Background
In the wake of the GFC, the Labor government's Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill (Bill) has now been passed by both houses. This legislation, which begins to take effect on 1 July 2011, is intended to increase transparency and accountability in executive remuneration matters.
At the heart of the proposed legislation is the “two-strike rule” which, despite conjuring up images of crisp efficiency, has been widely criticised as being a blunt instrument with many unintended and undesirable consequences from a corporate governance perspective. In light of this, perhaps a more appropriate name for the rule is: “two strikes and a thud”.
This update focuses on those changes which link to remuneration. We will address the other changes in a separate article.
How the legislation affects board tenure
How does the “two strike” rule operate in practice?
Shareholders of listed companies will be required to vote on whether the entire board (other than the managing director) should submit themselves for re-election if, at two consecutive AGMs, 25% or more of eligible votes cast are against the remuneration report.
The “spill resolution” must be put to shareholders at the end of the 2nd of the 2 consecutive AGMs. If 50% or more eligible votes are cast in favour of a board “spill”, the company will be required to convene another meeting within 90 days for an election of directors and all incumbents (with the exception of the managing director) will automatically cease to hold office with effect from the end of that meeting.
Will the company need to put to the vote a “spill resolution” at its 2011 AGM if the remuneration report received an unfavorable vote from shareholders at the 2010 AGM?
No. The spill resolution must only be proposed where both “strikes” occur in AGMs held after 1 July 2011. [1] This means that a company will be required to put its first “spill resolution” to members if:
· at the 2011 AGM, 25% or more votes cast are against adopting the remuneration report; and
· at the 2012 AGM, 25% or more votes cast are against adopting the remuneration report.
However, if there had been a 25% “no” vote in 2010, the 2011 notice of meeting must note that the “spill resolution” would have been put to the meeting had the section on “spill resolutions” applied.[2]
Who can vote on the remuneration report?
No member of the key management personnel whose remuneration details are included in the remuneration report can vote on the report; nor can a closely related party of such a person. In other words; directors, senior executives, their family members or any companies controlled by the directors/executives cannot vote. These restrictions on voting will apply to meetings held after 1 August 2011.
This may have serious consequences for smaller listed companies that do not have a wide shareholder base. Say for example, the founder holds 40% of the shares in the company and retains a Board or senior executive position. The founding shareholder will not be entitled to vote on the remuneration report or the “spill” vote. This would mean that if 15% of shareholders voted against the remuneration report in two consecutive years, the company would need to hold a “spill resolution” at which only 30% of shareholders would need to vote to remove the entire board.
How the legislation affects the AGM
What needs to be included in the notice of meeting?
An explanation of how the “two strike” rule and “spill” resolutions operate will need to be included in the explanatory memorandum that accompanies the notice of meeting.
The notice of meeting and explanatory memorandum will need to make it clear that key management personnel and their closely related parties that hold shares will be prohibited from voting in relation to the remuneration report.
What considerations need to be given to proxy votes?
Proxy forms will need to be carefully drafted to ensure that, if a member of a company’s key management personnel is to chair the meeting, they are able to vote undirected proxies.
Under the proposed legislation, key management personnel and their closely related parties will be prohibited from voting undirected proxies on all remuneration related resolutions, except where undirected proxies are given to a member of key management personnel who is to chair the AGM. In order for this exemption to apply, the shareholder who has lodged the proxy must have provided informed consent for the chair to exercise the proxy even if the resolution is connected with the remuneration of a member of the key management personnel.[3]
How the legislation affects dealings with remuneration consultants
Until now, the Corporations Act did not deal with the engagement of remuneration consultants.
Why has the legislation been changed in relation to the appointment of remuneration consultants?
Many boards engage remuneration consultants to advise them on matters relating to remuneration arrangements, pay structures and performance hurdles. They may also help companies benchmark their remuneration structures against comparable employers.
The stated rationale for these changes is the potential for conflicts of interest where remuneration consultants report directly to company executives, or where they provide other services to the same company. However, the new procedures will potentially add to the workload of non-executive directors, and reduce efficiency by preventing senior executives from directly engaging consultants to advise on the remuneration of managers who report to them.
In which financial year will these new laws come into action?
The required disclosures concerning the use of remuneration consultants apply to remuneration reports for the financial years starting on or after 1 July 2011. This means that this information will need to be included in the 2012 remuneration report.
Specific information about remuneration consultant in the Directors’ Reports
If the remuneration consultant makes a recommendation in relation to any key management personnel, the directors’ report must reflect this information. The details which will need to be present include the consultant’s name, the name of the person that they advised, the details of any other advice provided by the consultant to the company throughout the year and the amount and nature of consideration payable for the remuneration recommendation.
The obligation to include details in relation to any other advice provided by the consultant throughout the year may raise issues if, for example, the same remuneration consultant has provided advice regarding other confidential matters at some stage during the year. Under the proposed legislation, the nature (though not the content) of this advice would need to be disclosed in the directors’ report.
Process of engaging remuneration consultants
Under the Bill the board or the remuneration committee must sign off on the appointment of a remuneration consultant.
The remuneration consultant must address their recommendation on remuneration directly, to either the directors of the company, the remuneration committee, or both. They may only give their recommendation to executive directors if all the directors of the company are executive directors.
How the legislation affects the hedging of entitlements
While many companies’ securities trading policies prohibit or restrict the hedging of equity-based remuneration, their approach can vary.
The new laws prohibit the hedging of unvested incentive remuneration and of vested entitlements still under holding lock. This is an attempt to limit the ability of key management personnel to ‘de-link’ the value of their unvested entitlements from company performance.
The proposed prohibition on hedging applies to arrangements made on or after 1 July 2011, irrespective of whether the remuneration was for services rendered before 1 July 2011.
What should listed companies now do?
1. Review the results from last year’s AGM on the adoption of the remuneration report. If it received a significant “no” vote, it is worth considering whether any steps need to be taken to avoid incurring the first “strike” at the 2011 AGM.
2. Consider whether it is necessary or appropriate for the board to engage with shareholders on certain issues ahead of the AGM. This will allow the board to gauge investor sentiment.
3. Ensure that the notice of AGM and explanatory memorandum clearly explains how the “two-strike” rule operates so that members understand the potential implications for the company.
4. Ensure that the proxy forms, including instructions on how to complete the proxy forms, take into account the new restrictions.
5. If a remuneration consultant is engaged on or after 1 July 2011, ensure that the whole board or the remuneration committee signs off on the appointment. Also, make sure that the consultant only reports back to the directors as a whole, or to the Remuneration Committee.
6. Review share bonus plans and share trading policies to ensure that they are consistent with the prohibition on hedging of entitlements.
For more information on the changes, please contact:
