Services

HG Alert: Proposed Corporations Act changes: 'Two strikes' for executive remuneration and abolition of 'no vacancy' rule - 1 Mar 2011

Proposed amendments to the Corporations Act 2001 (Cth) could see numerous changes to the rules surrounding executive remuneration in Australia, directly affecting the boards and directors of publicly-listed companies.

The Federal Government has introduced the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 into the House of Representatives. If passed, the Bill will amend the Corporations Act 2001 (Cth) to give effect to recommendations made in the Productivity Commission's inquiry report into executive remuneration in Australia.

If the Bill is passed, the changes will come into effect on 1 July 2011.

The key changes proposed

  • The Bill introduces a 'two strikes' rule that will require a board spill if the resolution to approve a company's remuneration report receives 25 percent of votes against it in two successive annual general meetings.
  • The Bill abolishes the 'no vacancy' rule, so that a board will no longer be able to declare a maximum number of directors without first obtaining shareholder approval at a general meeting.
  • Any directed proxies that are not voted by the proxyholder at any general meeting will automatically default to the Chair of the meeting, who must vote all directed proxies.
  • The engagement of a remuneration consultant will require board or remuneration committee approval with the details of the engagement to be included in the company's annual report.
  • The Bill prohibits directors and executives from entering into hedging arrangements for their incentive remuneration.

The 'two strikes' rule

The Corporations Act currently requires listed companies to put their remuneration reports to a non-binding shareholder vote at the company's annual general meeting. The Bill proposes to introduce a 'two strikes' rule to strengthen the non-binding vote without introducing a binding vote on the remuneration report. The intention of the rule is to encourage listed companies to be responsive to a high proportion (25 percent) of negative non-binding votes on the remuneration report.

Under the rule:

  • at an annual general meeting of a company, where the resolution to adopt the company's remuneration report receives at least 25 percent of votes against the resolution; and
  • at the next annual general meeting of the company, the resolution to adopt the company's remuneration report receives at least 25 percent of votes against the resolution,

then at the later AGM, the shareholders must vote on a resolution (which will need to be included in the notice of meeting for the later AGM) that another meeting (a 'spill meeting') will be held within 90 days. At the spill meeting all the company's directors (other than the managing director) must vacate their positions and the shareholders will vote on resolutions to appoint directors to the vacant board positions. There is no prohibition on the vacating directors standing for re-election at the spill meeting. If the company fails to hold the spill meeting within the required 90 days, each director of the company at the end of the 90 days has committed an offence.

In order to avoid the company being left with less than three directors as at the time of or after the spill meeting, the candidates who are taken to have been appointed are those with the highest proportion of votes in favour of their appointment, even if they received less than half of the votes cast on the resolution in favour of their appointment.

Under the proposed amendments, key management personnel and their closely related parties (such as a spouse or child, a dependent or a company controlled by the key management personnel), whether in person or by proxy, will not be allowed to vote on the remuneration report if it includes details of the remuneration of a key management personnel.

Where a resolution to adopt the company's remuneration report receives at least 25 percent of votes against the resolution at the company's annual general meeting, the company will need to ensure that it has procedures in place for dealing with shareholder concerns. Where shareholder concerns are not clearly evident at the relevant annual general meeting, the company will need to seek feedback and comments from shareholders in order to deal effectively with any shareholder concerns.

Abolition of the 'no vacancy' rule

Most company constitutions state that the maximum number of directors the company can have is a stated number or such other number as declared by the directors. This is known as the 'no vacancy' rule. This rule makes it difficult for nominees not endorsed by the board to be voted onto the board, because the directors have the ability to declare that there are no vacancies.

Under the Bill, the board will no longer be able to declare the maximum number of directors without first obtaining shareholder approval at a general meeting. The notice of meeting must include explanatory statements stating the board's reasons for proposing to set a limit on the maximum number of directors. The limit approved by shareholders will expire immediately before the next annual general meeting.

Boards should consider whether the current maximum number of directors is suitable given the size and circumstances of the company and the current mix of directors. If required, boards should set an appropriate maximum number of directors.

Directed proxies must be voted

The Productivity Commission's report identified concerns where, as is currently allowed, proxies (other than the Chair of the meeting) are 'cherry picking' which directed proxies they wish to vote.

The Bill requires that any directed proxies that are not voted by the proxyholder will automatically default to the Chair of the meeting, who must vote all directed proxies. The intention of the amendment is to ensure that outcomes reflect shareholder views on a resolution.

Engaging remuneration consultants

Companies often engage remuneration consultants to advise their board on matters relating to remuneration arrangements, pay structures and performance hurdles, including strategic advice on how the levels of remuneration are benchmarked against industry standards. The Productivity Commission's report concluded that the potential for conflicts of interest can arise where consultants report directly to the company executives, or where they provide other services to the same company.

Under the Bill:

  • the board or the remuneration committee of the company must give their prior approval to the terms of engagement of a consultant before the consultant can be engaged to give recommendations about the remuneration of key management personnel (as defined in the accounting standards - directors and such persons having authority and responsibility for planning, directing and controlling the activities of the company);
  • the consultant must provide the remuneration recommendation to the board or the remuneration committee (or both) and cannot give the remuneration advice to an executive director of the company unless all the directors of the company are executive directors;
  • where the consultant gives any remuneration recommendations to the board, the consultant must include a declaration stating whether their recommendation is made free from undue influence by any key management personnel to whom the recommendation relates; and
  • if the consultant provided any recommendations for the remuneration of key management personnel, the company's annual report must include (among other things) a statement about whether the board is satisfied that the recommendations by the consultant was made free from undue influence by the key management personnel to whom the recommendation relates, and the board's reasons for being satisfied of this.

Boards will remain responsible and accountable to shareholders for the remuneration of key management personnel. Companies should ensure that any contracts to engage consultants and any remuneration advice are thoroughly reviewed by the board before the terms are considered for approval.

No hedging of incentive remuneration

The Productivity Commission's report raised concerns about the practice of directors and executives hedging their incentive remuneration, such as any shares and options that are part of their remuneration. The report concluded that the practice is inconsistent with a key principle underlying Australia's remuneration framework, which is that remuneration should be linked to performance.

The Corporations Act currently requires companies to disclose their policy for directors and executives hedging their incentive remuneration. The proposed changes to the Corporations Act will prohibit key management personnel and their closely related parties from entering into hedging arrangements for the key management personnel's incentive remuneration. The Australian Securities and Investments Commission has the ability to declare in writing that the hedging prohibition does not apply to specified arrangements.