AGMs - some areas of reform

AGMs Some areas of reform Inside Annual General Meeting 1 Shareholder meetings: 8 Proxy advisors 12 Two-strike rule 16 This paper considers the way that ASX-listed entities engage with their shareholders in the modern era and the compliance requirements for annual general meetings and shareholder communications. We consider whether the law in Australia requires reform to address developments in technology, the size of large publicly listed companies, continuous disclosure and the changing way large ASX-listed companies engage with their shareholders. In particular, we consider the following: • Is there any benefit in having a physical meeting for a company's annual general meeting (AGM)? • Is reform needed to govern question time at an AGM? • The evolving role of proxy advisors and whether reforms are required to ensure that shareholders fully appreciate how their vote is to be exercised. • Is the "two strike" rule working as intended to effectively regulate executive remuneration? www.bakermckenzie.com AGMs - some areas of reform | 1 1. Annual General Meeting Overview AGMs of shareholders were established (and an annual physical meeting of members was legislated): − to provide shareholders with an opportunity to obtain important information about the operations and financial performance of the company; − to provide shareholders with an opportunity to vote on resolutions of the company (e.g. appointing directors); and − to allow shareholders to ask questions of the chairman and auditors concerning the company. This made sense historically. However, over time technological advances have modified the way in which companies are able to distribute information. Information is commonly provided by electronic means, reducing (perhaps eliminating) the need for physicality. Three things have happened that make a physical meeting a redundant notion. These are: 1. technological advances (i.e. internet, email etc.); 2. explosion of number of direct shareholders and investment by way of superannuation and other funds; and 3. geographic diversity of shareholders. To be fair to the modern shareholder base, and to advance the company's interests in reporting to its shareholders, companies have embraced technology, making a physical meeting redundant. With technological advances, information is available almost immediately, and shareholders are able to assess information in "real time". Voting practices have also changed, with shareholders being able to vote via proxy, and more recently, by direct voting. This is in part a result of the significant size of the modern company. BHP Billiton Limited has more than 3.2 billion shares listed on the Australian Securities Exchange (ASX). These shareholders reside all over the world. For large listed companies it is not possible for shareholders to meet in person. With such an enormous number of shares, voters physically attending AGMs generally represent a very small percentage of the total shareholder base. In 2013 the Australian Institute of Company Directors (AICD) reported that less than 0.2% of shareholders physically attended AGMs.1 In this paper, we consider the core objectives of the AGM, in light of modern practices for distribution of information to shareholders and shareholder voting mechanisms. We also consider possible reforms to bring the regulation of AGMs into the modern era. In particular, we consider whether: − the information that is distributed as part of an AGM is already more effectively distributed through disclosure on the ASX and through investor briefings; and − voting on resolutions at the AGM (e.g. election of directors) requires physical attendance, or whether this is already achieved through alternative means, such as proxy voting or direct voting. 1 John M Green, 'Shareholders, Wherefore Art Thou?' (Australian Institute of Company Directors, 2013) ; John M Green, 'Wave Goodbye to a Show of Hands' (Australian Institute of Company Directors, 2013) < http://www.companydirectors.com.au/Director-Resource-Centre/Publications/CompanyDirector-magazine/2013-back-editions/July/Greens-Piece-Wave-goodbye-to-a-show-of-hands> www.bakermckenzie.com AGMs - some areas of reform | 2 Obtaining information about the company Under the Corporations Act 2001 (Cth) (Corporations Act), the directors must "lay", before the shareholders a financial report, director's report and auditor's report for the previous financial year.2 A public company is required to provide each of these reports to its members by the earlier of 21 days before the AGM or within four months of the end of the financial year.3 To "lay" a report is a physical undertaking. Listed companies have onerous disclosure requirements under the ASX listing rules. The listing rules require that companies publish their end of year results as soon as possible (and no longer than two months) after the relevant accounting period.4 Companies also have continuous disclosure requirements which require that a company immediately notify the market where it becomes aware of information that could have a material effect on the price or value of the listed entities securities.5 So a listed company will publish its annual results as soon as they are signed off, well in advance of the AGM that follows. It is almost universal (and best) practice for companies to publish investor presentations through the ASX and their website to support the release of quarterly and end of year results. This is done almost simultaneously with the release of the relevant results. This information is also often presented to investors at a series of investor roadshow presentations in the days and weeks that follow the release of the results. These investor presentations are often hosted by the house banker and well attended by fund managers, other investment bankers, substantial shareholders and media. Investor presentation generally combine physical meeting and electronic (dial in) facilities. This presentation is often more focused on current issues facing the company, interactive with questions and answers by management (not the Board) - and perhaps reflects the sort of meeting that was intended when the AGM was first implemented in London coffee shops all that time ago. These presentations focus on more relevant information that investors would like to see as opposed to going through the formalities of the AGM. It is interesting that stakeholders beyond just shareholders attend and participate in these investor presentations. The ASX states, in its guidance note on continuous disclosure,6 that it is prudent that a company publish any investor briefings with the ASX prior to providing the information to investors and analysts. Companies are also encouraged to publish these investor presentation on their website afterwards. Similarly, the Australian and Securities Investment Commission (ASIC) provide guidance on briefing investors and analysts7 and recommend that any price sensitive information should be posted on the company website and on the ASX on a timely basis.8 ASIC relatively recently issued a report on the common practice of investor and analyst briefings and the risk of disclosure of market sensitive information.9 ASIC support the use of investor/analyst briefings as a useful supplement to formal market announcements and can improve the market's understanding of information concerning listed entities.10 ASIC also highlighted that while their investigation did not identify any noncompliance with the continuous disclosure rules, it considered that briefings (whether formal or informal) can 2 Corporations Act 2001 (Cth) s 317. 3 Corporations Act 2001 (Cth) s315. 4 Australian Securities Exchange, ASX Listing Rules 4.3A, 4.3B 5 Ibid 3.1 6 Australian Securities Exchange, ASX Listing Rules Guidance Note, Number 8 at 7.7 7 Australian Securities & Investments Commission, Regulatory Guide 62 Better disclosure for investor, 1 August 2000 8 Ibid at 2, 8 9 Australian Securities & Investments Commission, Report 393, Handling of Confidential Information: Briefings and Unannounced Corporate Transactions, May 2014 10 Ibid at 6. www.bakermckenzie.com AGMs - some areas of reform | 3 be a significant risk area for selective disclosure of market-sensitive information.11 Accordingly, timely disclosure is common practice for listed companies. One matter that appears to escape attention is that the real time question and answers at these investor presentations are often not published. Thus there is a disparity in information. This should be an area of great care because if the Q&A revealed market sensitive information then the selective disclosure will breach the listing rules. We recommend that either the whole presentation is taped and available on the website or some other contemporaneous disclosure of Q&A is made public. Investor briefings provide investors with a real time overview of the performance of the company months before the information is provided at the AGM. In a recent publication John M Green12 wrote in the AICD Company Director Magazine:13 "The major problem is that what mostly consumes AGMs is history - material that's been publicly available for weeks, if not up to two months beforehand: the past year's results, the accompanying management presentation and the annual report. From the very first moment of their public release, a slavering mass of equity