacks accountability and oversight, RMG may ultimately consider the company's five-year TSR.

Classification of Directors and the Definition of Independence

The New York Stock Exchange (the "NYSE") and the Nasdaq require that a majority of the board of directors be classified as "independent" in order for a company to be listed on either exchange. In addition, the Securities and Exchange Commission (the "SEC") prohibits the NYSE, Nasdaq and other national securities exchanges and associations from listing any security of an issuer unless, among other things, each member of the issuer's audit committee is classified as "independent." Although the NYSE and Nasdaq have their own standards to determine whether a director falls into the category they have each deemed "independent," RMG also makes its determination of independence and will consider applicable listing standards in addition to other factors that it believes have an impact on the director's classification.

Directors who are Parties to Voting Agreements

RMG now differentiates between a director who is party to a voting agreement and a dissident director who is party to a voting agreement pursuant to the settlement of a proxy contest. RMG will continue to classify the directors in the former category as "affiliated outsiders" because RMG believes they tend to be management-friendly and may be conflicted with respect to safeguarding the rights of unaffiliated shareholders. However, RMG will classify directors in the latter category as "independent," unless determined otherwise, because RMG believes these directors have gained their board seats in connection with the settlement of a proxy contest and are not necessarily conflicted with respect to the rights of unaffiliated shareholders. In making its determination with respect to dissident directors, RMG will consider the terms of the settlement agreement, the duration of the standstill agreement and whether the dissident director has any conflicting relationships with the company.

Former CEOs of Special Purpose Acquisition Corporations ("SPACs")

SPACs have been increasing in number over the past several years, although the SPAC market has been relatively quiet in more recent periods. A SPAC is a shell or blank-check company that has no operations and goes public with the intention of merging with or acquiring a company with the proceeds from the SPAC's initial public offering.

RMG now differentiates between a former CEO of a SPAC currently serving as director on the board of an acquired company and a former CEO of a company currently serving as director of the same company. RMG will generally classify the former category of directors as "independent" unless determined otherwise. In making its determination, RMG will consider whether the director has operating ties to the company or other conflicting relationships. In contrast, RMG will continue to classify the latter category of directors as "affiliated outsiders."

Shareholder and Management Proposals Shareholder Proposals Relating to

Corporate Governance

Independent Chairman (Chairman/CEO)

In an uncontested election, RMG will recommend that its clients vote "for" shareholder proposals requiring that an independent director fill the Chairman's position, unless the company has:

  • A designated lead director, who is elected by the independent members of the board and has clearly delineated and comprehensive duties;
  • A two-thirds independent board;
  • All "key" committees comprised solely of independent directors;
  • Established governance guidelines;
  • Not exhibited sustained poor performance, unless there has been a change in the Chairman/CEO position during that particular time period; and
  • No problematic governance or management issues.

Companies should note that RMG no longer requires that a company disclose a comparison of the duties of the lead director and the Chairman, or its rationale for combining the Chairman and CEO positions.

Standing Board Committees

RMG will generally recommend that its clients vote "against" proposals to establish new standing board committees, believing that this degree of shareholder oversight would limit a company's ability to determine its own oversight mechanisms. However, in making its determination, RMG will evaluate a company's existing oversight mechanisms and its level of disclosure regarding the relevant issue in light of industry practice within its sector.

RMG stated that it developed these recommendations in response to, among other things, proposals filed in 2008 by labor unions requesting that homebuilders establish a compliance committee to monitor lending practices. In addition, over the past two years shareholders have increasingly requested that companies establish board committees to address sustainability and human rights.

Advance Notice Requirements

RMG will recommend voting on a case-by-case basis for proposals seeking to implement advance notice requirements. These are provisions that mandate the time period in advance of a shareholder meeting during which shareholders must provide notice of an intention to nominate candidates for election to the 6 board or introduce other business at a shareholder meeting. Advance notice requirements are intended to serve various purposes, including informing a company of shareholder business to be raised at a shareholder meeting, providing an opportunity for all shareholders to be adequately informed in advance of a meeting and enabling the board of a company to make informed recommendations or present alternatives to the shareholder business raised at a meeting.

RMG will generally support proposals that allow shareholders to submit proposals and nominations as close to a shareholder meeting and within the broadest window as is reasonably possible. RMG now considers it "reasonable" that a company's deadline for shareholder notice be not more than 60 days prior to a meeting with at least a 30-day window period before the submission deadline.

In addition, RMG will support a company's efforts to seek full disclosure of a proponent's economic and voting positions in the company, provided that such disclosure is reasonable and necessary for shareholder review.

Shareholder and Management Proposals Relating to Anti-Takeover Defenses

RMG continues to discourage the use of anti-takeover defenses, including classified boards, dual-class structures and poison pills.

Poison Pills

Companies adopt traditional poison pills as a way to deter accumulations of stock above a specified threshold, typically between 15% and 20%, without first obtaining approval from the company's board of directors. In an uncontested election, RMG will oppose the reelection of the entire board of directors if a company adopts or renews a poison pill without shareholder approval, does not commit to putting the poison pill to a shareholder vote within 12 months of adoption or makes this commitment and fails to honor it in the absence of a recommendation to do so. Furthermore, RMG's policy is to recommend that its clients vote "for" shareholder proposals requesting that a company submit any current or future poison pills to a shareholder vote or redeem it.

