Authors: Stephen Walmsley and Sarrè Cousens

Corporate governance revolution or storm in a (Parliamentary) tea cup?

The Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 became law on 27 June 2011. In general, its provisions (and the amending Regulations) came into effect on 1 July 2011.

While the Government has placed great store in this legislation as establishing a new high water mark in the regulation of executive remuneration, it has, in our opinion really done little more than introduce a further layer of administration and procedure for companies already groaning under the weight of recent legislative activity in the area of corporate governance.

The key things you need to know and think about coming out of these changes are set out below:

'No vacancy'

  • The Act does not change the ability of the Board, subject of course to the constitution of the company, to appoint additional directors to fill casual vacancies between AGMs.
  • The Act does not change the requirement that a nominee for election as a director must satisfy the requirements (whether timing, being a shareholder or having a minimum level of shareholder support) of the company's constitution relating to nomination for election.
  • The company's constitution does not need to be amended, merely because it provides that the Board may determine a maximum number of directors to hold office being less than the constitutional maximum. However, the Board can no longer exercise that power without shareholder approval. Accordingly, currently resolved maximums must be rescinded.
  • The change effected by the Act is that where the number of directors holding office is less than the constitutional maximum, any nominee for election can be elected to fill a vacancy, where previously the nominee would normally need to contest against the incumbent directors retiring at that meeting.
  • So, unless the constitutional maximum number of directors has been reached, an outside nominee will become a director if he or she receives 50%+1 of votes cast, rather than having to get more votes than a retiring director.
  • There is no legislative prohibition on the company amending its constitution to reduce the maximum number of directors nor against imposing minimum requirements for a valid nomination. However, for some inexplicable reason, proxy advisers (who obviously represent large institutional investors) oppose such amendments on the basis that they undermine the fundamental rights of shareholders (notwithstanding those they represent are more than capable of exerting their influence over Board composition).

Remuneration consultants

  • Remuneration Committees are not required to engage an external remuneration consultant in relation to KMP related (or any other) remuneration matters.
  • The new laws only apply where the Board or Remuneration Committee choose to seek external recommendations on such matters.
  • The laws require the consultant to be approved by the Committee before the consultant can provide the recommendation. You should consider how this impacts upon the workings of your HR/remuneration function.
  • The recommendation to be given must be provided directly to the Remuneration Committee by the consultant and cannot be provided to management.
  • Various opinions are currently being given as to what is and what is not a remuneration recommendation. We strongly encourage companies to carefully consider the definition (and the exclusions from that definition) in the Act as it applies in the context of their own specific remuneration framework.

Other changes – impact on 2011 reporting season

  • Changes will need to be implemented to existing voting procedures ahead of the 2011 AGM season to support the change prohibiting KMP and their closely related parties from voting on remuneration-related resolutions (including the non-binding resolution on the Remuneration Report).
  • This extends to undirected proxies – consideration should be given to voting exclusions for Notices of Meeting (and to shareholder engagement where undirected proxies typically represent a large number of potential votes on remuneration-related issues).
  • Changes will also need to be made to 2011 Notices of Meetings to reflect the change that proxy holders are now required to cast all of their directed proxies on all resolutions on a poll (i.e. no ability to 'abstain' from voting at the meeting).
  • While Remuneration Report disclosures will be simplified to key management personnel only (i.e. no longer necessary to disclose remuneration of 'Top 5' most highly remunerated executives), this applies to reporting periods commencing on or after 1 July 2011 – and therefore will not apply until the 2012 reporting season.

2011 AGM season – Annual Report thought starters

With the 2011 reporting season about to 'kick off', now is the time to consider this year's approach for the annual report.

Corporate Governance Statement

Although companies are not required to report against the diversity recommendations until their 2012 Annual Report, the ASX Corporate Governance Council is encouraging early adoption of a diversity policy and reporting against the new recommendations.

Even for those that do not 'early adopt' in full, given the current focus on this area, we are expecting that the majority of companies will provide at least some form of disclosure as to where they 'are at' in relation to diversity in their 2011 Annual Reports – and more detailed disclosure than we saw in 2010.