analysts, brokers, institutional investors, media, investor newsletters and websites pore over every line of those documents and tear them inside out, with the market absorbing all that analysis in real-time. By the time of the AGM it's all old news." This is a common criticism of the information provided at AGMs. With the rapid advancements in technology and the increased scrutiny of published material of listed companies, the material provided at AGMs offers little new information of the company's activities. If any new information is provided at the AGM, it will be available on the company's website and the ASX at the same time. The delay between company information being published and the company's AGM is often substantial. The table below shows the time between the announcement of full financial year results by some large ASX listed companies and the date that the associated investor presentation and the AGM. These details show that in many instances the investor presentations are released simultaneously with the end of financial year results. Detailed analyst reports are often published within the days following release of the information. This obviously promotes an efficient capital market. However, the AGM and its associated presentation are generally released between two to three months after the end of financial year results are first published. We recognise that the date of the AGM is informally set by the ASX (as opposed to the company). Regardless, this highlights the significant delay between the availability of the information to market and the presentation of the information at the AGM. 11 Ibid at 7, 17. 12 John M. Green is a company director and writer. He is a director of Worley Parsons and QBE Insurance Group. 13 John M Green, 'Shareholders, Wherefore Art Thou?' (Australian Institute of Company Directors, 01 June 2013) www.bakermckenzie.com AGMs - some areas of reform | 4 TABLE 1 DATE OF PUBLICATION OF FINANCIAL YEAR RESULTS AND DATE OF INVESTOR PRESENTATIONS AND AGMS (2014) Company Date of release of financial year end results Date of release of investor presentation on ASX Date of release of AGM presentation on ASX Australia and New Zealand Banking Group Ltd (ANZ) 31 October 2014 31 October 2015 18 December 2014 (48 days later) Whitehaven Coal Limited (WHC) 27 August 2014 27 August 2014 28 October 2014 (62 days later) BHP Billiton Limited (BHP) 19 August 2014 19 August 2014 20 November 2014 (93 days later) Lend Lease Group (LLC) 27 August 2014 27 August 2014 14 November 2014 (79 days later) Seven Group Holdings Limited (SVW) 27 August 2014 27 August 2014 19 November 2014 (84 days later) Voting at an AGM One of the key purposes of the AGM is to vote on resolutions of the company. Common resolutions include: − the election of directors; − the appointment of the auditor; − the fixing of the auditor's remuneration; and − the remuneration report (see our discussion of the two-strike rule at section 4). Voting at a company's AGM may be conducted in person, via proxy or, more recently, by direct voting. Prior to the AGM each shareholder receives a proxy ballot along with the proxy statement describing the issues to be voted on. Shareholders may return a form by mail agreeing to have their vote cast by proxy. A proxy vote is commonly used. The shareholder can elect to appoint the Chairman to vote as he or she sees fit or as directed, or alternatively the shareholder can nominate a third party to vote on their behalf. The shareholder may choose between directing the proxy agent to vote "for" or "against" a resolution or abstain from voting on a resolution. This is known as a directed proxy. Directed proxies are becoming less frequently used as a method of voting for companies that permit direct voting. Direct voting allows the shareholder to cast a vote on one or more matters and forward their vote directly to the company prior to the AGM, removing the requirement to appoint a third party proxy. All that is required for a company to implement direct voting is an amendment to the company's constitution. Proxy voting is not required by law. The take up of proxies is purely discretionary and reflects time, comfort and geographic dislocation. In many modern day AGM's, proxy voting results are demonstrated visually to the attending shareholders via electronic displays. The volume of proxy votes usually significantly exceeds the volume of attending www.bakermckenzie.com AGMs - some areas of reform | 5 shareholder votes, rendering the requirement to hold physical shareholder votes as relatively redundant. Debate continues as to whether the proxy results should be shown at the start of the AGM or only on the actual vote being taken. To show the proxy votes before conducting physical voting generally highlights the redundancy of the votes cast by those attending the meeting in person. Asking questions at an AGM We have considered this issue in detail and propose some reforms to the Corporations Act at Part 2 of this paper. Is reform of an AGM required? We consider that the distribution of important information and methods of voting are currently adequately achieved without the requirement to hold a physical AGM. The benefit of retaining a physical AGM is that it provides attending shareholders with an opportunity to receive information and vote on resolutions in person. On balance, however, we consider that streaming the AGM electronically would provide access to significantly more shareholders. Some companies, such as Telstra, stream the AGM live via webcast on the company's website.14 They also provide a recording of historical AGMs. The physical AGM provides a sense of accountability for directors as they attend and await re-election. It represents perhaps an opportunity to more closely observe the physical features of a director. It removes the often anonymity of the Board. However, as identified above, the majority of votes are received prior to the AGM, and in some instances, displayed prior to voting at the AGM, rendering the effect of the directors' performance at the AGM relatively immaterial. If a physical meeting is not required to achieve the purposes of the AGM, is there any detriment in retaining the physical AGM? For many companies the physical AGM is burdensome and does not reflect modern market behaviour. AGMs are often conducted at a large expense to the company. We have been advised by a company director of one of the larger listed companies that the cost of the previous AGM exceeded one million dollars. They also require substantial time commitments from the executives. Reforms required to AGM The efficacy and relevance of the AGM was considered in detail by the Corporations and Market Advisory Committee (CAMAC) in its paper entitled, The AGM and Shareholder Engagement. 15 That paper considers the relationship between companies and shareholders at the AGM and whether the AGM should be reformed or abolished. The paper proposes that the physical AGM could be limited to deliberative and decision-making functions only. Alternatively, CAMAC propose that AGMs be streamed online, as opposed to having a physical meeting. We consider that the second option is superior. In our view, the law should be reformed to allow a company to elect to provide an electronic AGM and to abolish the requirement for that company to hold a physical AGM, provided adequate technology is available to provide effective communication with its shareholders. 14 Catherine Livingstone, 'Telstra Shareholder Update - AGM 2014', Brisbane Convention and Exhibition Centre, 14 October 2014 15 Australian Government Corporations and Markets Advisory Committee, The AGM and Shareholder Engagement Discussion Paper, 14 September 2012 www.bakermckenzie.com AGMs - some areas of reform | 6 We consider that any company electing to provide an electronic AGM, should be able to demonstrate that it can deliver the AGM via a reliable alterative method (e.g. live streaming). Any reform should also provide flexibility for companies with different electronic capabilities. For example, companies should be able to "opt in" to such AGM reforms if they have the capabilities to ensure that the modified AGM can be delivered effectively. Companies that cannot offer electronic AGMs should be able to retain the status quo. Further, any reform must ensure that the original objectives of the AGM are achieved. As previously identified, the objectives of an AGM are to: − distribute information on the companies operations and financial performance − allow shareholders to vote on resolutions to govern the company, such as the re-election of directors; and − ask questions of the directors. Company information We consider that the AGM should be conducted in a similar format as the investor presentations, discussed earlier in this paper. Companies should prepare electronic AGMs that can be streamed online and accessible to investors in different geographic locations. The AGM would be delivered in much the same manner as they are currently provided, without the necessity for physicality. We would also encourage companies to adopt a more interactive investor presentation style format. We consider that an electronic AGM would achieve the same proposes as a physical AGM, without the geographic restriction on attendance. The electronic AGM could also include interactive links to company presentations and