The “two strikes” rule is now law – what Boards need to know

Issues surrounding the setting and reporting of remuneration for directors and senior executives have been hotly discussed in the Australian and global scene for some time.  Following the Productivity Commission’s inquiry into Executive Remuneration in Australia [1] the Federal Government proposed significant changes to the Corporations Act [2] with the stated intention of increasing alignment between management and shareholders.  The amending legislation was assented to on 27 June 2011.

Changes affecting listed companies

The change which has probably attracted the most attention is nicknamed the “2-strikes rule”.  Previously, the AGM vote on the remuneration report of a listed company was a compulsory but non-binding vote, and all shareholders could vote.  Now:

• Key Management Personnel (Directors and senior executives) whose remuneration is disclosed in the Remuneration Report will be excluded from voting.
• If 25% of the votes cast at an AGM oppose the report, and members make comments at the meeting, then in the following year the Board must report on any proposed responses to those comments, or explain why does not propose any response.
• If 25% of the votes cast at two consecutive AGMs oppose the adoption of the report, then at the second AGM, the company must give members the option (if 50% or more of votes cast are in favour of a “spill”) to require that the entire board (except the Managing Director) stand for re-election at a further general meeting. This meeting must take place within ninety days.

The spill resolution must only be proposed where both “strikes” occur in AGMs held after 1 July 2011.  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 at the time of the earlier meeting.

Although the nickname “2-strikes rule” conjures up images of crisp efficiency, this package of changes has been widely criticised as being a blunt instrument with many unintended and undesirable consequences.  For example:

• In smaller companies where founders retain a significant holding, the exclusion of Key Management Personnel from voting may concentrate power in the hands of a vigorous “minority with an agenda”. Such a group could use or threaten the “strike” and “spill” processes to deliver outcomes unrelated to remuneration.
• A “no” vote may or may not be explained in comments made at the AGM, and may not even be linked to remuneration issues.

What considerations need to be given to proxy votes?

Conflict between some of the new provisions has created uncertainty as to whether a chairperson whose remuneration details are included in the remuneration report is prohibited from voting undirected proxies on remuneration issues.   

The Government proposes to amend the Act to clarify that a chairperson can vote undirected proxies, provided there is express authorisation by the shareholder.

ASIC has published guidance [3] to assist companies until these amendments are introduced.  ASIC has suggested several options.  One possibility is to clearly state on the proxy form that unless the shareholder includes an express voting direction, the shareholder will be directing the chairperson to vote in accordance with the chairperson’s clearly stated voting intention. The voting intention of the chairperson would need to be disclosed in both the notice of meeting and the proxy appointment form.

Changes affecting listed companies and some other companies:

Other key changes include:

• New requirements affecting Remuneration Consultants.  In Remuneration Reports for financial years commencing 1 July 2011, listed companies must report on the Remuneration Consultants they use, what other services they provide, the nature of the advice provided and the cost.  From 1 July 2011, Remuneration Consultants engaged by companies which are disclosing entities must be retained by and report to the Board as a whole, or the Remuneration Committee.
• Removal of the “non vacancy” mechanism for all public companies.  Even if the constitution of a public company allows the Directors a discretion to set a lower number than a specified maximum, the Board will need to facilitate elections for all “vacancies” based on the maximum in the Constitution - unless the members specifically allow a smaller Board.  Boards may wish to update their constitutions to make the number of positions available on the Board more clear.
• Key Management Personnel of companies which are disclosing entities may not enter into hedging arrangements for unvested entitlements, or vested entitlements that are subject to holding lock.
• Greater accountability for persons holding directed proxies.  At present, a meeting Chairman must vote all directed proxies, but other proxy holders can “cherry pick”.  Now, all holders of directed proxies must vote them, and if they do not, the proxies will transfer to the chair.  This change applies to public and private companies.