Australian government releases draft additions to remuneration disclosure law, including new requirements for clawbacks
14/12/2012
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The Australian government released draft additions to remuneration disclosure law at 5.50 pm on Friday 14 December 2012. The draft requires disclosure of clawback, actual termination payments and payments post termination, as well as “past, present, and future” pay.

But don’t panic!  Unlike the last time the government introduced draft executive pay laws just days prior to the Christmas and New Year holidays, public responses to the proposed Bill are not required until the 15th of March 2013. The effective date for key aspects of the draft laws are from financial years starting on or after 1 July 2013.

The legislation is no surprise. As reported by us HERE, in May 2011 CAMAC reported on areas where the legislation could be revised in order to meet the government’s brief of a year earlier to reduce its complexity and more effectively meet the needs of shareholders and companies..

A quick summary

The Bill will amend the Corporations Act disclosure requirements in the remuneration report by:

·         requiring listed disclosing companies to include in the remuneration report a general description of their remuneration governance framework;

·         removing the requirement to disclose the value of lapsed options, instead requiring companies to disclose the number of lapsed options and the year which the lapsed options were granted;

·         requiring the disclosure of details of all payments made to key management personnel (KMP) as a consequence of termination of employment with the company; and

·         requiring listed disclosing companies to disclose for each KMP:

o    the amount that was granted before the financial year and paid to the person during the financial year;

o    the amount that was granted and paid during the financial year; and

o    the amount that was granted but not yet paid during the financial year.

Governance framework for setting executive remuneration

Basically, companies will be required to describe how executive remuneration is determined. Most companies do this to a degree already (for example, in relation to the use of remuneration consultants, and in reporting on ASX Corporate Governance Principles), so complying should not be onerous.

This change will help to ensure that the tiny minority of listed companies that do not have mechanisms to ensure an arms length and independent method of setting executive pay are encouraged to establish one. Others will be encouraged to improve processes to limit the undue influence of key management personnel affected by pay decisions (expect the term “undue influence” to figure prominently in disclosures in this regard).

Fortunately, the government has not been overly prescriptive on what is to be disclosed in this regard. The explanatory memo accompanying the exposure draft Bill suggests companies may like to describe the:

 

·         qualifications and experience of each member of a company’s remuneration committee;

 

·         length of time the Chair of the committee has served in that capacity;

 

·         changes in the composition of the committee since the last remuneration report;

 

·         management advice to the committee;

 

·         conflicts of interest that may have arisen and how they were managed; and

 

·         general ‘wrap up’ information, namely any other information that a shareholder would reasonably require to make an informed assessment of the remuneration governance framework of the company.

 

Pay in connection with termination – expect surprises

The draft legislation requires the reporting of all benefits provided in connection with the termination of Key Management Personnel (KMP). In a first, this requires reporting of agreed post termination payments. This will include restraint of trade payments (i.e. non-compete agreements) paid after an elapsed period of restraint, and post-employment consulting agreements known at the time of termination to the extent that these can be quantified. The reporting on the latter should be an interesting read for some listed companies.

The exposure draft does not appear to require disclosure in relation to the increasingly common practice of allowing long-term incentives (LTIs) to vest after termination, to redress an executive’s tendency to have a short term focus as retirement is approached, and encourage a legacy of more sound management during their tenure.

Reporting crystallised past pay, current period pay, and future pay – didn’t someone say that this was supposed to be simplification?

The requirements for listed disclosing companies to disclose past, present and future pay seem to apply in addition to existing reporting requirements.  It is not yet clear how the new requirements will be harmonized with the obligation under Corporations Act Regulation 2M.3.03 to apply the requirements of the relevant accounting standards in remuneration disclosures.

It is also not clear how the word “paid” is to be interpreted in relation to these disclosures.  Will it cover the vesting of equity to executives, when this does not result in any additional ‘payment’ from the company?

Reporting on options

The Corporations Act currently contains some nonsense, such as the requirement to report the value of lapsed options as if they had not lapsed. In response to submissions from Guerdon Associates and others, this provision is being replaced by a requirement to report the number of lapsed options, and when they were first granted.

Clawback, or the lack of clawback, will have to be reported

While well flagged beforehand, the proposed arrangements with respect to clawback are intriguing. Disclosure of a company’s clawback policy will be required, but only if there is a material misstatement in the financial statements over the prior 3 years.  Whether or not clawback is to be applied, and the form clawback is to take, will be a decision of the board in each case.

The new clawback rules will apply to listed disclosing companies that become aware, during the financial year, of material misstatements in any of their three previous financial statements. The disclosure must be made in their current year remuneration report.  If no remuneration has been clawed-back, an explanation must be provided.

The materiality of misstatement or omission refers to the concept of materiality in the accounting standards: 

Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.  Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances.  The size or nature of the item, or a combination of both, could be the determining factor.”

If ‘overpaid’ remuneration has been, or will be, clawed-back, details must be provided in the remuneration report. The clawback of remuneration would ordinarily include:

       a reduction in future pay for KMP;

       a repayment of previous overpaid remuneration that was paid to KMP; or

       another form of alteration of a KMP’s remuneration.

While the explanatory memorandum emphasises clawback of “overpayments”, there is no reference to being “overpaid” as a result of material misstatement in the draft legislation. In addition, if the material misstatement improves the company’s financial position, it appears that any resulting alterations to remuneration would also have to be disclosed.

What now?

There are many details in the exposure draft that pose interesting questions of interpretation and compliance.  We will report on these more fully in the New Year, and at our forthcoming Forum for directors and investors (see HERE

One thing is blindingly obvious. Instead of remuneration report “simplification”, we will have an additional three lots of numbers indicating how much an executive is paid, and probably many more pages explaining what these mean.

We will have further updates on the exposure draft and its implications in the New Year. In the meantime, we trust you will safely enjoy seeing out the old year, and welcoming in the new.

The exposure draft Bill and explanatory memorandum can be found HERE

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