reports, such as the annual financial report, directors' report and auditor's report, to support the information being provided by the Board. The company should also ensure that it complies with the notice requirements set out in the Corporations Act including providing 21 days' notice of the meeting16 and makes the financial, directors and auditor reports available electronically to investors no later than 21 days prior to the scheduled investor style AGM.17 In the United States, a greater use of technology has promoted accountability of management via online questions or comments. US companies may be leading the way, which is made easier due to the provisions of Delaware Law that allow the use of technology when engaging with shareholders. So too does the Corporations Act. Section 249S allows a company to hold a meeting of members at two or more venues using any technology that gives the members as a whole a reasonable opportunity to participate. In Australia, the further development of on-line meetings would provide a convenient and transparent forum for directors to engage with shareholders. In its submission to CAMAC's publication entitled AGMs and Shareholder Engagement, the Business Council of Australia supported the use of webcasting and online participation where it is technologically and financially viable for companies.18 16 as required by Corporations Act 2001 (Cth) s 249H 17 unless required earlier pursuant the Corporations Act 2001 (Cth) s 315 18 Business Council of Australia, Submission to the Corporations and Markets Advisory Committee, AGM and Shareholder Engagement Discussion Paper, February 2013, p 4 www.bakermckenzie.com AGMs - some areas of reform | 7 Voting on resolutions The second purpose for an AGM is to provide shareholders with a right to vote on company resolutions. The resolutions include the election of directors, the appointment of the auditor and the determination of executive and auditor's remuneration.19 It is clear from the prolific use of electronic proxy voting mechanisms that the requirement for physically voting by show of hands is redundant. Further, the use of direct voting facilitates shareholder engagement by permitting shareholders to directly vote at meetings without attending those meetings in person or by proxy. Several ASX top 50 companies currently permit direct voting as it generally only requires a simple amendment to a company's constitution. More companies may be encouraged to take up these practices if they were explicitly permitted by the Corporations Act or ASX Listing Rules.20 The use of direct voting is supported by the Business Council of Australia on the basis that it could enhance shareholder engagement in decision making as shareholder would be less likely to appoint a proxy agent or abstain from voting. The Business Council of Australia suggests that such a framework should be recognised in legislation but its application should be at the discretion of the company and according to its constitution.21 The BCA suggests that legislative recognition would need to avoid being unnecessarily prescriptive and mandating use of these facilities.22 We support the proposed reforms of the BCA to promote the use of direct voting. The use of direct voting (along with proxy voting) and the implementation of on-line meetings would provide shareholders with the right to vote of resolutions of the company including the election of directors, the appointment of the auditor, the fixing of the auditor's remuneration and resolution of the remuneration report and would essentially do away with the necessity to hold a physical AGM, whilst preserving (if not enhancing) the original purposes of the AGM. 19 Corporations Act 2001 (Cth) s250R 20 Lexology Iain Laughland, Shareholder Engagement - Has the CGM had its Day?, 5 October 2012 21 Business Council of Australia, Submission to the Corporations and Markets Advisory Committee, AGM and Shareholder Engagement Discussion Paper, February 2013, p 4 22 Business Council of Australia, Submission to the Corporations and Markets Advisory Committee, AGM and Shareholder Engagement Discussion Paper, February 2013, p 4 www.bakermckenzie.com AGMs - some areas of reform | 8 2. Shareholder meetings: Reform needed to the shareholder right to question/comment and 100 member resolutions Overview On 19 March 2015, the "100-member rule" was abolished. The Corporation Legislation Amendment (Deregulatory and Other Measures) Act 2015 received Royal Assent. This ended the long standing right for 100 members to cause the company to hold a general meeting of members. The general rationale for this reform was couched in terms of economic efficiency - the cost (both direct and indirect) was regarded as too expensive having regard any benefit. One feature of the numerous commentaries supporting this change was the observation that other rights of shareholders were not compromised. The AICD stated:23 "Our support for the repeal of the 100-member rule is not an attempt to stifle shareholder democracy. Rather, it is a recognition this particular provision has not worked in the manner in which it was intended." In its submission to the Corporations and Market Advisory Committee AGM and Shareholder Discussion Paper dated February 2013 the Business Council of Australia stated that:24 "As long as the 100-member rule under section 249D remains in the Act, there will be impetus for groups to unreasonably exploit it." The Law Council of Australia also supported the abolition of the 100-member rule. The Law Council submission stated that the abolition "…will achieve an appropriate balance between the interests of minority and majority members." The Law Council noted the cost of holding such meetings. CAMAC also noted that the 100-member rule should be abolished to "…achieve a balance between legitimate shareholders rights and the potential abuse of those rights at what could be a substantial cost to the company".25 In short, the themes behind abolition of the 100-member rule are primarily: − open to abuse; and − cost/benefit. Shareholder questions (and other rights of shareholders to information) We submit that "question time" at an AGM (or other shareholder meetings) should similarly be restricted to members with at least 5% of the votes. We submit elsewhere in this paper that the AGM (and other shareholder meetings) should also be abolished - at least in requiring a physical meeting presence as is currently the case. Our submission on that issue is that 23 Australian Institute of Company Directors, Canning 100-member rule a step towards efficiency, accessed 30 June 2015. 24 Business Council of Australia, Submission to the Corporations and Markets Advisory Committee, AGM and Shareholder Engagement Discussion Paper, February 2013, p 5 25 Corporations and Markets Advisory Committee, AGM and Shareholder Engagement Discussion Paper, September 2012, p 27 Law Council of Australia submission relating to the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 (Bill), January 2015, p3. www.bakermckenzie.com AGMs - some areas of reform | 9 technology can provide the information sought to be communicated in a more effective and efficient manner. Physical proximity fails on a cost/benefit analysis. Shareholders of listed companies currently enjoy the benefit of the following rights to information: − Inspect the company's books26 - "books" are defined broadly27 to be a register, any other record of information, financial reports or financial records and a document although some exclusions do apply. A shareholder can apply to the court for an order to inspect the company's books. However, the court will only grant an order where the shareholder is acting in good faith and the inspection is for a proper purpose and is at the court's discretion. − Copies of documents and resolutions lodged with the Australian Securities and Investment Commission which relate to the division and conversion of shares and which affect rights attaching to shares and members.28 − Access to minutes of members' meetings and resolutions of members passed without meetings.29 − Copy of the company's financial report, directors' report and auditor's report at the company's AGM.30 − Continuous and periodic disclosure by the company.31 Companies may also choose (and many do) to disseminate additional information. This is generally by sending letters to shareholders or posting information on the company website. Shareholders currently have the following rights at the company's AGM: − To submit a written question to the company's auditor prior to the company's AGM.32 − To ask questions or make comments on company management or the remuneration report at the company's AGM.33 − To ask questions to the auditor at the company's AGM.34 Section 250S requires that the chairman of an AGM "…must allow a reasonable opportunity from the members as a whole at the meeting to ask questions about or make comments on the management of the company." Thus an environmental or other activist who has acquired one share in a company has the same right as a substantial shareholder (5%) to ask a question or make a comment. Given that substantial shareholders seldom attend an AGM, the majority of questions (and thus time at the AGM) are from members with a very small investment. We submit that, like the 100-member rule, this is a grossly inefficient and an unfair right to accord a shareholder who does not have at least a substantial interest in the company. Like the 100-member rule, it is open to abuse and is regularly abused by environmental activists and other members who have a desire to 26 Corporations Act 2001 (Cth) s 247A 27 Corporations Act 2001 (Cth) s 9 28 Ibid s 246G 29 Ibid s 251B 30 Ibid s 317 31 ASX Listing Rules Chapters 3, 4 32 Corporations Act 2001 (Cth) s 250PA 33 Ibid s 250S, s 250SA 34 Ibid s 250T www.bakermckenzie.com AGMs - some areas of reform | 10 "make a point" or "grab a media headline" rather than engage in constructive dialogue. An AGM is not, we submit, the appropriate place for such questioning. The questioning to the chairman or the auditor can take up a disproportionate amount of the meeting time. This is exacerbated when the shareholder's motive is to simply denounce the company, the Board, the management or an activity (or all) to promote an "agenda". We do not seek to deny any shareholder the right to ask a question or comment. We think there is a better way. Our submission is that the notice of the meeting should expressly state that a shareholder may ask a question or make a comment on the basis we propose. We propose that if a question is asked or comment made by a shareholder during the "question period" the company must publish the question/comment on a special section of the company's website. Other shareholders can access that section of the website. In asking a question or making a comment, the shareholder must disclose the: − full name and address of the shareholder; − number of shares held (and for how long); − number of questions asked/comments made in the "question period"; − full name and position of the person asking the question or making the comment (if not the actual shareholder). The company must answer all questions (but need not respond to comments) by the date of the AGM. The "Question Period" will end, say, five business days before the AGM date. Answers will be posted on the website. Questions to the auditor will be dealt with in the same manner. Provision will need to be made to ensure it is the auditor who is responding via the company's website. In our view, this should result in a better quality of question and a more considered response. It will also allow the company to provide one answer if it receives multiple similar questions. Provision should be made for vexatious questions. If the company does not have the technology to carry out our proposal the status quo for asking questions at the AGM should apply. Right to propose a resolution The following members have the right to give a company notice of a resolution that they propose to move at a general meeting: − members with at least 5% of the votes that may be cast on the resolution; and − at least 100 members who are entitled to vote at a general meeting.35 The 100-member rule was concerned with requesting a meeting. The right to propose a resolution remains unchanged. That is, a group of 100 members can propose a resolution at a properly convened meeting - but can no longer call that meeting themselves. We submit that this right to propose resolutions is also susceptible to abuse by activists. The proposal need not relate to the business of the meeting. For the same reasons that the 100-member rule was abolished then so too should this right. If it is no longer appropriate for the 100-member threshold to apply to the ability to call a shareholder meeting, then it would seem to follow that this restriction should be mirrored for the right to propose resolutions at a meeting. 35 Corporations Act 2001 (Cth) s 249N www.bakermckenzie.com AGMs - some areas of reform | 11 Whilst the cost of calling the meeting is not the responsibility for the 100 members - having to deal with their proposed resolution remains a distraction to management and the Board and is thus a cost that outweighs any benefit. PROPOSED REFORMS Shareholders' right to ask questions at the company's AGM (or other shareholder meeting): − limit this right to shareholders who hold at least a 5% shareholding; − any shareholder can submit a written question and make a comment to the company (or Auditor) at any time during the "Question Period". This is the period between the publication of the Annual Report and five business days before the date of the AGM. The company must publish all questions/comments. The company or the Auditor (as the case may be) shall have an obligation to respond to all questions by the time of the AGM; − status quo to prevail if a company so chooses; − a shareholder with more than 5% shareholding continues to have the right to ask questions at the AGM. Shareholders' ability to propose resolutions at a company meeting should be limited to shareholders who hold at least 5% shareholding in the company. www.bakermckenzie.com AGMs - some areas of reform | 12 3. Proxy advisors Overview The appointment of proxy advisors has increased dramatically in recent times and has been seen as an important means by which shareholders can ensure that directors are held accountable for their actions and the future direction of the company and is therefore a key mechanism by which shareholders play a role in the governance of the company.36 AGMs are held during a relatively short period of time in the second half of the year. Institutional investors will often have exposure to a large number of companies and therefore, the ability to efficiently digest information and be engaged with each listed entity is limited. Institutional investors will often outsource research on matters for consideration at the AGM to proxy advisors to provide recommendations and conduct market research on a wide range of issues including director remuneration. As a result proxy advisors play a large role in the shareholder engagement process and have strong influence on institutional share voting at AGMs. Leading proxy advisors include companies such as ISS, GPS, CGI Glass Lewis and MSCI (RiskMetrics). These companies focus on supporting institutional investors, hedge funds, asset service providers and other corporations through governance research services, proxy vote management and technology services, securities class action claims and data research and modelling tools. Influence of proxy advisors There has been increasing discussion over the role that proxy advisors play in AGMs and the extent to which institutional investors simply rely on the recommendation of their proxy advisors. Since the introduction of the two-strikes rule in 2011, proxy advisors have become increasingly active on the issues of remuneration. Proxy advisors have become very savvy at identifying "best practice" for remuneration. As a result of the large volume of empirical data held by these entities, they have become very influential on the issue of remuneration. Accordingly, many companies engage regularly with proxy advisors to gauge the proxy advisors view on issues of remuneration prior to submitting the remuneration report to a vote at an AGM. Companies may find that they deal on key issues with the proxy advisors rather than the shareholder itself. There have been calls for greater regulation and transparency of the proxy advisors, to ensure that company directors have insight into the identity of the entity that holds the right to vote or influence the vote on company resolutions. There has also been increased scrutiny over proxy advisors expertise and whether such expertise is commensurate with impact they can have over a company's operations. In 2011 the AICD issued a report entitled Institutional Share Voting and Engagement − Exploring the links between directors, institutional shareholders and proxy advisors. 36 Australian Council of Superannuation Investors, A guide for superannuation trustees to monitor listed Australian companies, ACSI Governance Guidelines (July 2011) www.bakermckenzie.com AGMs - some areas of reform | 13 The origins of the report derive from the Chairman's Forum which brings together chairmen of Australia's major listed companies to promote discussion of current and emerging corporate governance issues. In these discussion the AICD identified that Australia's chairmen were increasingly interested in improving engagement between Boards and institutional investors and to better understand the actual "decision-makers" in the share voting process. In particular the chairmen wanted to better understand the role and influence of proxy advisors.37 The AICD commissioned an independent investigation to identify, amongst other things, the key trends of proxy advisors. The report identifies a number of key findings that identify the engagement processes between Australian listed companies and proxy advisors. Firstly, the report identified that the institutional share voting environment is characterised by high volume decision making in a compressed time, which impacts how institutional shareholders vote. Approximately 80 per cent of votes cast by institutional investors on listed company resolutions occur in a six to eight week period otherwise known as "peak proxy season". Further, approximately 80 per cent hold their AGMs in October to November in each year. At the peak of the season there may be 30 or more company meetings to be considered in a week.38 Accordingly time and cost efficiencies promote the outsourcing of these functions to proxy advisors. The report also identifies that the high volume and limited time affects how the parties in the institutional share voting process communicate with each other. Due to the high volume of AGMs communication between proxy advisors, institutional shareholders and companies is limited during the peak proxy season and engagement is most likely to occur outside of this peak season. This forces companies to engage with proxy advisors all year round. Interestingly the report identified that continuous disclosure requirements do not impact on the continual communication process.39 Importantly the report identified that proxy advisory firms are an important influence on institutional share voting in Australia. In particular, the report identified:40 − there is a near universal view by all key participants in the share voting system, including company directors, managed funds and superannuation funds that proxy advisors are influential in the voting process; − the high-volume, time-pressured AGM season means proxy advisors perform a function that most institutional share owners would consider that would not be able to do internally; − there appears to be a growing acceptance of the role of proxy advisory firms and the evolving relationship between companies and proxy advisors; and − engagement between companies and proxy advisors is becoming less adversarial and more professional in nature. 37 Australian Council of Company Directors, Institutional Share Voting and Engagement - Exploring the links between directors, institutional shareholders and proxy advisors (2011), pIII. 38 Ibid p3 39 Ibid p4 40 Ibid p6 www.bakermckenzie.com AGMs - some areas of reform | 14 The graph below identifies the influence of proxy advisors on institutional shareholder voting across the ASX200.41 The report also suggests that a significant majority of company directors believe that proxy advisors are improperly influential. They believe too much responsibility has been outsourced by institutional investors, making proxy advisors essentially de facto decision makers.42 Further, a significant number of directors felt very strongly that it was the clear responsibility of institutional investors to actively make voting decisions and to devote sufficient time and resources to think about the issues involved. To do otherwise, they argued, was to abrogate an important responsibility.43 The following graph identifies the extent to which directors of the ASX200, managed funds and superannuation funds consider that the level of experience, expertise and knowledge of proxy advisors in understanding the driver of shareholder value in companies.44 The report does not propose to provide solutions to the issues, rather just to highlights its findings. It does however recommend that companies should be aware of proxy advisor share voting policies (along with the voting policies of institutional investors and industry bodies) as these have an important impact on institutional share voting.45 41 Ibid p6 42 Ibid p6 43 Ibid p6 44 Ibid p7 45 Ibid p5 www.bakermckenzie.com AGMs - some areas of reform | 15 Areas for reform In the wake of both strong backlash and support of proxy agents, the Business Council of Australia lodged a submission in 2013 addressing concerns of directors and shareholders in the role of proxy advisors entitled The Submission to the Corporations and Markets Advisory Committee AGM and Shareholder Engagement Discussion Paper. 46 The BCA from the outset, stated that in the area of corporate governance and shareholder communication "one size does not fit all".47 It noted that in fact most institutional shareholders are engaged with the Board throughout the year, and the regulatory environment must afford companies with flexibility to cater for individual circumstances and shareholders.48 The BCA noted that the most pertinent concern was the increasing influence and standards of proxy advisors. The discussion paper considers the option of developing standards for proxy advisors and for investors using proxy advisors, to promote professional conduct and reinforce the role of the shareholder as the ultimate decision maker (as opposed to the proxy advisor).49 The BCA identified its for support the development of appropriate industry principles to govern: − the disclosure of proxy advisor qualifications and voting policies; − how proxy advisors conduct analysis before making a recommendation, including any outsourcing of analysis; − how the proxy advisor will engage with its client and companies to ensure fairness and completeness of advice and ultimate decision making. In developing these standards the BCA does not support regulatory intervention, but rather the enhancement of existing voluntary industry-based codes (such as the code developed by the industry body, the Financial Services Council) or the development of a new voluntary industry-based code where necessary. It is clear that the proxy advisor will continue to play a key role in the governance of large listed companies. We support the view that additional regulation is required to increase transparency around proxy advisor identity, voting policies and engagement with shareholders and the company. 46 Business Council of Australia, Submission to the Corporations and Markets Advisory Committee, AGM and Shareholder Engagement Discussion Paper, February 2013 47 Ibid p3 48 Ibid p4 49 Ibid p6 www.bakermckenzie.com AGMs - some areas of reform | 16 4. Two-strike rule Overview The two strike rule was introduced in 2011 to provide shareholders with a binding vote on a company's remuneration report. The motive behind this movement was to make directors more accountable to shareholders for allocation of company profits following the excessive payments approved for executives and directors of Wall Street companies in the lead up to the GFC. Prior to the introduction of the two-strike rule, the Corporations Act 2001 (Cth) required a listed company to submit its remuneration report to shareholders for a non-binding vote at the AGM.50 However, the Corporations Act did not stipulate any consequences where shareholders voted against a remuneration report and the Board generally disregarded the members vote and proceeded with its remuneration policy. Section 250R(2) requires that at a listed company's AGM, a resolution that the remuneration report be adopted must be put to the vote. The vote on the resolution is advisory only and does not bind the directors or the company.51 The remuneration report must include the following information for each key management personnel:52 − A discussion of Board's policy for determining the nature and amount of remuneration of the key management personnel. − The relationship between the Board's Policy and the company's performance. − Details of performance conditions including reasoning for the conditions and calculation methodology and assessment criteria. − Details of any comparisons made with external factors used as a benchmark. − Prescribed details of the remuneration (including any options) and details of the amount linked to performance. Under the two strike rule, where a company receives a "no" vote of 25 per cent or more on the remuneration report of the directors at two consecutive AGMs53 then a spill motion must be put to the shareholders.54 Where 50 per cent or more of eligible votes support the spill resolution, then a spill meeting is called and all Board positions held at the time that the remuneration report was submitted are considered vacant (other than the Managing Director) and all directors are required to stand for re-election.55 The spill meeting must be held within 90 days following the spill resolution. If a director is reappointed during the spill meeting, the term of office of the reappointed director is run as if the spill meeting and re-appointment had not taken place.56 50 The non binding vote on the remuneration report was a measure introduced in 2004 by the Corporate Law Economic Reform Program (CLERP) 9. 51 Corporations Act 2001 (Cth) s250R(3) 52 Ibid s300A 53 Ibid s250U 54 Ibid s50V 55 The Corporations Act 2001 (Cth) s205V(b) 56 Ibid s250Y www.bakermckenzie.com AGMs - some areas of reform | 17 In 2009 the Productivity Commission considered the relevant threshold to apply to the two strike rule. Submissions from industry proposed that the threshold should be set at 50 per cent at both, or at least the second, AGM.57 The Productivity Commission recommended, in its report on Executive Remuneration in Australia58 that: "confining mandatory explanations to remuneration reports that received less than 50 per cent support would mean that, on current voting patterns, relatively few companies would be compelled to report their response. A lower 'no' vote trigger (for example, a requirement for 75 per cent to be in favour, in line with the level of support required for special resolutions) would have greater reach, and arguably better align with voting levels commonly accepted as indicative of serious shareholder concern about remuneration".59 The 75 per cent threshold was subsequently adopted in the amendments to the Corporations Act. First reactions? The 2 strike rule was immediately taken up by many shareholders as a right to object to remuneration reports. In 2011, approximately 108 companies (~5 per cent of listed companies) received a first strike. Four of these were ASX 100 companies. Companies that received a first strike included Crown Ltd, Pacific Brands Ltd and Linc Energy Ltd. In the first year many companies actively engaged with their shareholders on remuneration issues and received approval of the subsequent remuneration reports. This included Bluescope, Crown, Perpetual, Pacific Brands, GUD and UGL. However, of the initial 108 companies, approximately ten companies received a second strike, including Penrice Limited, Globe International Limited, Linc Energy Ltd, Rey Resources Limited, Emerald Oil and Gas NL, Celamin Holdings NL, Cabcharge Australia Limited and Ask Funding Limited. None of these companies were ASX 100 companies.60 Of the ten companies that received a second strike, three companies voted in favour of a spill meeting.61 These were Penrice Limited, Globe International Limited and Rey Resources Limited. Following the vote in favour of the spill meeting the entire Board of Rey Resources resigned removing the requirement for the spill meeting. In the case of Penrice, the incumbent Board was re-elected with 75% support and the other candidates were defeated with a similar vote against. The re-elected Chairman was highly critical of the two-strikes regime and called for it to be abolished stating "I think directors generally are more than capable of identifying and responding to prevailing shareholder sentiment without needing a legislative sledgehammer to do it for them".62 Similarly, in the case of Globe International, the spill meeting provided little value and in fact was cited as a waste of management time and shareholder resources because the incumbent directors identified their intention to use their large shareholdings to re-elect themselves and no other candidates had nominated themselves for election.63 57 Productivity Commission, Inquiry Report No. 49, 19 December 2009, p298 58 Ibid 59 Ibid p295 60 Peter Jolly, Thynne & McCartney, Two strikes rule — playing by the rules (February 2013) < http://www.thymac.com.au/wpcontent/uploads/2013/01/Two_strikes_executive_remuneration_February2013_.pdf> 61 Penrice Limited, Globe International Limited and Rey Resources Limited. Note however, that the entire Board of Rey Resources resigned after the meeting so there was no need for a spill meeting to be held. 62 Carolyn Pugsley, Herbert Smith Freehills, First spill meetings under two-strikes rules (20 February 2013) 63 Ibid www.bakermckenzie.com AGMs - some areas of reform | 18 Over the first year, the results represent that the vast majority were been successful in avoiding a second strike. Further, of the companies that received a second strike, a minority were required to schedule a spill meeting. This suggests that companies were active in discussions with shareholders and proxy advisors following a first strike and may also support the view that proxy advisors and shareholders understand that a Board spill is a drastic measure to address concerns over remuneration. Has it been effective since? In the following year (2012), twenty one ASX listed companies received a second strike, however only five of those passed a spill resolution.64 In 2013 and 2014, three companies in the ASX 100 received their first strike against their remuneration report. None of these companies receive a second strike.65 In 2014, 17 companies had received one strike and another three received three strikes or more. These companies included Cabcharge, Linc Energy and Cash Converters.66 One of the highest backlashes was received by the Board of Newcrest, with 45% of shareholders rejecting the remuneration report.67 Despite this there has been very limited instances of Boards being spilled. What does this tell us? These numbers show a clear trend toward issuing a single strike or two strikes without the necessity to hold a spill meeting or spill the Board. This poses three alternative scenarios: Firstly, that the two strike rule is so effective in curbing excessive remuneration or promoting engagement with shareholders after a first strike, that the punitive requirement to potentially spill the Board is reserved only as a drastic action (Alternative 1). Secondly, that the regime, in its current form, is ineffective in that it promotes shareholders to issue strikes against the company without the ability to spill the Board (Alternative 2). Finally that shareholders are voting no against remuneration reports for reasons unrelated to executive remuneration (Alternative 3). Alternative 1: The deterrent The first theory is that companies that have received a first strike have been proactive in engaging with shareholders, proxy advisors and fund managers to address remuneration concerns. In cases where comments are made on the remuneration report that were considered at the AGM where the "first strike" occurred, the company's subsequent remuneration report is required to contain an explanation of the Board's proposed action (or reasons for inaction) in response to those comments. In the first year many companies actively engaged with these parties on remuneration issues and received approval of the subsequent remuneration reports. This included Bluescope, Crown, Perpetual, Pacific Brands, GUD and UGL. 64 Johnson Winter & Slattery, 2013 AGM Season Survey Results (2014) 65 Ibid 66 Su-Lin Tan, '"Struck" companies pare executive pay', BRW, (online) 30 October 2014 67 Sue Lannin, 'Shareholders deliver big protest vote against newcrest's executive pay packets' ABC News, (online) 31 October 2014 www.bakermckenzie.com AGMs - some areas of reform | 19 Following the "no" votes in 2010, and with the implementation of the 2 strike rule in 2011, both Transurban and Challenger took steps to review and substantiate the remuneration to earn shareholder support in 2011. This included engaging independent experts to restructure executive pay and reducing CEO salaries respectively.68 Whilst the first strike in this instance took place prior to the implementation of the two-strike rule, it demonstrates the companies' willingness to address the remuneration concerns. To date, none of the ASX 100 companies that have received a first strike have received a second strike in the subsequent year. The tables below demonstrates the voting percentage on the remuneration for ASX 100 companies that received a first strike in a particular year and percentage that voted for a second strike in the following year.69 This shows a clear trend, at least amongst the larger ASX listed companies, that following a first strike the Boards react to address the concerns of shareholders rather than ignore the issues. The strategies adopted vary between reductions of remuneration, increased transparency and restructuring personnel. 2011-12 Company 2011 no vote percentage 2012 no vote percentage Dexus Property Group 2 28.20 1.70 UGL Limited 30.13 16.77 Crown Limited 55.52 6.71 Bluescope Steel Limited 39.25 1.58 The reason for the reduction in "no:"votes between 2011 and 2012 was a result of proper shareholder engagement and either altering the remuneration or increasing transparency of remuneration methodology. UGL and Crown each indicated that they had responded to their first strike in 2011 by increasing transparency rather than reducing remuneration. Dexus Property Group and BlueScope Steel chose to alter the remuneration structure of the executives and altered key management personnel. 2012-13 Company 2012 no vote percentage 2013 no vote percentage Cochlear Limited 31.02 4.52 Fairfax Media Limited 34.59 2.6 Lend Lease 25.78 1.33 68 Patrick Durkin, 'Shareholders Use Two-Strikes Rule Judiciously', Australian Financial Review (online) 23 November 2011 69 Johnson Winter & Slattery, 2013 AGM Season Survey Results(2014) www.bakermckenzie.com AGMs - some areas of reform | 20 The reduction in "no" votes between 2012 and 2013 resulted from engagement with shareholders from Lend Lease and Cochlear. Cochlear also obtained external advisors for remuneration and consulted with institutional proxy advisor firms. Fairfax Media adjusted the remuneration including implementing a freezing on senior executive salaries and fees paid to non-executive directors and the Chairman as well as updating incentive schemes in order to better reflect the transformation strategy of the company.70 2013-14 Company 2013 no vote percentage 2014 no vote percentage Alumina Limited 50.09 11.45 Aurizon Holdings Limited 28.06 7.31 David Jones Limited 39.53 N/A (delisted) Similarly to previous years the companies that received their first strike in 2013 increased shareholder engagement and obtained external advice prior to the 2014 AGM. Of particular note is the growing trend to deal with proxy advisors. Both Alumina and Aurizon engaged with proxy advisor groups on concerns with the executive remuneration. Modifications to the remuneration included freezing pay (Aurizon) restructuring remuneration and KPIs (Alumina). It is quite clear that, at least amongst the ASX 100, receiving a first strike provides a clear incentive to liaise with shareholders and their proxy advisors and to either restructure or increase transparency of remuneration. In some instances companies have engaged an independent third party to verify the remuneration report. Boards have also increasingly engaged remuneration experts to inform them of industry and peer standards. There appears a real desire to not push the boundaries and hence seek professional