Understanding How ISS Views “Trigger Words” In The CD&A

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Certain words can result in positive or negative recommendations. A primer.

Trigger words or statements are used by proxy advisors and investors to signal that certain disclosure should be scrutinized. These words can either help or harm a company trying to get support from shareholders on a ballot item. Given the importance of communications in the proxy, it’s worth examining how proxy advisors like ISS use certain trigger words, and how certain words can result in positive or negative recommendations.

Although ISS looks for trigger words throughout a company’s proxy statement, trigger words are mostly scrutinized by ISS when evaluating the CD&A portion of the proxy statement. ISS may seek out terms like “one-time award” or “special grants” to scrutinize the structure of these awards. They may also look out for words such as “adjustment” or “modification” to review any changes a company may have made to existing goals and targets, a practice that ISS has come out against at many companies during the pandemic.

The biggest trap that companies fall into is when they disclose in an 8-K filing that an executive has resigned from the company and also received severance benefits. Most of the time, companies are using the term “resign” loosely when they really mean the executive’s employment was terminated. However, out of respect for the executive, companies generally do not put in an 8-K that they were fired.

ISS is aware of this practice, so they give companies an opportunity in the proxy to clarify whether the executive really resigned or if they were in fact terminated. ISS believes that severance is intended for involuntary or constructive job loss, and that it is not appropriate for executives that voluntarily resign or retire. Unfortunately, ISS is unable to tell in many cases whether the executive received severance because they were terminated, or whether they received severance for resigning. Therefore, ISS will recommend against Say on Pay if a company discloses an executive resigned and received severance without additional clarification.

To that end, ISS says that it will be looking for a statement in the proxy that would signal to the ISS analyst that severance to the executive was warranted. In its Compensation FAQs, ISS states they will be looking for clear disclosure around the nature of an executive’s termination and how the board determined to pay severance. ISS cites the following example as a statement that would satisfy their concerns: “The board determined the termination to be ‘without cause’ as defined in the executive’s employment agreement and paid the severance amount provided under the agreement.” This statement is therefore a trigger for ISS to understand that the executive was in fact terminated or resigned with good reason.

Another trap that many companies fall into with ISS is the practice of lowering targets in bonus plans below previous years. Companies could receive recommendations against Say on Pay from ISS for reducing targets without additional explanation, especially if those new targets lead to large payouts or if the company increased the value of potential payouts. To avoid a potential negative recommendation, ISS will be looking for statements saying that the targets, while lowered, were still “in line with public guidance” or “based on the company’s internal budget” at the time of setting those targets. Without this additional explanation, ISS would assume that the company has simply made it easier for executives to receive payouts under bonus plans.

As discussed above, it’s extremely important for companies to have clear communications about their practices. Companies should also understand how trigger words can lead to unexpected recommendations from proxy advisors. This can often be the difference between a recommendation for or against a ballot item from proxy advisors like ISS.

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