On 23 February 2011, the Government tabled the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (Bill).
The Bill is the means by which the Government is implementing most of the recommendations of the Productivity Commission relating to executive remuneration and builds on recent amendments to the Corporations Act relating to termination payments.
The Bill contemplates that the new legislation, if enacted, will take effect from 1 July 2011; however, it is not presently clear whether the legislative timetable of the Government will accommodate this ambition. The Bill was debated in the House of Representatives in the last week of the Autumn session; however, the earliest it may be passed is when Parliament resumes for the Winter session on 10 May 2011. The Opposition appears set to support the Bill, notwithstanding their concerns about “over-regulation”, but has indicated they will be seeking to make amendments.
The following is an outline of the key reform proposals contained in the Bill.
The 2 strikes rule
The Corporations Act 2001 (Act) currently requires every listed company to prepare a remuneration report, which must be submitted to a non-binding vote of shareholders at the AGM of the company. The Bill proposes to strengthen this requirement by introducing a two strikes and re-election process.
The first strike will occur where a company’s remuneration report receives a no vote of 25 per cent or more. Where this occurs, the company’s subsequent remuneration report must explain the board’s proposed action in response or, if the board does not propose any action, the board’s reason for inaction.
The second strike will occur where the company’s subsequent remuneration report receives a no vote of 25 per cent or more. Where this occurs, shareholders will vote at the same AGM to determine whether the directors will need to stand for re-election. This will be known as the spill resolution. Notice of the spill resolution must be contained in the notice of meeting for the AGM to ensure notice has been given in the event that the second strike is triggered. The notice must explain the circumstances in which the resolution will apply and invite members to appoint a proxy to vote on the spill resolution
If the spill resolution passes with 50 per cent or more of the eligible votes, then a spill meeting must take place within 90 days. The company will still need to provide the minimum notice period for holding the spill meeting and comply with any minimum notice period in its constitution for the nomination of candidates (to ensure shareholder nominated candidates can seek endorsement at the spill meeting). At the spill meeting, the directors required to stand for re-election are those directors (other than the managing director) who were directors when the directors’ report was passed at the most recent AGM. These directors cease to hold office immediately before the spill meeting. If none of these directors remain directors of the company by the time of the spill meeting, then the company is not required to hold the spill meeting. This is the case whether or not all of those directors have been replaced.
If the company fails to hold the spill meeting within 90 days after the spill resolution is passed, each person who is a director of the company at the end of those 90 days will commit an offence. However, this does not apply to a director appointed after the last day on which a notice of meeting may be given.
As the 2 strikes rule is intended to take effect from 1 July 2011 and therefore will apply to resolutions put to shareholders after 1 July 2011, the earliest that a spill resolution can occur is around 2 years from that date; ie, July 2013.
The draft legislation also contains a mechanism designed to ensure that a minimum of three directors remain after the spill meeting.
If a director is re-elected at the spill meeting, their appointment continues uninterrupted, by contrast with new directors elected at the spill meeting, whose appointment will commence at the end of the meeting. In this regard, it is not clear why a director who has been re-elected should have this disregarded when determining the directors to retire by rotation – there is no reason why a new director appointed by shareholders at the spill meeting should have a 3 year term from the date of the meeting, while a director who stood for and was re-elected at the spill meeting does not. Another curiosity is that the spill meeting will proceed even if a majority of the directors has changed between the 1st AGM and the 2nd AGM. Evidently the view is taken that the reason for the spill is to punish the current directors for not satisfactorily addressing the concerns underlying the first no vote of 25 per cent or more, rather than to remove directors who have twice received no votes of 25 per cent or more.
Many corporate lawyers question why we need this process, as the Corporations Act already contains a mechanism for shareholders to requisition a meeting to spill incumbent directors. Accordingly, it is arguable that the proposed two strikes and re-election process is not actually necessary – the Corporations Act is complex enough without unnecessarily adding another four pages or so of legislation. However, what is proposed is better than another alternative considered – and fortunately not pursued – by the Government, to convert the non-binding vote into a binding vote, as that would have undermined the responsibility and accountability of directors to manage companies, and been associated with many practical difficulties, as companies would not have been able to finalise an executive employment contract until shareholder approval was obtained.