advice. It is also quite clear that the incentive for directors of these companies that receive one strike to avoid the second strike to prevent the ultimate risk of spilling the Board. To this extent the two strike rule appears to be achieving its objective. It should be noted that in other instances companies have elected to ignore the "no" vote and identified that they would not implement any changes to their executive remuneration. The most obvious example of this is the case of Cabcharge which has received four consecutive "no" votes between 2011 and 2014 (as well as receiving non-binding no votes prior to the implementation to the two strike rule). Cabcharge has been vocal on this issues and has taken aim at proxy advisors and shareholders stating that "it must be humiliating not to think for one's self" after 41% of voters agreed with the proxy advisors and voted against the remuneration report in 2011.71 Pacific Brands also stated that they would continue to adapt the same strategy regardless of the "no" vote in 2010 (prior to the implementation of the two strike rule).72 Despite this initial resistance in 2011, Pacific Brands ultimately reduced the base and committee fees for non-executive directors by 25 per cent, imposed a 70 Karina Marcar, Alice Hudson, '2013 AGM Season Survey Results Acumen', Johnson Winter & Slattery (online) March 2014 71 Patrick Durkin, 'Shareholders Use Two-Strikes Rule Judiciously', Australian Financial Review (online) 23 November 2011 72 Ibid www.bakermckenzie.com AGMs - some areas of reform | 21 salary freeze on most senior management, and a introduced a 50 per cent reduction in short term incentives for executives to secure shareholder approval for its 2012 remuneration report.73 Despite minor resistance, it appears that on balance, obtaining one strike incentivises companies to engage with professional advisors, shareholders and/or their advisors and resolve the issue prior to proceeding to a second strike and a potential Board spill. Alternative 2: Spill meetings ineffective The second alternative is that despite issuing strikes against the company, shareholders are either unable, or do not see value in spilling the Board. The statistics strongly support this notion. What is not as clear is whether shareholders are unable, or unwilling to spill a Board. The table below shows a list of the ASX 200 companies that received "no" votes in 2011 and the percentage of shareholders voting against the remuneration report in that year.74 Company % of votes cast against the remuneration report Austar United Communications 29.21 BlueScope Steel Ltd 38.61 Cabcharge Australia 40.61 Coca-Cola Amatil 29.28 Crown Limited 55.52 Emeco Holdings 26.26 Fleetwood Corp Limited 36.25 Gyphon Minerals Ltd 29.02 Linc Energy 41.23 Macquarie Atlas Roads Limited 33.18 NRW Holdings United 39.10 Pacific Brands Limited 52.66 Perpetual Limited 26.20 Rio Tinto Limited 25.62 UGL Limited 29.07 Whilst this table relates only to the first strike, it demonstrates the volume of shareholders who oppose the remuneration report, arguably at its most offensive stage (prior to receiving the first strike and implementing any changes to address shareholder concerns). As demonstrated by the above list, the vast majority of cases (in fact, all but two) that voted against the remuneration report do not exceed the 50 per cent threshold 73 Trevor Gillespie, 'Pac Brands directors avoid second strike', ABC News (online) 23 October 2012 74 Australian Institute of Company Directors, Two strikes health check, Company Director Magazine (1 February 2012) www.bakermckenzie.com AGMs - some areas of reform | 22 required to request a spill meeting. Further, a vote to hold a spill meeting, and especially to spill a Board, is likely to attract less voting support than a vote to reject a remuneration report due to the significant impact on the company. The table below shows a list of all non-ASX 100 companies that received a second strike in 2012 (the first year that a second strike was possible under the two-strike rule), and the percentage of those shareholders that voted in favour of a spill meeting.75 Company Resolution to hold a spill meeting (%) Austar United Communications 29.21 BlueScope Steel Ltd 38.61 Cabcharge Australia 40.61 Coca-Cola Amatil 29.28 Crown Limited 55.52 Emeco Holdings 26.26 Fleetwood Corp Limited 36.25 Gyphon Minerals Ltd 29.02 Linc Energy 41.23 Macquarie Atlas Roads Limited 33.18 NRW Holdings United 39.10 Pacific Brands Limited 52.66 Perpetual Limited 26.20 Rio Tinto Limited 25.62 UGL Limited 29.07 Whilst this table relates only to the first strike, it demonstrates the volume of shareholders who oppose the remuneration report, arguably at its most offensive stage (prior to receiving the first strike and implementing any changes to address shareholder concerns). As demonstrated by the above list, the vast majority of cases (in fact, all but two) that voted against the remuneration report do not exceed the 50 per cent threshold required to request a spill meeting. Further, a vote to hold a spill meeting, and especially to spill a Board, is likely to attract less voting support than a vote to reject a remuneration report due to the significant impact on the company. The table below shows a list of all non-ASX 100 companies that received a second strike in 2012 (the first year that a second strike was possible under the two-strike rule), and the percentage of those shareholders that voted in favour of a spill meeting. 75 Johnson Winter & Slattery, 2013 AGM Season Survey Results(2014) www.bakermckenzie.com AGMs - some areas of reform | 23 Company Resolution to hold a spill meeting (%) Globe International Carried – 85 Ask Funding Not carried – 35 MZI Resources Not carried – 2 Penrice Soda Carried – 61 Cabcharge Australia Not carried – 14 Linc Energy Not carried – 26 ICSGlobal Not carried – 30 Celamin Holdings Not carried – 33 Emerald Oil & Gas Not carried – 38 Australian Ethical Investment Not carried – 31 Rey Resources Carried – 79 Whilst not representative of all of listed companies, the table above serves to demonstrate the limitation on effecting change under the two strike rule. In many instances, those who do not favour the remuneration are unable to gain the required threshold to hold a spill meeting and spill the Board. In other cases, shareholders may elect not to hold a spill meeting or spill the Board because the result is not proportionate with the issue at hand, or will not provide the best outcome for the shareholders. As identified earlier none of these meetings resulted in spilling the Board, although the Rey Resources Board did resign. There are also factors that prevent shareholders from spilling the Board (even where they wish to do so). A key inefficiency of the ability of shareholders to spill the Board was demonstrated at the Crown AGM. After shareholders voted against Crown's remuneration report, James Packer, the executive chairman and major shareholder (46%) advised shareholders that if a Board spill meeting was called he would use his shareholding to reinstate all Board members.76 Interestingly in that instance the issue for shareholders (other than James Packer) was one of disclosure rather than remuneration.77 Whilst this demonstrates the inability for the Board spill methodology to be effective in such circumstances, this example is limited to those instances where the directors are also major shareholders in the company or have influence over major shareholders in the company. The Australian Financial Review (AFR) recently published78 that companies have been flouting the two-strike rule by passing resolutions for executive remuneration on a show of hands at the AGM rather than requiring a poll. In a recent article, the AFR state that dozens of companies that clearly received a strike in proxy votes 76 Andrew Cleary, 'Packer comes out swinging after first strike on pay', The Australian Financial Review (online) 28 October 2011 77 Claire MacMillan, 'Executive remuneration in Australia - lessons from company AGMs in 2011', Mondaq (online) 28 April 2011 78 Patrick Durkin, 'Executive pay back in spotlight as protest votes double', Australian Financial Review (online) 12 July 2015 www.bakermckenzie.com AGMs - some areas of reform | 24 prior to the AGM, claimed that the resolution to approve executive remuneration passed on a show of hands at the AGM. The AFR have proposed that one potential fix to this loophole was to require poll voting for all resolutions on executive remuneration. This regime is currently in place in jurisdictions such as Hong Kong. This issue has been reportedly raised with ASIC who have not yet formed the view that they should recommend that any amendments to voting on executive remuneration in Australia be modified by legislation to address this issue. We note that our proposed reforms to voting in Parts 1 and 2 of this paper would provide a remedy to this potential loophole. Regardless of the reason for not holding a spill meeting or spilling the Board the above statistics clearly demonstrate that the ultimate recourse to shareholders is not appropriate to address remuneration. Whether the real success of the two-strike rule is the deterrent on directors to address the issues after the first strike (as identified at Alternative 1 above) remains to be determined absolutely. In 2014, Egan Associates conducted a