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Remodelling executive remuneration

Feature Articles

Cite as: Cite as: March 2012 86 (03) LIJ, p.52

Strict rules now regulate the fixing of executive pay and bonuses, but the matter may not be entirely settled.

By Emma Goodwin

The past two years have seen significant activity in the regulation of executive remuneration in Australia. Reforms to the Corporations Act 2001 (Cth) (Corporations Act) rules on termination payments for directors and senior executives took effect in 20091 and both the Productivity Commission2 and the Companies and Securities Advisory Committee (CAMAC)3 have recently reported on the subject.

In June 2011, federal Parliament passed further legislative change through the Corporations Amendment (Incorporating Accountability on Director and Executive Remuneration) Act 2011 (Cth). The changes, which remain contentious,4 are intended to “give unprecedented power to shareholders, improve the accountability of company directors on remuneration issues, address conflicts of interest . . . in the remuneration setting process and promote a culture of responsible remuneration practices”,5 by addressing “the dangers of remuneration structures that focus on short-term results, reward excessive risk-taking and promote corporate greed”.6 This article provides an overview of the amendments, then clarifies applicable penalties and dates of effect.

THE AMENDMENTS

The “two strikes” rule

Under s250R(2) of the Corporations Act, at a listed company’s annual general meeting (AGM), a resolution that the remuneration report be adopted must be put to a non-binding shareholder vote (note that slight amendment has been made to the wording of s250R(2)). Concerns arose that boards were not responding to negative shareholder feedback on executive remuneration via this process.7 Accordingly, new s250U of the Corporations Act provides that:

  • ‌where at an AGM (the first AGM) at least 25 per cent of votes are against adoption of the remuneration report (“strike one”) (s250U(b)); and
  • ‌at a subsequent AGM (the second AGM), at least 25 per cent of votes are again against adoption of the remuneration report (“strike two”) (s250U(a)); and
  • ‌no s250V resolution (see further below) was put to vote at the first AGM (s250U(c)); then:
  • under s250V, there must be put to vote a resolution (a “spill resolution”) that:
  • a “spill meeting” be held within 90 days (s250V(1)(a));
  • all persons who were directors (with the exception of certain managing directors) at the time of the second AGM cease to hold office immediately before the spill meeting (s250V(1)(b)); and
  • resolutions to appoint new directors be put to the vote at the spill meeting (s250V(1)(c)).

The spill resolution will be passed if at least 50 per cent of eligible votes cast are in favour. Sub-sections 250R(4)-(10) (see further below) apply to such resolutions, but s203D (which contains rules usually relevant to removal of directors of public companies) does not (s250V(2) and (3)). If the spill resolution passes and the spill meeting does not take place within 90 days, the directors commit a strict liability offence attracting a penalty of 10 penalty units (ss250W(1), (5) and (6) and Schedule 3, item 70A), unless within the 90 days no directors remain in their positions (s250W(4) and (7)) or a particular director was not a director during the time between when the spill resolution was passed and the last time when notice of the spill meeting could be given (s250W(8)).

Notwithstanding anything in the Corporations Act or the company’s constitution to the contrary, directors appointed at a spill meeting assume office at the end of the meeting (s250W(9)). A director who loses office as a result of a spill, but is reappointed at the spill meeting, is considered to have continued in office with no break (s250Y). As s201A(2) requires the company to have at least three directors, special rules apply to deem some persons who had sought to be appointed to have been so appointed, if there would otherwise be fewer than three directors immediately after the spill meeting (s250X).

Finally, new s249L(2) (replacing former s249L(2)) amends requirements for a notice of an AGM of a listed company. The notice must now inform members that a resolution on the remuneration report will be put at the AGM and that, if at the immediate previous AGM at least 25 per cent of the votes cast on resolution of a remuneration report were against (but the same did not occur at the AGM before that), a s250V(1) spill resolution will be put to vote.

Prohibiting key management personnel (KMP)8 from voting in remuneration matters

Historically, KMP were not prohibited from participating in the non-binding vote on remuneration (ss195 and 224). As there is “a real, as well as perceived, conflict of interest when . . . [KMP] vote on their own remuneration packages”,9 this has been altered. Essentially:

  • ‌under new s250R(4)-(10), a vote on the non-binding remuneration report resolution or a spill meeting resolution must not be cast by, or on behalf of10 a member of KMP whose remuneration details are included in the remuneration report, or their closely related party,11 unless the vote cast is a proxy vote and is cast consistently with the wishes of the person who appointed the proxy;
  • ‌under new s250BD, if a member of KMP for a company or consolidated entity, or their closely related party, is appointed as a proxy, they must only act on that appointment to vote on a resolution directly or indirectly connected with the KMP’s remuneration where the appointment dictates the way in which the appointee must vote on that resolution (s250BD(1)). However, this does not apply to the chair of the meeting, where the appointment expressly authorises exercise of the proxy in relation to such resolutions (s250BD(2)).

