The assistance of Rahil Patel, solicitor, of Addisons in the preparation of this article is noted and greatly appreciated
Following the global financial downturn and community concern about excessive executive remuneration, in March 2009 the Australian Government (Labor) (Government) asked the Productivity Commission (Commission) to undertake a review of the Australian executive remuneration legal framework in respect of listed companies.
On 4 January, 2010, following extensive public consultation, the Commission released its final report. In its response to the Commission's final report on 16 April 2010, the Government supported nearly all of the Commission's recommendations and, consequently, laid the foundation for the draft Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (Amendment Bill).
The Amendment Bill was introduced into the House of Representatives on 23 February 2011 and is expected to pass in the current session of Parliament and is proposed to commence on 1 July 2011. In this respect, it is important for companies who have annual general meetings scheduled in the later half of this year to understand the implications of the Amendment Bill.
Executive Summary of Amendment Bill
In summary, the new obligations imposed by the Amendment Bill are:
- (a) requiring directors of listed companies to stand for re-election if they do not adequately respond to shareholder concerns on the remuneration report over two consecutive years (Two Strikes Rule);
- (b) requiring companies to disclose details relating to the use of remuneration consultants (Remuneration Consultant Requirement);
- (c) prohibiting key management personnel of a company from voting on remuneration matters (Remuneration Voting Exclusion);
- (d) prohibiting key management personnel for a company that is a disclosing entity from hedging their incentive-based remuneration (Hedging Prohibition);
- (e) prohibiting proxy vote holders from "cherry picking" which proxies they exercise, by requiring them to cast all directed proxies (Proxy Requirement); and
- (f) requiring, in respect of a public company, shareholder approval for a board declaration that there are no vacant board positions if the number of board positions filled is less than a maximum number specified in the company's constitution (No Vacancy Rule).
Two Strikes Rule
Currently, section 250R(2) requires a listed company to put its remuneration report to a non binding shareholder vote at its annual general meeting (AGM). There are no consequences where a board proceeds with its remuneration proposal despite a negative shareholder vote. According to the Commission's final report, it is not ideal that, if shareholders are dissatisfied with the remuneration report, the only solution is the removal of directors, as this alternative is often too extreme in circumstances where the director is having a positive impact on the company.
Under the Amendment Bill, where a listed company's remuneration report receives a "no" vote of 25% or more (the first strike), the company's subsequent remuneration report must explain whether shareholders' concerns have been taken into account and, either:
- how they have been taken into account; or
- why they have not been taken into account.
Listed companies may find this requirement difficult to meet for two reasons. Firstly, a shareholder vote is a blunt instrument and it is difficult to conceive how companies will comprehend the precise "concerns" of shareholders through a simple "yes" or "no" vote. Companies may need to seek the reasoning behind the negative members' vote - possibly on an anonymous and/or voluntary basis. Secondly, it is not clear whether only the major, or all, concerns of shareholders need to be addressed.
Where the listed company's subsequent remuneration report receives a "no" vote of 25% or more (the second strike), a resolution (spill resolution) must be put to shareholders at the same AGM in respect of whether:
- another general meeting (spill meeting) be held within 90 days; and
- all the directors who were directors of the company when the directors' resolution to make the relevant director's report was considered (except the managing director of the company), should cease to hold office immediately before the end of the spill meeting.
The listed company therefore has an opportunity to re-elect or replace those directors at the spill meeting.
As a practical matter, any listed company who has received a first strike will need to include notice of the spill resolution in its AGM notice for the following year, in case a second strike is received at that AGM and the spill resolution is therefore required to be voted upon by shareholers.
The spill meeting must take place within 90 days of the date on which the spill resolution is passed unless none of the directors required to stand for re-election remain in office by the end of that period. Each director will be held to have committed an offence if a spill meeting does not take place within the 90-day period.
While the Amendment Bill has in principle bi-partisan support, the Shadow Federal Treasurer has recently suggested that the Coalition will seek an amendment to the Two Strikes Rule. The proposal put forward by the Coalition is to require 25% "of all available votes" to be voted against the remuneration report before the Two Strikes Rule is enlivened. It is clear, therefore, that, when compared to the Government's proposal as expressed in the Amendment Bill, the Coalition's proposal aim is to limit the application of the Two Strike Rule by requiring a higher shareholder rejection threshold.
Remuneration Consultant Requirement
The Commission's final report raised concerns that remuneration consultants are often placed in a conflict of interest, whereby the advice they provide in respect of the remuneration report may influence whether the consultant's services are retained, either in relation to remuneration advice or other services the consultant may offer.
Under the new law, the remuneration report must disclose a wide range of information relating to services provided by the remuneration consultant to the company, including:
- the name of the consultant;
- whether the consultant provided any other kind of advice to the company for the financial year;
- the amount and nature of consideration provided by the remuneration consultant under the engagement letter in respect of the remuneration advice;
- the amount and nature of consideration provided by the remuneration consultant for any other kind of advice provided; and
- whether the board is satisfied that the remuneration recommendation is made free from undue influence by the key management personnel to whom the recommendation relates and the board's reasons for being satisfied with this.
In addition, remuneration consultants are required to be engaged by non-executive directors, and must report to the directors of the company other than executive directors (unless all directors are executive directors) or the remuneration committee. Whilst the term "executive director" is not defined in the Corporations Act, it is commonly regarded to apply to full time employees who are board members and are involved in the daily management and control of the company. Criminal liability generally applies where a remuneration consultant provides advice to executive directors.