In addition, RMG will recommend voting on a case-by-case basis for management proposals to ratify a poison pill. RMG suggests that it will support a pill that includes a 20% or higher flip-in or flip-over, a twoto three-year sunset provision, no dead-hand or slow-hand provisions and a shareholder redemption feature. RMG also stated that it has been flexible in the context of the adoption of a shareholder rights plan with a term of less than 12 months. In making its determination, RMG will consider a company's existing governance structure, including board independence, existing takeover defenses and any problematic governance concerns. Accordingly, it is important that a company thoroughly explain its rationale for adopting the pill in the context of the company's overall defensive structure, especially if the company's pill includes a provision viewed negatively by RMG.

In light of these issues and the severe limitations on a pill's effectiveness if it complies with RMG's guidelines, many companies have refrained from adopting new poison pills and have instead kept a pill "on reserve" and ready to be adopted at a moment's notice. We note, however, that in light of the recent substantial declines in stock market valuations, there has been some reversal of this trend, with approximately 76 new rights plans having been adopted in 2008 as compared with 42 in the same period in 2007.

Net Operating Loss Pills ("NOL pills")

Companies should note that RMG now distinguishes between traditional poison pills and NOL pills. In the wake of difficult market conditions, an increasing number of large, formerly profitable companies are adopting NOL pills to preserve their tax assets. NOL pills are essentially shareholder rights plans adopted in order to preserve a company's ability to carry forward net operating losses ("NOLs") to reduce taxable income. In contrast to traditional poison pills, NOL pills have a much lower threshold, typically just below five percent. Section 382 of the Internal Revenue Code limits a company's ability to carry forward NOLs if the company has undergone a change in control by one or more five percent shareholders during any three-year period. Accordingly, companies adopt NOL pills in order to forestall possible changes in ownership that would limit their ability to use NOLs.

RMG will recommend voting on a case-by-case basis for management proposals to adopt NOL pills, and will consider their trigger, value and terms and any other shareholder protection mechanisms in place at the company.

Management Proposals Relating to M&A/Capital Restructuring

Common Stock and Preferred Stock Authorizations

RMG will recommend voting on a case-by-case basis for proposals to increase the number of shares of common or preferred stock authorized for issuance. In its determination, RMG will consider the specific reason for a proposal and its dilutive impact based on an allowable cap generated by RMG's quantitative model. In addition, RMG will consider the board's governance structure and the risk to shareholders if they do not approve the proposal. Companies should note that RMG previously evaluated these proposals on a case-by-case basis only if they failed RMG's allowable cap by no more than five percent. In the 2009 Policy Update, the allowable cap is only one factor in RMG's evaluation and therefore can be overridden if a proposal is deemed justifiable based on other relevant factors.

In addition, RMG recommends that its clients who own stock at companies with a dual-class capital structure vote "against" proposals to increase the number of authorized shares of the class possessing superior voting rights. This could result in shareholders who own the class of superior-voting stock only being able to acquire low-vote stock in the future.

SPAC M&A

RMG will recommend voting on a case-by-case basis for proposals to approve acquisitions by SPACs. In its determination, RMG will consider the reasonableness of a SPAC's valuation of the target company, the market reaction to, and the timing of, the proposed transaction, the negotiating process, voting agreements and any conflicts of interest and governance issues raised by the proposed transaction.

Shareholders of a SPAC possess the special right to approve or reject a proposed merger or acquisition (in contrast to a strategic acquirer in a cash acquisition, which generally does not need to obtain shareholder approval). Generally, a SPAC must complete a transaction within an 18- to 24-month time period or face liquidation, at which time shareholders will recoup most of their investment. An increasing number of investors are treating SPACs like trust funds and holding their investment in the company as a form of cash substitute with the intention to vote against any proposed transaction. Accordingly, RMG's recommendation may play an important role in the ability of a SPAC to obtain a sufficient number of votes to approve a transaction.

Shareholder Proposals Relating to Corporate Responsibility

RMG updated its position on a broad range of shareholder proposals relating to corporate responsibility, such as a company's use of genetically modified ingredients and concentrated area feeding operations, energy efficiency, equality of opportunity, gender identity and labor and human rights standards. In particular, RMG addressed a possible link between executive compensation and social criteria, including customer or employee satisfaction, community involvement and human rights or environmental performance.

RMG generally will support proposals requesting a report from a company on its corporate responsibility policies, unless the company already discloses this information to the public and has not recently been involved in related controversies or litigation. However, RMG will recommend voting on a case-by-case basis for proposals to implement labor and human rights standards at the company. In addition, RMG will not support proposals to directly link executive compensation to social criteria, or that request an analysis from a company of the pay disparity between its executives and other employees.

Executive Compensation

In the wake of the collapse of many prominent financial institutions and the federal government's passage of the Troubled Asset Relief Program ("TARP"), public scrutiny of executive compensation promises to be an important issue for the 2009 proxy season. In the 2009 Policy Update, RMG has issued a number of significant recommendations on executive compensation. RMG has taken a new approach to evaluating a company's pay for performance policy and poor pay practices, shareholder proposals on clawbacks of incentive pay and the construction of compensation peer groups. In the face of intense public scrutiny, companies should take note of RMG's recommendations and re-evaluate their policies on executive compensation even if they are not subject to TARP restrictions. For an in depth analysis of the 2009 Policy Update regarding executive compensation, please see the Fried Frank Memorandum " What You Need to Know About RiskMetric's Updated Compensation Guidelines for the 2009 Proxy Season."

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.