survey of directors to determine whether the two-strike rule has been effective. The survey found as follows:79 − 82 per cent of respondents believed the two strikes rule had been a key driver of Boards' remuneration decisions. − 63 per cent said remuneration policies had improved since the introduction of the rule. − 33 per cent stated that although past and present remuneration policies had led to excessive executive remuneration, balance was returning. − 43 per cent said Board and management restraint in setting remuneration was already having positive effects. This can be contrasted with a similar survey conducted by Towers Watson in the US which found only 26 per cent of US directors believed the US's non-binding say on pay rule had been a key driver of Board remuneration decisions. This may support the view that the harder-hitting two strikes rule has been more effective in Australia. Alternative 3: "No" vote used and abused The final alternative is the proposition that a strike is used (and arguably abused) by shareholders to place pressure on the Board for reasons other than remuneration. The 25 per cent threshold for a "no" vote provides shareholders with an opportunity to demonstrate general dissatisfaction with the performance of the company and its management without requiring over 50 per cent of the votes required to remove a Board member. Further, the two strike rule affects all Board members rather than just a single director. In this way it is an effective tool for shareholders to influence the behaviour of directors. Executive director of the proxy advisory firm ISS Dr Ulysses Chioatto supports this view, stating that "the two strike rule may in fact be used as a vote of no confidence, rather than an attempt to spill the Board and does not always relate to remuneration".80 To determine the second issue requires an assessment of the balance between shareholder rights and the management of the company. This is a highly divisive issue. 79 Company Directors, Remuneration Policies and two strikes Rule, The KMP Report - Company Director Magazine (6 April 2014) p 8 80 Tim Binsted, 'Advisers warn of surge in activism', Australian Financial Review, 2 June 2014 www.bakermckenzie.com AGMs - some areas of reform | 25 The case has been made for concern regarding the disproportionate amount of time now being allocated to discussions around executive remuneration, instead of other pressing issues that in fact may be more important to the shareholders in the longer term.81 A spokesperson for The Australian Institute of Company Directors has shed light on the rule since coming into operation, saying that in light of inappropriate use by shareholders, they are undecided as to whether it has been a positive step forward in the management of a company.82 The critics of shareholder activism have stated that under this new model, Australia will follow US trends and experience a sharp rise in shareholder activism over the coming years. This will come from investment funds established with a mandate to engage in activism and Boards and management will be absorbed in costly battles against protagonists with short-term motives.83 Dr Ulysses Chioatto, executive director of proxy advisor ISS, states that Australia could see a wave of shareholder activism which will have "mixed outcomes for shareholders, who will benefit if a company is forced to lift its game, but lose out if short-term activists wade in and undermine long-term strategic planning.”84 The cost burden Regardless of the preferred view of its effectiveness, the two strikes regime has increases the cost and administrative burden of convening an AGM. The cost can be significant, particularly where a company is required to hold several meetings and appoint a new Board. Again, this can be seen either as an inefficiency of the two strike rule or incentive for the company to avoid a second strike. There is, however, a pressing need for a cost benefit analysis of the two strike rule to enable parties to determine whether, in its current form, it is achieving its policy objectives and providing benefits to shareholders. A global perspective To understand the opportunity for reform, we have considered below the regulation of executive remuneration in leading economies around the world.85 In the United States the Emergency Economic Stabilization Act, 2008 implemented a requirement that financial firms receiving public GFC bailout funds must provide shareholders with a non-binding advisory vote on executive pay. Since then The Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010 extended the non-binding advisory shareholder vote on pay to all US public companies. Corporations must report against the results of the say-on-pay vote the following year including how, and to what extent, the Board considered the results of shareholder votes. The vast majority of votes are supportive of executive remuneration. For example, in 2012 only 2.6% of companies which held votes on say-on-pay measures failed to pass them. 81 Leonie Lamount, 'ASX 100 companies escape executive pay concerns, for now', The Sydney Morning Herald (online) June 22, 2011 82 Glenda Korporaal and Andrew White, 'Activists use two-strike rule as 'proxy' for issues other than exec pay', The Australian, 20 October 2014 83 Company Directors, Riding the new wave of activism, Company Director Magazine, (1 July 2014) 84 Ibid 85 Julie Walker, 'Australia Has Had Three Years With The Two-Strikes Law And Executive Pay Pain Won't Go Away', Business Insider, (online) 17 October 2013 www.bakermckenzie.com AGMs - some areas of reform | 26 In the US, the vote is non-binding and serves as an indication of shareholder perception only. However, shareholders retain a general right to litigate against the company based on the disclosures made by the directors. The first round of litigation has already commenced in the US with shareholder lawsuits alleging breach of fiduciary duty by directors of negative say-on-pay firms. Following this, shareholders lodged actions against the companies alleging the inadequate disclosure of remuneration. In the UK companies are required to have an annual advisory vote on director remuneration.86 However, the shareholder vote is advisory only and is not binding on the Board. In 2013 new legislation was provided to allow shareholders of UK public companies to vote the company's remuneration policy every three years.87 This provides the company with a right to reject the remuneration policy; however it does not permit the shareholders to determine the remuneration. The position across Europe is similar to the United Kingdom. The European Commission recommended a shareholder vote on executive pay in 2004. There is now say-on-pay voting in the Netherlands (since 2004), Sweden (since 2006), Norway and Denmark (since 2007), and Belgium (since 2012). There is a proposal to introduce a directive to EU member states on executive remuneration which would largely mirror the UK framework to promote director and shareholder engagement across all member states.88 Reform The statistics above and general market sentiment suggest that opinion is divided as to whether or not the current framework represents the right structure for executive remuneration. One key issue to consider is the fact that Australia leads the way in enforceable shareholder votes over executive remuneration. Therefore there is limited argument to suggest that further reform is required to bring Australia into line with global practices. There also appears to be strong support for the responses to a first strike with the deterrent being a potential second strike and Board spill. There seems little support for the abolition of the principle generally. Accordingly, we see little appetite to reform this rule in Australia. Philip Christensen Philip Christensen is a Partner at Baker & McKenzie with more than 25 years' experience in the corporate law and mining sector, and recently served for several years as a non-executive director on the Board of Whitehaven Coal and Aston Resources Limited, each an ASX-listed company. Peter de Jonge Peter de Jonge is a Senior Associate at Baker & McKenzie specialising in corporate, commercial and competition law. August 2015 86 Companies Act 2006 (Cth) s 439 87 Enterprise and Regulatory Reform Act 2013 s 79 88 Linklaters, Employee Incentive News - Remuneration - Say on Pay proposals from Europe, 15 April 2014 www.bakermckenzie.com Baker & McKenzie has been global since inception. Being global is part of our DNA. Our difference is the way we think, work and behave – we combine an instinctively global perspective with a genuinely multicultural approach, enabled by collaborative relationships and yielding practical, innovative advice. Serving our clients with more than 5,300 lawyers in more than 47 countries, we have a deep understanding of the culture of business the world over and are able to bring the talent and experience needed to navigate complexity across practices and borders with ease. Baker & McKenzie, an Australian Partnership, is a member firm of Baker & McKenzie International, a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organisations, reference to a "partner" means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an "office" means an office of any such law firm. © 2015 Baker & McKenzie All rights reserved. 2581849-v1\SYDDMS