Directors remuneration

Transcription

1 Briefing A review of the Government s June 2012 proposals for a binding shareholder vote on directors pay and new pay disclosures Summary This briefing looks at the detailed proposals for the new regime for UK listed companies and in particular considers the timing for transition and the different implications for current and new directors. There are some significant changes since consultation began in March this year. If you would like further information on this topic please contact Simon Evans T E simon.evans@freshfields.com Jocelyn Mitchell T E jocelyn.mitchell@freshfields.com Freshfields Bruckhaus Deringer llp 1

2 Our briefing of 20 June 2012 summarised the key elements of the proposed new regime. The key features of the proposals are: there must be a binding shareholder vote on a forward looking directors remuneration policy; a policy must be voted on at least every three years and more frequently if there are changes; it must include a policy for termination payments; there does not need to be a separate vote on exit payments as initially proposed a 50 per cent majority will be sufficient to pass the vote; the binding vote means that directors can only be paid within the scope of the approved policy; an annual advisory vote will still be required to approve directors pay in the past year; if the advisory vote fails, the policy must re-approved or a new policy put forward; and a single pay figure for each director must be disclosed in the DRR. The effect of the proposals will be to split a DRR into a forward-looking section on policy the policy report and a backward-looking section reporting on the previous year s remuneration the implementation report. The Government has said it intends the Companies Act and regulations to be enacted with effect from 1 October The binding vote will need to be put to shareholders no later than 2014 to take effect from 1 January 2015 at the latest. There are some helpful transitional provisions for contractual pay and termination arrangements entered into before 27 June These are not subject to the requirements for shareholder approval as long as they are not amended or modified. The detail of the provisions is contained in the Enterprise and Regulatory Reform Bill which will amend the Companies Act 2006 and introduce new provisions relating to directors remuneration and payments for loss of office The Government has also issued a consultation paper setting out revised content requirements for the directors remuneration report (DRR) and draft new DRR regulations. The deadline for responses to the consultation paper is 26. Which companies do the new rules apply to? The new rules will apply to all quoted companies. This means any company incorporated in England and Wales which is admitted to listing in the UK or in an EEA state or which is admitted to dealing on the New York Stock Exchange or NASDAQ. What does the binding vote mean? A quoted company cannot legally make a payment, or provide a benefit, to a director (including a termination payment) unless that payment is consistent with an approved remuneration policy or if shareholders specifically approve the payment by way of a separate ordinary resolution. A director will not be able to enforce a contractual term giving him or her a right to a payment which is not within the limits of an approved policy unless the term is grandfathered (see below). One particular challenge will be whether and how to draft a policy to give sufficient flexibility to the remuneration committee to negotiate terms with a new hire part way through a year. If items are agreed with a new hire that are not covered by the existing policy, they will have to be agreed on the basis that they are subject to shareholder approval in the policy vote at the next AGM. 2 Freshfields Bruckhaus Deringer llp

3 Considerable care will need to be exercised in drafting remuneration policies to ensure that all payments that directors expect to receive and that a remuneration committee may wish to pay (in particular on termination) will fall within the parameters of the policy. What does the policy report need to cover? The draft regulations contain a lot of detail but there a number of gaps which will hopefully be addressed in the consultation process. The policy must include: a table describing each element of pay; how each element of pay supports the short term and long term strategic objectives of the group, how it operates, whether there is claw-back, the maximum potential value directors may receive, a summary of the performance metrics and the period over which they are measured; any change in any element of pay since the last policy and the reason for it; a statement of all provisions in directors service contracts relating to remuneration (this could be very lengthy); a graphical description of what directors are expected to receive if performance is at, or above or below the threshold performance level; policy on notice periods and termination payments and their calculation (see below for further detail); whether and to what extent benchmarking metrics, wider employee pay and shareholders views were taken into account when setting directors pay; the percentage change in profit, dividends and company spend on directors pay compared to previous years; and percentage change in the CEO s pay compared to that of the group s employees generally (or any other appropriate comparator group of employees). The consultation paper suggested that companies would not be required to disclose commercially sensitive aspects of their performance targets but that has not been reflected in the draft regulations. The format of the table is not prescribed but the example given in the consultation table is given at the back of this briefing. How does the binding vote operate? The binding vote is required at least every three years. For example if a policy is put to a binding vote at a company s AGM in 2014, a new policy must be approved by the 2017 AGM at the latest. However, any changes to the remuneration policy or a vote against the implementation report (see below) will require a new policy report to be approved. So it would seem, for example, that an increase in salary could result in a new policy being needed, unless the policy permits increases either by setting specific limits eg contemplating increases in line with inflation, or by allowing increases at the discretion of the remuneration committee. The consultation paper acknowledges that shareholders should be able to approve a policy that allows a framework within which the ultimate outcome will still rely on the discretion of the remuneration committee. The Government accepts that it is for companies to consult with their shareholders to understand their expectations as to the level of detail to be set out in policies. There is an expectation that best practice guidance will be developed. Companies will want to engage with their institutional investors in advance and in sufficient time to develop a policy that will be acceptable. If a policy vote fails, then the remuneration committee may either hold an EGM and put forward a revised policy, or wait until the next AGM and continue to remunerate executives in line with the previously approved policy. Freshfields Bruckhaus Deringer llp 3