Of course, the need to report in 2012 also means that companies will, technically, need to have their publicly-available diversity policy in place on or shortly after commencement of the 2011/12 financial year to enable them to report against the Recommendations, including the company's progress toward achieving their measurable objectives for achieving gender diversity for the period (given that LR 10.4.3 requires that if a Recommendation is followed for only part of a reporting period, that must be stated).

In relation to progress on the company's diversity policy and reporting for the 2011 financial year, companies should consider:

Diversity framework

  • Noting that you will need to have a 'policy' or summary disclosed for the 2011/12 reporting period, have you finalised (or are you close to finalising) your company's diversity framework? Even if the detailed measurable objectives are still being finalised, can the publicly available policy or a summary be posted on your website?
  • Are the details of the measurable objectives the company is looking to achieve and appropriate timeframes for assessing the company's performance against the stated objectives better placed in internal working guidelines, rather than the publicly available policy?
  • What internal processes will be implemented to enable the company to monitor and evaluate (and the Board to sign off 2012 disclosures around) progress against the stated objectives?

Reporting in the 2011 Annual Report

  • Assuming the company will not 'early adopt', can you disclose your commitment in relation to the focus, objectives and strategies that will be put in place in advance of formally reporting against the diversity recommendations?
  • If you do not yet have a 'complete framework' in place yet, what progress has been made so far (e.g. diversity council established, policy adopted, measurable objectives being developed)?
  • How can this be communicated to show you are 'on track'?
  • Are there processes currently in place (e.g. Board selection) that do support objectives of diversity that can be highlighted?

Remuneration Report

In recent years, coming off the back of the GFC, remuneration disclosures have been somewhat 'defensive'.

With the 2011 economic climate looking a little more positive and some companies' performance making a turnaround, the messages set out in the Remuneration Report may need to be refocused.

However, against this, we are also seeing awards vest this year that were based on hurdles set during the GFC using lower profit bases and shareholder returns, which will require careful explanation (especially where the hurdles appear too easy to achieve).

In particular, with the new 'two strikes' rule coming into effect, it is becoming even more important that Remuneration Reports clearly set out the link between company performance and executive remuneration.

Companies will also need to start to think about the new disclosure requirements in respect of remuneration consultants - which generally apply in relation to financial years commencing on or after 1 July 2011 - so that they are in a position to report against them next financial year.

Here are some 'thought starters' for the Remuneration Report:

Tone and structure

  • Did the 2010 report contain 'defensive' disclosures and explanations around executive pay and why it was appropriate in the economic climate (such as payfreezes for directors / senior executives)?
  • Can the disclosures be re-prioritised to highlight positive messages around company performance?
  • Are there any new plans or changes that are worth highlighting for shareholders? Are there new incentive or retention arrangements that need more detailed explanation?
  • Is the order of the report still relevant for 2011? Were some disclosures (for example company performance) 'hidden' in the back of the report?
  • Were some disclosures put into text rather that graphs (for example, was a decrease in company performance explained in words rather than in an illustrative table)?

Vesting of awards based on GFC performance conditions

  • Did awards vest in 2011 based on hurdles that were set during the GFC? Do the hurdles now appear low or too easy based on the current economic climate, and does this need to be explained in more detail?
  • Is it appropriate to have a graph linking performance to increased pay and increased shareholder value?
  • Have the 2011 hurdles been rebased or recalibrated to take the post GFC climate into account? Should this be highlighted in the report?

Disclosure of the use of remuneration Consultants

While the new disclosure requirements in respect of remuneration consultants will not be required in the current FY11 remuneration report, companies should start to consider:

  • Which consultants are to be classified as remuneration consultants, and whether they provide remuneration recommendations (for the purposes of the new laws)?
  • What other kinds of advice do the consultants provide?
  • What processes and arrangements will the Board / Remuneration Committee put in place to satisfy itself that the remuneration consultant is free from undue influence by the KMP to whom the recommendation relates?

Watchlist

Below is a snapshot of legal and regulatory developments currently in the marketplace.