Remuneration Voting Exclusion
Concerns were raised by the Commission's final report about whether it is appropriate that directors and executives whose remuneration is disclosed in the remuneration report can vote as shareholders in relation to the non-binding remuneration report resolution at an AGM.
Under the new law, key management personnel and their closely related parties (or any person acting on their behalf), must not cast a vote in relation to the non-binding resolution on the remuneration report or in relation to the spill resolution. In addition, any key management personnel or their closely related party, who is appointed as a proxy by a shareholder, must not exercise the proxy on a resolution connected directly or indirectly with the remuneration of any key management personnel if the proxy is undirected (i.e. if the appointment does not specify the way the proxy is to vote on the resolution).  Any vote cast in contravention of these provisions is taken to have not been cast and will not be counted in determining whether the resolution has passed.
The term "key management personnel" is defined in the Australian accounting standards as persons having authority and responsibility for planning, directing and controlling the activities of a company, directly or indirectly, including any director (executive or otherwise) of that company (each a KMP).
A "closely related party" is defined as being, in relation to a member of the company's KMP:
- (a) a spouse or child of the member;
- (b) a child of the member's spouse;
- (c) a dependant of the member or of the member's spouse;
- (d) anyone else who is one of the member's family and may be expected to influence the member, or be influenced by the member, in the member's dealings with the entity;
- (e) a company the member controls; or
- (f) a person prescribed by the regulations for the purposes of this paragraph (none in this category are included with the Amendment Bill).
Currently, it is possible for directors of listed companies who have "at risk" remuneration (usually achieved by providing equity-based packages) to enter into third party contracts (such as trading in derivatives) to reduce their current exposure and protect or enhance the value of their personal financial interest in the company's success. The Commission's final report points to a perceived conflict of interest where directors of a listed company stand to profit from a fall in the company's share price.
Under the new law, a KMP or their closely related party must not enter into an arrangement that has the effect of limiting the KMP's exposure to risk in relation to an element of their remuneration that depends on the satisfaction of the performance condition.
Both listed company directors and third parties making hedging arrangements with directors need to be aware of this prohibition. Liability for a contravention of this requirement is strict. In contrast, where a closely related party contravenes this prohibition, it is only an offence where the person's actions were reckless or intentional.
While current requirements exist that oblige a company to set out their hedging policy, the Hedging Prohibition may significantly impact directors' pay, and may even de-value and reduce the number of equity-based remuneration salaries to be offered to directors. The proposed hedging prohibition applies to arrangements on or after 1 July, 2011, irrespective of whether the remuneration was for services rendered before or after this date.
Under the Amendment Bill, proxy holders will be required to cast all of their directed proxies on all resolutions. Currently proxy holders (other than the chair) may choose which proxies to cast.
The new provisions will apply to polls demanded on or after 1 July 2011, notwithstanding whether the proxy was appointed before, on or after that date.
No Vacancy Rule
The constitutions of many public companies permit the board to 'shrink the board' from the maximum number of directors prescribed under the constitution, by making a declaration that there are no vacant positions on the board, despite the constitutional limit not being reached (a no vacancy declaration). The practical effect of a no vacancy declaration is to impose a 'dead man's rule' on the election of new directors at general meetings. That is, for a director to be elected, the candidate must not only receive more than 50 per cent of the shareholder vote, but must receive more votes than the board-endorsed or incumbent director who is up for re-election.
Although somewhat tangential to the central focus of regulation of remuneration arrangements of public companies, the Commission recommended the introduction of the No Vacancy Rule on the basis of a concern that the practice of making no vacancy declarations impedes the election of non-board endorsed candidates, thins the "gene pool" and, therefore, impairs good decision-making at the board level. As a result, from 1 July 2011, the Amendment Bill will require public company directors to obtain shareholder approval of a no vacancy declaration before that declaration can be enforced against a nominee standing for election to the board
Accordingly, if directors wish to set a board limit below the maximum limit specified in a public company's constitution without passing a shareholder resolution to that effect, an amendment to the maximum limit prescribed in the company's constitution needs to be made prior to 1 July 2011.
Where shareholder approval is sought for a no vacancy declaration, the relevant notice to meeting must set out the directors' reasons for proposing the resolution to limit the number of board members and all other information reasonably required by shareholders to pass that resolution. There is also a requirement that ASIC must be notified within 14 days after the resolution is passed. If shareholder approval is given, it will be effective until the following AGM. This means that the approval will need to be renewed each year to remain effective.
To allow for a degree of flexibility in the management of the public company at any time, the approval of a no vacancy declaration does not prevent directors from appointing other directors during the period that the no vacancy resolution is effective. However any interim appointment must be confirmed at the public company's next AGM.
From 1 July 2011, where directors make a no vacancy declaration without shareholder approval:
- any appointments of directors made at the general meeting will be invalid; and
- person's aggrieved by that failure may institute Court proceedings against the company for loss or damage.
. All references are to the Corporations Act 2001 (Cth) as amended by the Amendment Bill, unless otherwise stated.
. Section 300A(1).
. Section 250V.
. Section 250W.
. House of Representatives, Hansard Documents of 24 March, 2011 (page 36). See: http://www.aph.gov.au/hansard/reps/dailys/dr240311.pdf.
. Section 300A.
. Section 250R.
. Section 250BD(1).
. Section 206J.
. Section 300A(1)(da).
. See Part 2G.2, Division 6.
. Section 201P(3).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.