Another major reform proposal contained in the Bill relates to remuneration consultants. The proposal contemplates that, where a remuneration consultant makes a remuneration recommendation in relation to the key management personnel (KMP) of a disclosing entity, it will be necessary to disclose various details in the remuneration report of the disclosing entity. These details include:
- the name of the consultant and a statement that the consultant made a remuneration recommendation in relation to KMP
- the amount and nature of consideration payable for the remuneration recommendation. The explanatory memorandum states that this obligation must be satisfied by disclosing the aggregate consideration paid to the remuneration consultant for remuneration recommendations
- if the consultant provided any other advice, a statement that the consultant provided that advice
- the amount and nature of consideration payable for the other advice. Once again, the explanatory memorandum states that this obligation may be satisfied by disclosing the aggregate consideration paid to the remuneration consultant for all other advice
- information about arrangements implemented to ensure the remuneration recommendation would be free from undue influence by KMP to whom the recommendation relates, and
- a statement about whether the board is satisfied the remuneration recommendation was in fact made without undue influence by KMP to whom the recommendation relates and, if so, the reasons for being satisfied.
Importantly, the Government has backed away from the requirement contained in the exposure draft of the Bill that the remuneration report contain a summary of the nature of the advice and the principles on which it was prepared. Understandably, concerns were expressed by remuneration consultants that disclosure of their advice would commoditise that advice and lead to remuneration consultants withdrawing from the Australian market. Remuneration consultants also argued, of course, that there would have been a consequential drop in the quality of services being delivered. In any event, lobbying by remuneration consultants has been successful, and it is no longer proposed that details of their advice be disclosed. The Government has also backed away from the requirement contained in the exposure draft of the Bill that the individuals who engaged the consultants and to whom advice was given be named in the remuneration report. Instead, the Bill now contains requirements relating to the absence of undue influence by KMP.
A remuneration consultant will be defined as a person, other than an officer or employee, who provides a remuneration recommendation about KMP under a contract for service with the company. There will also be an expanded definition of what constitutes a remuneration recommendation – essentially, a recommendation about the amount or elements of remuneration for KMP. Legal (including tax), accounting and actuarial advice is excluded, as is the provision of facts and information of a general nature relevant to all employees.
The Bill contemplates that, before a disclosing entity enters into a contract with a remuneration consultant, the proposed consultant must be approved by the board or the remuneration committee (being a committee of the board that has functions relating to the remuneration of KMP). Further, a remuneration consultant, once engaged, must give their remuneration recommendation directly to non-executive directors or the remuneration committee, rather than company executives, except where all directors are executive directors. In this regard, the explanatory memorandum states that “an executive director is widely understood to be a full time employee of the company who takes part in the daily management of the company, and is delegated control of the company’s activities from the board of directors”. Finally, a remuneration consultant who makes a remuneration recommendation relation to KMP of a disclosing entity must include with the recommendation a declaration about whether the recommendation is made free from undue influence by KMP to whom the recommendation relates. A contravention of any of these requirements will be a strict liability offence; however, it will not affect the validity of any contract with a consultant.
Consequently, once a remuneration consultant has been engaged, the consultant will need to take considerable care with their on-going communications with management. It appears that they will be permitted to have an ongoing dialogue with management in order to obtain any information they need in order to make a recommendation, including advice from other advisers; however, under no circumstances will they be permitted to give their recommendation directly to management. Interestingly, the Bill makes it clear that the prohibition applying to the remuneration consultant does not apply to anyone else, so that presumably the non-executive directors or the remuneration committee may chose to disclose the recommendation of a remuneration consultant to management.