4 This approach is far more practical than the government s initial proposal, in which a remuneration committee would have had 90 days in which to agree a revised policy with shareholders. The Financial Reporting Council will consult on requiring companies to make a statement as to how they will address concerns if a significant minority of shareholders vote against the policy. It leaves open what happens if the first remuneration policy in 2014 is not approved. How would a company identify a previously approved policy when none will have been required before? This is important because from 1 January 2015 directors can only be paid in line with an approved policy (unless paid under a grandfathered arrangement). There are civil liability consequences for any director who authorises payments outside the limits of the policy as approved by shareholders so that they will be jointly and severally liable to indemnify the company for any loss arising from the payment. When do the new rules apply? The new regime does not apply to any payment to a director before the end of 2014 (for 31 December year end companies) or in the case of other companies, the end of their 2014/15 financial year (assuming the legislation is enacted in October 2013). The new regime requires companies to get approval for their first remuneration policy at their AGM in 2014 (or in the 2014/15 financial year for companies without 31 December year ends) and for the policy to come into effect no later than the end of that financial year. The current drafting does not seem to allow the policy to be effective from a date before shareholders approve the policy. It is not clear if that is intended. There will be a curious and lengthy transitional period. Companies seemingly will have to prepare a new implementation report under the new regime for remuneration paid in 2013 (or 2013/14) which will be subject to an advisory vote at their 2014 (or 2014/15) AGM and they will propose a remuneration policy for approval at that AGM to take effect at the beginning of the following financial year. The implementation report in 2015 will report on remuneration paid in 2014 which in turn will not have been subject to a binding vote will be the first year in which the implementation report will report on pay paid under an approved policy. How are directors existing rights affected? A key concern arising out of the initial consultation process was how a binding vote would interact with existing contractual rights. The initial proposal from the government was that any payment made under an existing right that conflicted with an approved remuneration policy would, following October 2013, be unenforceable. The new proposals give grandfathered status to arrangements (be they under a service contract, LTIP award, pension promise or otherwise) which were entered into before 27 June Payments made in respect of safeguarded rights will not be subject to civil consequences in the event that they breach a shareholder approved remuneration policy. However, there is an anti-forestalling measure any amendments or modifications to a pre-27 June 2012 agreement could result in the protection falling away. We think this means that only amendments to the specific remuneration term concerned (and not changes to an unrelated term in a service contract) should cause grandfathered status to be lost but any amendments to employment contracts, pension arrangements or share plans should not be undertaken without first considering the impact on safeguarded rights. Grandfathered status will be particularly important to protect rights 4 Freshfields Bruckhaus Deringer llp

5 eg existing share awards, deferred bonus arrangements, sign on/buy out awards for new hires or pension promises that have been created but are not due to pay out until after the 2014 or 2014/15 financial year. How do the new rules affect termination payments? The government s initial proposal was to require a binding vote for termination payments in excess of one year s base salary. This has been toned down significantly. Instead, it is proposed that there be a preapproval regime as part of the binding vote on the remuneration policy. The policy report must set out in some detail the principles on which termination payments will be calculated. Termination payments (other than those that are grandfathered) will then have to be made on a basis that is consistent with this policy. The policy does not have to be individualised (although if different directors have different termination entitlements then the policy will inevitably have to make distinctions between named directors). There is no prescribed form, but an explanation of the following information must be included as a minimum: notice periods; how each element of pay (salary, bonus, LTIP, pension) will be dealt with when calculating the termination payment; whether different types of leaver circumstances will be treated differently; how performance will be taken into account; and whether there are contractual provisions that are grandfathered and how they will impact on the termination payments. Directors who authorise termination payments outside the limits of the policy as approved by shareholders, will be jointly and severally liable to indemnify the company for any loss arising from the payment. Disclosure of termination payments Termination payments must be disclosed immediately following the director s departure. Typically at present they are not usually disclosed until the following year s DRR is published. The disclosure must be made on the company s website (it is not yet clear whether this also has to be disclosed on a RNS along with the normal announcement of a Director s departure) and must set out: the level of compensation received broken down into key elements; and how each element was calculated. Remuneration committees will want to be mindful of the full disclosure that will be required at the time of termination but also in the following year s DRR when negotiating and agreeing termination arrangements with departing directors. The DRR disclosures will, in addition, require an explanation of how relevant discretions were exercised. This requirement could be effective as soon as the legislation is enacted, ie from October How will the advisory vote operate? The existing advisory vote on the DRR is to be maintained. As before the approval threshold for the vote is 50 per cent. However, to give this advisory vote teeth the Government proposes that if the advisory vote on the implementation report fails, the current remuneration policy must be put up for re-approval at the following AGM regardless of whether the policy report itself has been approved. What does the implementation report have to cover? The Government s stated aim is to achieve greater transparency of directors remuneration. The implementation report has to include: a single figure for the total pay of each director to be disclosed in a table; Freshfields Bruckhaus Deringer llp 5

6 details of actual performance against metrics for bonus and long-term incentives; an explanation of defined benefit pension entitlements; termination payments made in the year; details on variable pay awarded in the year (at face value); total shareholdings of directors; a chart comparing the CEO s pay with company performance (based on total shareholder return); information on the use of remuneration consultants and their fees; and an explanation of how shareholders views on the previous year s DRR have been taken into account. The draft regulations are still at consultation stage. More work is required on them since on a number of points they do not actually reflect statements in the Consultation Paper. It is unclear when they will be finalised. Some companies may want to prepare their 2012 DRR on the basis of the new disclosure framework but they will of course have to ensure that the DRR report meets the current legal requirements. What does the single figure include? There has been much debate on how to produce a single figure for pay when directors remuneration is made up of many different elements, a large part of which will be variable. The proposed disclosure is based on the recommendations of the Financial Reporting Lab. The information must be set out in a prescribed table format. For each executive and non-executive director a number must be given for each element of their pay in separate columns with a final column showing the total. This will replace the existing emoluments table. The table will show what has been paid in the year under review. In the case of bonuses that may have a deferred element, the deferred portion is to be valued at face value. Face value is not currently defined with any precision. In the case of long term incentives such as share awards and options, disclosure will include the value or estimated value of awards/options where final vesting is determined as a result of the achievement of performance conditions during the year under review. In the case of options the value is to be calculated even though the director may not yet have exercised the option and received any benefit. If an estimate has had to be made of the final value (because at the time of calculating the single figure the final vesting level was not known), and this varies from the actual value that is received, it is suggested that companies may want to inform the market. There is no requirement to restate numbers in the following year s report but this is where market practice guidelines might be developed. For bonus and LTIPs there must be an explanation of performance conditions and the extent to which they were met and any exercise of discretion. This may raise some concerns for companies who do not currently disclose bonus or LTIP performance metrics in detail due to commercial sensitivity. The Government is seeking views on whether limited disclosure should be permissible on these grounds. In the case of pension benefits, this will include cash paid in lieu of pension, the amount of defined contributions to a money purchase plan, the additional value accrued during the year under a defined benefit scheme or unfunded scheme, calculated using HMRC s methodology for the purposes of income tax using a multiple of Freshfields Bruckhaus Deringer llp

