House of Representatives

Explanatory Memorandum

Circulated by the Authority of the Parliamentary Secretary to the Treasurer, the Hon David Bradbury MP

Chapter 2 - Improving accountability on the use of remuneration consultants

Context of amendments

2.1 The primary responsibility for remuneration arrangements rests with company boards. However, many boards engage remuneration consultants to advise them 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.

2.2 The PC inquiry concluded that a potential for conflicts of interest can arise where remuneration consultants report directly to the company executives, or where they provide other services to the same company. Improved disclosure will help shareholders assess the independence of the advice that remuneration consultants provide to boards and their remuneration committees.

2.3 A key concern raised by stakeholders is that remuneration consultants may be placed in a position of conflict if they are asked to provide advice on the remuneration of officers who might have the capacity to affect whether or not that consultant's services will be retained again (either for remuneration advice or other services the consultant may provide to the company). For example, a remuneration consultant may feel that remuneration advice that is unfavourable to the company executives may compromise their ability to obtain future work from the company.

2.4 While the advice of remuneration consultants may be influential in determining a company's remuneration decisions, the responsibility for remuneration arrangements rests with company directors. It is important that company directors are accountable to shareholders for ensuring that remuneration consultants are providing their advice free from undue influence by those directors to whom the advice might relate.

Summary of new law

2.5 Under the new law, a company's engagement of a remuneration consultant must be approved by the board or remuneration committee and the remuneration consultant must report to the non-executive directors (unless the board consists only of executive directors) or the remuneration committee (unless the company does not have a remuneration committee), rather than company executives.

2.6 A remuneration consultant that makes a remuneration recommendation for a company that is a disclosing entity will also be required to make a declaration that the recommendation is made free from undue influence by KMP to whom the recommendation relates.

2.7 A company's remuneration report will have to disclose a range of information about the remuneration consultant and the board will be required to make a statement about whether the board is satisfied that the remuneration recommendation was made free from undue influence by members of the KMP to whom the recommendation relates. The board must also outline its reasons for being satisfied that such undue influence has not occurred.

2.8 This reform is intended to deliver greater transparency for shareholders, and to put them in a better position to assess potential conflicts of interests associated with the use of remuneration consultants. It will also facilitate greater independence of remuneration consultants by ensuring that their advice is provided directly to non-executive directors or the remuneration committee, rather than the company executives.

Comparison of key features of new law and current law

Detailed explanation of new law

Engaging remuneration consultants

2.9 Under the new law, before a company enters into a remuneration consultancy contract, the proposed consultant must be approved by either the board of directors or the remuneration committee [Schedule 1, Item 8, subsection 206K(2)] . This requirement applies to a company that is a disclosing entity that engages a remuneration consultant to make a remuneration recommendation in relation to one or more members of the KMP of the company [Schedule 1, Item 8, subsection 206K(1)] .

2.10 A remuneration consultant is a person who is not an employee of the company, and who provides a recommendation on the remuneration of one or more KMP of the company under a contract for services with the company. [Schedule 1, Item 4, section 9]

2.11 If a remuneration consultant is engaged without the approval of the company's board or remuneration committee, it will not affect the validity of the contract with the remuneration consultant [Schedule 1, Item 8, subsection 206K(3)] . This will ensure that the remuneration consultant is not adversely affected by the actions of the company, where they cannot be expected to be aware of the deliberations of the board or remuneration committee.

2.12 The company commits an offence if, at the time the company enters into a contract, the directors or the remuneration committee have not approved the proposed remuneration consultant [Schedule 1, Item 8, subsection 206K(4)] . This offence is an offence of strict liability on the company, as a failure to seek approval would be a serious breach of the requirements and would diminish board accountability [Schedule 1, Item 8, subsection 206K(5)] .

Remuneration recommendation from remuneration consultants

2.13 Under the new law, a remuneration consultant is required to give their recommendation on remuneration (known as the remuneration recommendation) directly to either the directors of the company, or the remuneration committee, or both. However, they are prohibited from giving their remuneration recommendation to executive directors, unless all the directors of the company are executive directors. [Schedule 1, Item 8, subsections 206L(2) and (3)]

2.14 The Bill relies on the ordinary meaning of the term 'executive director'. An executive director is widely understood to be a full-time employee of the company who takes part in the daily management of the company, and is delegated control of the company's activities from the board of directors. This typically includes, for example, the chief executive officer and the chief financial officer.