The Bill also contains a number of other reform proposals:
- Prohibiting hedging of incentive remuneration: Under the Bill, there will be a prohibition against KMP and their closely related parties entering into an arrangement (with anyone) that has the effect of limiting the KMPs’ exposure to risk relating to an element of their remuneration that has not vested or, if it has vested, remains subject to a holding lock. The current disclosure requirement relating to hedging will be repealed.
- Participating in non-binding vote on remuneration report: KMP and their closely related parties will be prohibited from casting a vote on the non-binding resolution on the remuneration report or on a spill resolution. There will be an exception where the person is exercising a directed proxy. A vote cast in contravention of the prohibition will not affect the validity of the resolution. However, the vote will be regarded as not having been cast and will not be counted in determining whether the resolution passed. ASIC will have the ability to provide relief from the prohibition, where doing so would not cause unfair prejudice to the interests of any shareholder.
- Voting undirected proxies on remuneration related resolutions: KMP and their closely related parties will be prohibited from voting undirected proxies on all remuneration related resolutions, including any spill resolution. However, an exception to this prohibition will apply where the KMP (or closely related party) is chairing the meeting and the appointment expressly authorises the chair to exercise the proxy even if the resolution is related to remuneration. A vote cast in contravention of this prohibition will not affect the validity of the resolution. It will, however, be taken to have not been cast and will not be counted in determining whether the resolution passed. ASIC will have an ability to provide relief from the prohibition, where that would not cause unfair prejudice to the interests of any shareholder.
- Relaxation of remuneration disclosure requirements: Currently, remuneration details of both the KMP and the 5 most highly remunerated officers (if different) must be disclosed in the remuneration report for both the parent entity and the consolidated entity. Under the Bill, remuneration disclosures will be confined to the KMP of the consolidated entity.
- ‘Cherry picking’ proxies: Currently, proxy holders, other than the Chairman, are not required to cast all of their directed proxies on all resolutions, but may choose which proxies to cast. The Bill expands this requirement so that where a person (other than the Chairman) is appointed as a proxy, but does not attend or vote, the Chairman will be substituted as proxyholder and accordingly, must vote as directed. In addition, where a proxy holder (other than the Chairman) elects to vote but does not vote as directed, the proxy holder will not commit an offence where they have not agreed to their appointment as proxy or held themselves out as being willing to act as proxy.
- No vacancy rule: Public companies will need to seek shareholder approval before declaring that there are no vacant board positions, where the number filled is less than the maximum specified in the constitution. Any declaration will last only until the next AGM.
Clawback of executive remuneration
On 20 December 2010 the Government also released a discussion paper ‘The clawback of Executive remuneration where financial statements are materially misstated’, which contains a further proposal that executive remuneration be clawed-back where financial statements are materially misstated. This proposal was not identified in the Productivity Commission, although it was subsequently foreshadowed by the Government in its April 2010 response to the Productivity Commission’s report ‘Executive Remuneration in Australia’.
The discussion paper suggests that, based on information provided by ASIC, material misstatements in financial statements are not an uncommon occurrence among listed companies in Australia.
The proposal is that directors and executives will be obliged to repay to the company any remuneration that is based on financial information that turns out to be materially misstated. The proposal is intended to simplify the process for shareholders to pursue the overpayment of remuneration and to hold directors and executives more directly accountable for repaying remuneration to which they are not entitled. ASIC would also have the power to pursue recovery.
The ability to clawback overpaid bonuses has been implemented in a number of overseas jurisdictions, including the United States. The Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly known as the Dodd-Frank Act) which came into force on 21 July 2010, incorporates a provision to facilitate the claw back of overpaid remuneration to any executive officer when financial information is materially misstated, irrespective of whether or not there has been any misconduct.
The discussion paper is the first step in the public consultation process to canvass the introduction of a clawback provision. Comments on the discussion paper and in particular, whether a clawback requirement should be introduced in Australia, and if so, how it should be implemented, are due by 30 March 2011.