And the accountants do ok too

 

Despite the administrative load and liabilities that the new Bill on executive remuneration will impose on listed company directors, part of us has a new found admiration for the lobbying powers of certain advisory firms, and the legal profession in general.  Not only have the lawyers and accountants managed to carve out an exemption for their professions as remuneration advisers, thereby avoiding all the compliance and criminality issues associated with this, they get a legislative outcome that, over time, will deliver them a fee bonanza.

 

Under the draft version of the Bill released on 20 December 2010, lawyers providing remuneration advice would have been classified as remuneration advisers, and the fees they get from management would have been disclosed.  While we expected the legal fraternity would get a good hearing regarding their concerns (many of which we agreed with), we did not expect they would achieve this degree of success.

 

For companies, the result will be a growing list of compliance issues, as they sort out which of the remuneration advice they receive is caught by the new rules. 

 

Non-executive directors can expect to be bamboozled by the legal flack thrown their way by management’s hired guns. 

 

Shareholders will be in the dark on the advice directors receive on the additional remuneration law, because it will not be “remuneration” advice. 

 

And there will be instances of abuse of process that will never come to light.

 

How has this come about?

 

The Bill on the issue of remuneration consultants

 

The Bill requires remuneration consultants to be approved by the board or the remuneration committee.  Remuneration consultants must provide their recommendations directly to the directors or remuneration committee.  Remuneration consultants must provide a declaration about whether their advice is free from undue influence by the key management personnel to whom the advice relates.

 

The board must disclose whether it is satisfied remuneration recommendations are free from undue influence (and the reasons it is so satisfied), and the steps taken to ensure there is no undue influence.

 

But what is a remuneration adviser?

 

The Bill starts by saying that a remuneration consultant is someone who provides a remuneration recommendation.  So far ok, although the alarm bells started to ring with the use of the word ‘recommendation’ rather than ‘advice’. 

 

The Bill then makes clear that management does not advise on remuneration.  That may be news to you and us.  So no disclosure is required on whom in management provided advice, or, as we suggested in our advice to Treasury, on how the board manages the conflict inherent in this arrangement.

 

We would have preferred the UK approach where disclosure is limited to those who provide material advice.  It is principle-based, simple, and takes two sentences.

 

The government has not done it that way.  So, in response to the almost unanimous avalanche of submissions pointing out that this would drag in every person and his/her dog that sniffed around the edges of KMP remuneration, the government has tried to define what remuneration advice is and what it is not.

 

That’s a big ask.  But they have had a go.  So what is remuneration advice?

 

It is a ‘remuneration recommendation’ (from someone who is not management) that is about either or both of the following:

 

(i) how much the remuneration should be;

 (ii) what elements the remuneration should have;

for one or more members of the key management personnel for a company; or

 (b) a recommendation or advice about a matter or of a kind prescribed by the regulations.

 

But even advice on these matters will not be a ‘remuneration recommendation’ if it is:

 

(a) advice about the operation of the law (including tax law); 

(b) advice about the operation of accounting principles (for example, about how options should be valued);

 (c) advice about the operation of actuarial principles and practice;

 (d) the provision of facts;

 (e) the provision of information of a general nature relevant to all employees of the company;

 (f) a recommendation, or advice or information, of a kind prescribed by the regulations.

 

In effect, the legislation manages to carve out the advice from the largest suppliers of board remuneration advice as not being remuneration advice.

 

Hence, these advisers can continue to be hired by both management and the board, remain conflicted, provide conflicted advice, receive fees from both sides of the fence, and not have the fact that they provided advice or the extent of any conflict disclosed, not have to sign off that they have not been unduly influenced by management, and not be subject to criminal penalty when they provide their recommendations to management.

 

Not only this, but the extent of fees they get for executive remuneration work will grow exponentially.  This is not only because no disclosures are required of the advice they provide, but also because of the clause that the government inserted to allow them to add a regulation later if they have forgotten something in the current Bill.

 

This is a black letter law approach.  It follows the US model.  This started with a few pages of law, and now is over 900 pages of regulation and explanatory notes – all to do with executive pay.

 

The UK principles-based approach remains a few lines, and has worked nicely, thanks very much.  That is, except for the fact that is does not provide specialist law firms with mountains of fees interpreting and finding loop holes in black letter law.

 

We chatted to Mr. Bradbury about this.  Mr. Bradbury indicated that a principles-based approach would create uncertainty, as it will depend on the creation of case law.  But this does not seem to be a problem for the Brits.

 

Mr. Bradbury said that the government had made provision for managing these issues through regulation.

 

There will be lags with this method.  There will be abuse.  There will be mountains of black letter law requiring specialist lawyers to provide expensive advice beyond the means of many small listed companies. 

 

Examples of situations which will not be caught by the Bill

 

The following examples illustrate situations where the Bill will not protect shareholders.

 

Example 1.  The Corporations Act s211 provides an exception from the requirement that the remuneration of related parties (including executive directors and non-executive directors) be approved by shareholders if the board determines the remuneration is “reasonable”. 

 

Under this Bill, advice on whether the CEO’s ideas on his/her own remuneration are reasonable would not be a remuneration recommendation.  The CEO could put forward suggestions for his own pay to the board, accompanied by legal advice from a conflicted law firm that this is reasonable.  The adviser and the extent of the adviser fees sourced from management are not required to be disclosed.  The advice can be provided to the executive.  The executive can hire the adviser direct.  An independent remuneration consultant would not be hired because the advice has already been proffered by the CEO’s hired gun.

 

Example 2.  The CEO hires his own adviser to make his pay more tax effective.  This is not remuneration advice under the Bill.  The advice suggests that the executive receives a non-recourse loan to buy shares because of capital gains tax benefits.  He hires an accountant who advises that the cost is no different to the performance share plan it would replace.  He puts his proposal and advice to the board.  There is no disclosure.  An independent remuneration consultant would point out that this way of paying would require either significant use of cash flow or a significant dilution of shareholders’ equity.  But the independent consultant would not be hired because the advice has already been proffered by the CEO’s hired gun.

 

Example 3.  Facts are not advice under the Bill.  The CEO hires conflicted advisers to provide the results of a survey of companies to show pay levels, but only if this is a sample of companies that pay their CEOs more than his current pay.  He presents the survey results with a demand that his pay be adjusted to “market levels”.  The fact that he hired conflicted advisers, who they were and the extent of management fees they received would not be disclosed.  An independent remuneration consultant would not agree with the CEO’s views or the selection of the comparator companies.  But the independent consultant would not be hired because the advice has already been proffered by the CEO’s hired guns.

 

Principles-based law is already in the UK Companies Act (see Regulation 11, Schedule 8, Part 2, Paragraph 2 (Consideration by the directors of matters relating to directors’ remuneration), see HERE.  It is simple, concise, and avoids the loopholes evident in this Bill.

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