2.15 A remuneration recommendation is a recommendation about how much the remuneration should be and/or the elements of the remuneration package [Schedule 1, Item 6, section 9B] . The Bill also contains a regulation making power to prescribe a particular kind of recommendation or advice as a remuneration recommendation. This power will provide flexibility to include other types of recommendations or advice, if required.

2.16 The Bill provides that a contravention of the requirement for a remuneration consultant to provide the remuneration recommendation to the directors of the company and/or the remuneration committee is not an offence [Schedule 1, Item 8, subsection 206L(5)] . This is intended to ensure that a remuneration consultant is not criminally liable for a failure to prepare or produce their recommendation altogether (although a remuneration consultant may face civil liability, for example, a claim for breach of contract for their failure to do so). In contrast, where the remuneration consultant prepares the remuneration recommendation and provides it to a prohibited person, then the remuneration consultant will be guilty of a criminal offence [Schedule 1, Item 8, subsection 206L(5)] .

2.17 Persons other than the remuneration consultant are not prevented from providing the remuneration recommendation to a person who is neither a director of the company nor a member of a remuneration committee [Schedule 1, Item 8, subsection 206L(6)] . This ensures that the remuneration recommendations can be distributed internally within the company, for example, to a human resources division within the company or other support staff.

Declaration by remuneration consultants

2.18 A remuneration consultant who makes a remuneration recommendation in relation to the KMP of a company that is a disclosing entity must include with the recommendation a declaration about whether the consultant's recommendation is made free from undue influence by the KMP to whom the recommendation relates. [Schedule 1, Item 8, subsection 206M(2)]

2.19 Failure to comply with this requirement is an offence of strict liability by the remuneration consultant, as a failure by the remuneration consultant to make a declaration would be a serious breach of the requirements, particularly as shareholders require this information to make an informed assessment about the independence of the remuneration consultant's recommendations. [Schedule 1, Item 8, subsection 206M(3)]

Disclosure relating to the use of remuneration consultants

2.20 Under the new law, a disclosing entity that is a company or, if consolidated financial statements are required, the consolidated entity, will be required to disclose, in its remuneration report, details relating to the remuneration consultant. In particular, the following details are required to be disclosed:

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the name of the consultant;

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a statement that the consultant made such a recommendation;

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if the consultant provided any other kind of advice to the company or entity for the financial year, a statement that the consultant provided that other kind or those other kinds of advice;

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the amount and nature of the consideration payable for the remuneration recommendation. This disclosure obligation may be satisfied by disclosing the aggregate consideration paid to the named remuneration consultant for remuneration recommendations (rather than separately disclosing the consideration paid under multiple contracts with that particular remuneration consultant);

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the amount and nature of the consideration payable for any other kind of advice referred to above. This disclosure obligation may be satisfied by disclosing the aggregate consideration paid to the named remuneration consultant for each other category of advice, such as tax advice, legal advice, and accounting services (rather than separately disclosing the consideration paid under multiple contracts with that particular remuneration consultant);

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information about the arrangements the company made to ensure that the making of the remuneration recommendation would be free from undue influence by the KMP to whom the recommendation relates;

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a statement about whether the board is satisfied that the remuneration recommendation was made free from undue influence by the KMP to whom the recommendation relates; and

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if the board is satisfied that the remuneration recommendation was made free from undue influence by the KMP to whom the recommendation relates, the board's reasons for being satisfied with this. This requirement is intended to provide the board with an opportunity to demonstrate to shareholders the steps that have been undertaken to ensure that the remuneration recommendation is independent.

[Schedule 1, Item 19, paragraph 300A(1)(h)]

Application and transitional provisions

2.21 The proposed disclosures concerning the use of remuneration consultants apply in relation to remuneration reports for financial years starting on or after 1 July 2011.

2.22 The proposed measures relating to the engagement of remuneration consultants apply to the execution of contracts on or after 1 July 2011.

2.23 The proposed measures relating to the advice from remuneration consultants apply to advice given under contracts executed on or after 1 July 2011.