Failure to comply constitutes an offence (ss250BD(1), 250R(7) and 1311(1)), with a potential penalty of 200 penalty units, five years’ imprisonment or a combination of both (Schedule 3, items 66A and 68AB). Further, the vote cast is invalid (ss250BD(4) and 250R(8)). However, ASIC may declare the rule inapplicable where this would not unfairly prejudice any member of the company (ss250BD(3) and 250R(6)).

Individuals to be named in the remuneration report

Previously, s300A(1)(c) required that the remuneration report contain details of remuneration for KMP and the five most highly remunerated officers (where they were not also KMP). This has been amended so that only the remuneration details of KMP of the consolidated entity are required to be disclosed in the remuneration report (new s300A(c)). This is designed to “enable shareholders to better understand the company’s remuneration arrangements” and reduce the regulatory burden on companies, while maintaining accountability.12

Prohibition on remuneration hedging

Historically, KMP were permitted to hedge their executive remuneration, although companies were required to disclose their hedging policy in the annual report (former s300A(1)(da), now repealed). To ensure that executive remuneration is linked to performance and reduce the potential for conflict of interest, this has altered.13 Under new s206J, neither a member of KMP (member) of a disclosing entity, nor their closely related party, may enter into an arrangement that would limit the exposure of the member to risk in relation to remuneration that has:

  • ‌not vested in the member; or
  • ‌has vested in the member, but remains subject to a holding lock (s206J(1)).

The Corporations Regulations provide examples of what may or may not constitute relevant remuneration (reg 2D.7.01). A breach constitutes a strict liability offence (s206J(5)). A member commits an offence if a closely related party of the member intentionally breaches the section and the member is reckless as to the contravention (ss206J(6) and (7)). ASIC may declare that a specified arrangement is not caught by s206J, if this would be unreasonable (s206J(8)). The penalty for breach of s206J is 60 penalty units (Schedule 3, item 49A).

Remuneration consultants

To reduce the potential for conflicts of interest, provide greater transparency for shareholders, ensure remuneration consultants are not subject to undue influence, promote board accountability and ensure that “the primary responsibility for remuneration arrangements rests with company directors”,14 new restrictions apply in relation to use of remuneration consultants (RCs).

For the purposes of these provisions:

  • ‌a “remuneration consultancy contract” (RCC) is one between a company and an RC who will provide services, including making a remuneration recommendation (RR) in relation to one or more members of the KMP for a company that is a disclosing entity (s206K); and
  • ‌an RR is about what the amount of remuneration should be, or how remuneration should be comprised, for one or more of the company’s KMP, or any other recommendation or advice prescribed by the Regulations (s9B). Some recommendations, such as legal, accounting or actuarial advice, are expressly excluded, as is provision of general information relevant to all company employees, or a recommendation, advice or information of a kind prescribed by the Regulations (ss9B(2)). Officers or employees of the company are not RCs (s9). ASIC may also declare that a specified recommendation or advice is not caught by s9B, if this would be unreasonable (s9B(4)).

Before entering into an RCC, the proposed RC must be approved by the directors, or the remuneration committee (a committee of the board of directors which has functions relating to the remuneration of company KMP) (s206K(1) and (2)). Failure by the company to secure appropriate approval before engaging the RC is a strict liability offence (s206K(5)) attracting a penalty of 60 penalty units (s206K(4) and Schedule 3, item 49B)), but does not affect the validity of the contract (s206K(3)).

When making an RR, the RC must include a declaration as to whether the RR is free from undue influence by the member or members of KMP to whom the RR relates (s206M(2)). Failure to do so is a strict liability offence (ss206M(2) and (3)) attracting a penalty of 60 penalty units (Schedule 3, item 49D). Further, RRs made by an RC in relation to one or more KMP of a disclosing entity must be provided directly to the directors and/or remuneration committee (s206L(2)). Failure to do this is not an offence in itself (s206L(5)) but it is an offence for the RC to provide the RR to an executive director, unless all directors of the company are executive directors, or to anyone else (ss206L(3), (4) and (5). Again, a penalty of 60 penalty units applies (Schedule 3, item 49C). It is, however, possible for someone other than the RC to provide the RR to a person other than a director or remuneration committee member (s206L(6)). This allows provision of the RR to a human resources officer, for example.15

Finally, a company or consolidated entity will need to disclose in its remuneration report key details regarding the RC, including for example the RC’s name, the amount the RC was paid for providing RRs and other services to the company and whether the board is satisfied the RR was free of undue influence (s300A(1)(h)).