TOPIC INSTRUMENT SUMMARY PROPOSAL/ACTION STATUS
Executive remuneration Corporations Amendment Regulations 2011 (No. 2)

Regulations to support changes made by the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 prescribe:

  • " that internally generated remuneration advice or information is not a 'remuneration recommendation'
  • the types of arrangements that would, and would not, be considered to be a hedge (in the context of the prohibition on hedging incentive remuneration)


 The Regulations came into force on 1 July 2011.
Executive Remuneration ASIC Advisory [AD 11 – 130]

ASIC has indentified 4 areas where disclosure of executive remuneration arrangements in Remuneration Reports can be improved, namely:

  • board policy on the nature and amount of remuneration for KMP
  • non-financial performance conditions in STI plans
  • why performance conditions have been chosen
  • terms and conditions of incentive plans

ASIC reviewed Remuneration Reports of 60 listed companies for the FY 30 June 2011, and provides examples of where companies provided better disclosure.

 Released 30 June 2011.
Executive Remuneration Discussion Paper – 'The Clawback of Director and Executive Remuneration in the Event of a Material Misstatement' The Parliamentary Secretary to the Treasurer has released a Discussion Paper on a proposal to 'clawback' remuneration paid to company directors and executives where a company's financial statements are materially misstated. The Discussion Paper sought comments on whether a clawback requirement should be introduced in Australia, and if so, how it should be implemented.

Discussion Paper issued on 20 December 2010, and submissions closed on 30 March 2011.

Treasury to review all 28 submissions received (available on Treasury's website).
Executive Remuneration CAMAC – Executive Remuneration Report (April 2011)

The Corporations and Market Advisory Committee (CAMAC) has issued its Report on Executive Remuneration which addresses two broad issues – incentive arrangements and reporting requirements. The key messages from the Report are:

  • (incentive arrangements) the current 'best practice' approach is preferable to introducing prescriptive rules to govern remuneration arrangements, and the flexibility which companies have in designing executive remuneration arrangements should remain. CAMAC is of the view that there is a risk that over-regulation of remuneration will place pressure on companies to replace incentive or variable pay with fixed or guaranteed pay
  • (reporting requirements) in light of the impending 'two strikes' rule, the best approach to simplifying the current remuneration reporting requirements is through a number of specific legislative amendments, rather than a complete review and rewrite of the current requirements


 The Parliamentary Secretary to the Treasurer has indicated the Government will respond in due course.
Directors' Duties The James Hardie decision

The High Court has granted ASIC special leave to appeal the NSW Court of Appeal decision which overturned the fines and penalties against several of the James Hardie directors.

ASIC is seeking to:

  • uphold the trial Judge's finding that the directors of James Hardie approved an ASX announcement that was misleading, and thus breached their duties owed to the company
  • appeal the NSW Court of Appeal's finding that ASIC did not meet the principles of procedural fairness as a public interest regulator by not calling a key witness

Mr Shafron (Co Sec/General Counsel) had his fine reduced by the NSW Court of Appeal but his 7 year disqualification was still upheld. Mr Shafron, who has also been granted special leave to appeal, will challenge these penalties.

ASIC and Mr Shafron have been granted special leave to appeal in the High Court.

The appeal is to be listed for hearing.
Directors' Duties The Centro Decision – ASIC v Healey & Ors [2011] FCA 717

The Federal Court has found that directors of the Centro Properties Group failed to discharge their duties of care and diligence by approving the 2007 financial accounts which substantially understated the Group's short term liabilities. The decision turns on the directors' failure to pick up on the incorrect classification of the debts as non-current liabilities, even though the accounts had been recommended for approval by management and auditors.

Please contact us if you would like a copy of our note on the Centro decision.

Judgment delivered on 27 June 2011.

The Court is expected to hear submissions on penalties for the directors in August.
Prospectus disclosures for offers of securities in the European Union European Union Prospectus Directive 2010/73/EU The Directive extends existing disclosure exemptions for offers of securities made in EU Member States, including increasing certain thresholds under small scale exemptions. Member States must implement the Directive changes on or before 1 July 2012.

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