7 Timeline for proposals on shareholder votes on directors remuneration and loss of office payments for company with calendar year accounting period First FY ending after legislation comes into force - new DRR format will apply to remuneration paid in this FY First FY beginning after legislation comes into force First Remuneration Policy must be put to shareholders at the accounts meeting (AGM) held in this FY Third FY beginning with first FY after the AGM at which First Remuneration Policy approved Second Remuneration Policy needs to be approved (assuming no changes to First Remuneration Policy in the meantime) June 2012 Agreement or obligation entered into before 27 June 2012 are grandfathered unless changed or modified 1 Jan 2013 May 2013 AGM (a) 2012 DRR: advisory vote under old rules & old format (any additional information under new format optional) October 2013 Legislation comes into force - from this date details of termination payments must be disclosed at time of payment(?) 1 Jan 2014 May 2014 AGM (a) 2013 DRR: advisory vote under new rules & new format (b) First Remuneration Policy to be effective 1 January 2015: binding vote (latest date to approve) 1 Jan 2015 Latest date for First Remuneration Policy to be effective ( ED ) May 2015 (a) 2014 DRR: advisory vote new rules & new format (b) Remuneration Policy : binding vote only if changes 1 Jan Jan Jan 2018 May 2016 (a) 2015 DRR: advisory vote (b) Remuneration Policy : binding vote only if any changes May 2017 AGM Second Remuneration Policy: binding vote Payments due under agreement or obligation entered into before 27 June 2012 are not subject to approval of Remuneration Policy provided no changes or modifications made. Remuneration and loss of office payments made after ED must be consistent with approved Remuneration Policy (unless under pre 27 Jun 2012 agreement/obligation)

8 Mock-up policy table setting out all elements of remuneration Key elements of remuneration Base salary Purpose and link to strategy Help recruit and retain employees. Reflects individual experience and role. Operation Reviewed annually and fixed for 12 months commencing 1 April. Decision influenced by: role, experience and performance; average change in broader workforce salary; and total organisational salary budgets. Salaries are benchmarked against the FTSE 10. Benefits Help recruit and retain employees Directors are entitled to healthcare, car and life assurance. Annual bonus Rewards the achievement of annual financial and strategic business targets and delivery of personal objectives. Deferred element encourages long-term shareholding and discourages excessive risk taking. Targets are renewed annually and relate to areas of the business over which the executive has particular control. Bonus level is determined by the Committee after the year end, based on performance against targets. Individuals may choose to defer up to 50% of any bonus earned over 3 years. The deferred element is subject to forfeiture if the performance which led to its being paid is found to be incorrect or in the event of misconduct. Long term incentive plan Incentivises Directors to achieve returns for shareholders over a longer time frame. Company X has one LTIP which was agreed by shareholders on XX. Awards of conditional shares are made annually with vesting dependent on the achievement of performance conditions over the three subsequent years. The committee reviews the quantum of awards annually to ensure that they are in line with market rates. Pension Rewards sustained contribution. Company X operates a defined contribution pension scheme. Benefits are accrued according to length of service up to retirement. Company does not provide cash in lieu of pensions or a top up scheme. Company X has closed its DB scheme but Director 1 is still a member. 2/3 final salary scheme, accrual rate 1/60; no service requirement, retirement age 60; no additional benefits on early retirement. 8 Freshfields Bruckhaus Deringer llp

9 Opportunity Performance metrics Changes in year Page Maximum annual increase of 5%. None Directors salaries increased by 2%. Full cost of annual policy c. 40,000 Target % of salary: 125%. Maximum % of salary: 200%. Maximum % of salary: 600%. Working maximum: 400%. New executives receive 15% base salary (they contribute 5%). None The majority of the bonus is based on achievement of challenging financial objectives: 75% judged by performance of Group operating profit; 25% judged on Group profit before interest and tax; and adjusted to reflect individual performance in achieving global sales and restructuring the Group. The deferred element of the bonus is subject to the same performance measures as the LTIP. Awards vest at end of three year performance period based on three equally weighted performance measures: business diversification performance; adjusted free cash flow; and relative TSR. 25% vests at threshold, rising to 100% for stretching performance exceeding the set threshold by a specified margin. Against comparator group comprising 10 other companies, 30% vests at median with 100% vesting for upper quartile performance. None None No change has been made to measures or weighting. None Freshfields Bruckhaus Deringer llp 9

10 Total remuneration opportunity table (000s) Pension LTIPs Options Other benefits Deferred bonus Bonus Salary Below Target On Target Maximum 10 Freshfields Bruckhaus Deringer llp

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