No vacancy

Previously, a board could, without shareholder approval, declare that it had no vacant positions even though the maximum number of directors allowed by the relevant constitution had not been reached (see Part 2D.3, now amended). This made it difficult for non-board-endorsed candidates to be elected.16 New subdivision B of Division 1 of Part 2D.3 alters this, mandating that where a board is permitted under a company’s constitution to set a number of directors lower than the maximum the constitution permits (a “board limit”) (s201N), the board must not set a board limit unless a resolution approving the proposal has been passed at a general meeting, before which a notice of the proposed resolution and an explanation of it was provided (s201P(1)). If made, notice of the board limit resolution must be lodged within 14 days (s201S) and the resolution will be effective until the next AGM (s201P(2)). The resolution does not prevent other directors appointing a director between general meetings, but such an appointment must be confirmed by resolution at the next AGM or it will lapse (ss201P(3) and (4)). Certain records must be kept (s201R) and failure to do so attracts a penalty of 5 penalty units (s201R(2) and (3) and Schedule 3, item 39A). Failure to comply with these rules means the board limit is ineffective, may invalidate some director appointments and may give rise to a claim for compensation by the company or a prospective director (s201U).

“Cherry picking”

Previously, where persons (other than the chair) were appointed as proxies pursuant to an appointment which directed the appointee on how to vote (a directed appointment), the appointee could choose whether to exercise the proxy vote(s) (see former s250A, now amended). This was known as “cherry picking” and was believed to lead to “outcomes that do not clearly reflect shareholder views on a resolution”.17 Accordingly, former sub-ss250A(4), (5) and (5A) have been repealed. New s250BB(1) requires that, where an appointee is appointed pursuant to a directed appointment, the appointee must vote as directed. Failure to do so may constitute an offence (ss250BB(2), (3), and (4)), attracting a penalty of five penalty units (Schedule 3, item 66). If the proxy does not attend, or does not vote, and the proxy has been given a directed appointment, the chair is taken to be appointed as the proxy for the purposes of voting on the relevant resolution (s250BC).

APPLICATION OF THE AMENDMENTS

The amendments received royal assent on 27 June 2011. Most amendments took effect on 1 July 2011, with the exception of the changes introduced by ss250BB, 250BC, 250BD and 250R(4)-(10), all effective 1 August 2011 (see new Part 10.17, ss1517-1525).

CONCLUSION

Clearly, the amendments outlined above introduce significant change in an area of law that has already been subject to substantial reform in recent years. In light of this, CAMAC has recently suggested that no other changes be made at this time, among other things to permit an assessment of the effect of this latest wave of amendments before any further reform.18 However, even so, this latest round of amendments may not be the last. In December 2010, the federal government released a discussion paper on the potential for a company to claw back executive remuneration based on financial information that has been materially misstated.19 While no steps have been taken to enact such legislation, the proposal suggests that regulation in this area may not yet be entirely settled and companies and officers must remain vigilant as to matters arising in relation to executive remuneration.




EMMA GOODWIN is a senior associate with Mallesons Stephen Jaques, Melbourne. The views expressed in this article are those of the author and not necessarily of Mallesons Stephen Jaques.

1. See further Emma Goodwin and Anna Casellas, “Golden handshake weakens its grip” (2011) 85(9) LIJ 42.

2. Productivity Commission, Executive Remuneration in Australia: http://tinyurl.com/7fdqkgj.

3. CAMAC, Executive Remuneration Report: http://tinyurl.com/748jo9d (CAMAC Report).

4. See, for example, Australian Institute of Company Directors, media release, “Flawed executive pay laws passed by Parliament”, 20 June 2011: http://tinyurl.com/6nc7xkg and Damon Kitney and Glenda Korporaal, “Report’s warning on executive pay rules”, The Australian, 26 May 2011: http://tinyurl.com/7fohddr.

5. Parliamentary Debates, Second Reading Speech for the Corporations Amendment (Incorporating Accountability on Director and Executive Remuneration) Act Bill (Cth) (Hon David Bradbury MP, 23 February 2011) (SRS), p1099.

6. SRS, note 5 above, p1096.

7. SRS, note 5 above, pp1096-1097 and Revised Explanatory Memorandum to the Corporations Amendment (Incorporating Accountability on Director and Executive Remuneration) Act Bill (Cth) (EM), p5.

8. “Key management personnel” has the same meaning as in the Australian Accounting Standards and includes those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity: see s9.

9. SRS, note 5 above, p1098.

10. For clarity on the meaning of “on behalf of”, see s250R(9).

11. A “closely related party” includes a member’s spouse, child, dependant, spouse’s child or dependant, any other of the member’s family who may be expected to influence, or to be influenced by, the member in the member’s dealings with the entity, a company the member controls, or another person prescribed in regulations (s9).

12. SRS, note 5 above, p1098 and EM, note 7 above, p33.

13. SRS, note 5 above, p1098 and EM, note 7 above, p21.

14. SRS p1097 and EM p11.

15. EM p14.

16. SRS, note 5 above, p1098 and EM, note 7 above, p25.

17. SRS, note 5 above, p1098.

18. CAMAC Report, note 3 above, p8.

19. Australian Government, “The clawback of executive remuneration where financial statements are materially misstated: Discussion paper”, December 2010: http://tinyurl.com/8xjpkyb.

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