Regulatory Update: Executive Remuneration, Insolvent trading and Financial accounts
January 2010
The pace of regulatory reform and review has not slowed going into 2010 and in January the Government and ASIC released reports relating to governance and financial reporting that all directors and executives should monitor.
The Productivity Commission Report on executive remuneration, which has been released by the Government, makes recommendations on remuneration that will be of particular interest to listed companies. This Report has already generated considerable debate.
The Treasury consultation paper in insolvent trading may lead to major changes in the law and the ASIC review of annual accounts has signalled a new focus on unlisted entities.
Executive Remuneration & Termination Payments
The Productivity Commission Report was released on 4 January 2010 to far less fanfare than the announcement of the review in March 2009. The Report of over 500 pages is an interesting fact based analysis of executive remuneration - the trends, concerns and recommendations for reform.
The Productivity Commission found that, while there had been strong growth in executive remuneration from the 1990s and executive pay varied greatly across listed companies in Australia, generally speaking, Australian executives were paid in line with smaller European companies and not at the high levels paid in the UK or the US. However, a recurring theme in the Report is concerned about the perception of excess and the loss of investor and community trust.
The Productivity Commission has watered down some of its original proposals and has not recommended some of the more interventionist reforms such as pay caps, binding shareholder votes, or a sacking of the board after ‘two strikes’ against the remuneration policy by shareholders at subsequent AGMs. This is despite some criticism in the Report of compliant boards, lack of diversity and little real evidence of shareholder activism.
Salary caps have been introduced in France, Germany and the US, but not across the board and only where firms have received government assistance.
Instead, the Productivity Commission has opted for changes to strengthen corporate governance and the role of boards and non-executives in overseeing remuneration as ‘agents for shareholders’. The Productivity Commission proposes:
- Less complex plain English remuneration reports
- More transparency in board selection and, controversially, shareholder approval for invoking the ‘no vacancy’ rule
- Remuneration committees independent of the influence of executives
- Greater board accountability and shareholder engagement through a number of measures, including disclosure of voting by institutional investors and a revised 'Three strikes' vote
The Productivity Commission has made 17 recommendations requiring a mix of law reform, ASX listing rule changes and voluntary codes. One of the more controversial changes is a proposal that, if remuneration reports are voted down by 25% or more of the shareholders at an AGM in subsequent years, there should be a resolution for those directors that sign the report to stand for re-election at an extraordinary general meeting to be held within 90 days. If more than 50% of the votes cast vote in favour of such a resolution, the positions of the directors who signed the remuneration report will effectively be spilled.
Some shareholder groups and unions have criticised the Report as not going far enough. While business groups are relieved about the softening of some of the options, they are still concerned that there will be too much focus on remuneration at the expense of strategic oversight by the board.
The Government is considering the recommendations and intends to respond by 31 March 2010.
In the meantime, the new law in relation to executive pay termination payments came into effect on 24 November 2009 after much debate and a difficult passage through the Senate late last year.
Under the Corporations Amendment (Improving Accountability on Termination Payments) Act 2009:
- Termination benefits for company directors and executives exceeding one years’ base salary are subject to shareholder approval;
- The provisions will be extended to apply to senior executives and key management personnel;
- The definition of benefit has been broadened; and
- The penalties for breach have been substantially increased.
Insolvent Trading – Proposed safe harbour for directors
During the Global Financial Crisis and resulting credit squeeze, there were concerns about whether the current insolvent trading laws negatively impacted on the ability of companies and, in particular directors, to preserve shareholder value and creditor recoveries through genuine informal workouts.
External administration or liquidation is often expensive, will usually have a detrimental effect on existing contracts and will most certainly affect value and market confidence, which can threaten the continued operation of a business that may, if restructured, be otherwise viable.
The difficulty is how to balance these issues against the need to protect creditors from the risks of insolvent trading.
The Government has released a consultation paper that proposes three alternatives:
- Maintain the status quo;
- Introduce a modified business judgment rule; or
- Allow directors to invoke a moratorium while attempting to reorganise but limiting the period and giving creditors the right to terminate.
It is clear from the consultation paper that the Government has not reached a position and is searching for a workable solution.
As the law currently stands, a director must apply for relief from liability from the Court if the board wants to pursue an informal workout when the company is insolvent, even if a workout would be in the best interests of shareholders and creditors as a whole. (To read about the problems for directors when managing companies in distress, please see our bulletin Companies in Distress - What should directors do?)
Introducing a business judgment rule may give directors comfort but there are still problems with the practical application of the rule, as highlighted in the consultation paper. The proposed moratorium model has features similar to the Chapter 11 procedure in the United States but with less formality and possibly more uncertainty.
Submissions are to be made by 2 March 2010.
If the Government opts for a safe harbour option (which seems likely given the wide support), the changes will mark a significant shift in how insolvency or potential insolvency is handled by companies and those who manage and advise them.
ASIC Review of Accounts – focus on unlisted entities
Consistent with the practice first announced by ASIC leading into the last 31 December reporting season (for more details on this please see our bulletin Part 2 Financial Reporting and Continuous Disclosure - How hard is it?), ASIC has again published a summary of key findings for its review of 30 June 2009 accounts and has foreshadowed the issues it will consider in its up coming review of accounts for 31 December 2009.
The interesting aspect of the 30 June 2009 review is that ASIC reviewed the accounts of 100 unlisted entities.
Under the Corporations Act, listed entities, all public companies (whether they are listed or not), all large proprietary companies and registered schemes are required to prepare annual financial reports. According to ASIC Commissioner, Michael Dwyer, this is the first time ASIC has reviewed the accounts of unlisted entities as part of its annual review program.
This is evidence of ASIC’s increasing concern about transparency and the importance of accurate financial reports and is likely to be an ongoing focus in future reviews.
ASIC’s review noted a number of concerns, including particular issues that related to current market conditions such as the failure to disclose significant judgements and incorrect or insufficient information about the classification of current and non-current assets and liabilities.
ASIC's recent action against executive and non-executive directors of the Centro Group shows ASIC is prepared to take a tough approach to enforce accounting standards. (For more on the proceedings commenced against the Centro Group, see our bulletin ASIC sends warning to directors on approving accounts)
A particular focus for ASIC in the next review will be compliance with the revised accounting standards.
For more information on this topic, please contact a member of our Governance, Risk & Compliance team.
