A periodic update designed to provide a summary of important developments affecting share plans, including legal, tax and accounting issues, as well as comments on market practice and practical tips.
If you would like further information on any of the areas covered, please email suzannah.crookes@pinsentmasons.com or speak to your usual Pinsent Masons adviser.
Contents
Short summaries of each article shown below. If you would like to view the full article, click on the underlined links. To return to the start, click on the "Go back" link.
New ABI Guidelines - simplification
On 14 December 2006 the ABI published its revised guidelines on executive remuneration. The new guidelines ("Executive Remuneration – ABI Guidelines on Policies and Practices") are available on the ABI's website (www.ivis.co.uk). Read more
Companies Act 2006 – the definitive version is finally published
Companies Act 2006 was given Royal Assent on 8 November 2006, and the text of the Act has now been published. Although many of the provisions will not come into effect until 2008, there are some important areas where action is required now, including:
- Interim Management Statements and financial reports – new rules apply for financial years starting on or after January 2007 Read more
- Disclosure of interests in shares - details of total voting rights in issued share capital to be released by 31 December 2006 Read more
A number of significant changes are currently being made to the share plan accounting regime, including the issue by the International Accounting Standards Board of a revised Share Based Payment Accounting Standard "IFRS2". Read more
Recent case law – Commerzbank AG v James Keen
The Court of Appeal decision in this case indicates that, in alleging irrationality or perversity on the part of an employer in exercising a discretion, an employee must be able to present clear evidence in order for the case to proceed. It also confirms that the Unfair Contract Terms Act 1977 will not apply in the context of bonus schemes. Read more
FULL ARTICLE
New ABI Guidelines – simplification
On 14 December 2006 the ABI published its revised guidelines on executive remuneration. The new guidelines ("Executive Remuneration – ABI Guidelines on Policies and Practices") are available on the ABI's website (www.ivis.co.uk).
We have set out below a summary of the main changes to the guidelines – as in past years these changes reflect certain recent cases that concerned the ABI's members. However, this year the main alteration to the guidelines is that the format has been substantially changed in order to make the guidelines more readable and more accessible to companies, rather than being a "practitioners' document". This is clearly a welcome development.
New Style Guidelines
The thinking behind the new-style guidelines was to follow a format that companies are already familiar with. To do this, the ABI and its members have borrowed the style used by the Combined Code and has divided the new guidelines as follows:-
- There are five key principles;
- There are 17 main provisions;
- Detailed guidance supports the 17 main provisions.
None of the five key principles is new. They can be summarised as:
- Remuneration policies should promote long term value creation and should be aligned to corporate objectives.
- Remuneration Committees must oversee remuneration practices and should engage with shareholders on such matters.
- Remuneration levels should retain and motivate but benchmarking should be treated cautiously to avoid ratcheting effects.
- Remuneration arrangements should be performance linked, promote alignment with shareholders' interests and be clear and understandable.
- Payments for non-performance should be avoided.
Detailed changes
- Remuneration Committees
There is a change in how the ABI's members would prefer Remuneration Committees to make disclosure of remuneration policy. There is a new provision that requests Remuneration Committees to:
"establish effective procedures for disclosure and communication of strategic objectives, which enable shareholders to take an informed and considered view of remuneration policy and its implementation."
The emphasis on how policy aligns with strategic objectives is new although many companies will already do this. However, it may be that companies respond to this in a "boiler plate" way – for example by saying that remuneration policy will deliver rewards for improved financial performance or for increasing returns to shareholders.
- Base pay
The guidelines have been changed in relation to the need to justify salaries benchmarked to a median level. In the 2005 guidelines, salaries above median levels required justification; now justification is required for salaries "at or above median".
The ABI's thinking behind this change was that Remuneration Committees are expected to undertake a conscious analysis when benchmarking salaries as to whether, in a company's particular circumstances, a median (or above median) salary is appropriate, rather than a median salary being the "default position".
- Annual bonuses
The ABI and its members are retaining their increased focus on annual cash bonuses, particularly as (in general) maximum levels for annual bonuses have continued to increase in 2006. There is new guidance that where maximum bonus levels increase there is an expectation that correspondingly more stretching performance measures will apply. This has in practice been a concern expressed by the ABI in relation to cases where there have been increases in bonus maximum levels in 2006.
Within the revised guidelines there is also a clarification in relation to how the ABI wishes companies to structure annual bonus. The revised guidelines encourage "a contractual link" between variable pay and performance. By making such a link contractual, this would limit the ability of companies to make discretionary bonus payments, for example where performance measures had been missed.
A further new point that applies to annual bonuses is a suggestion that if bonuses have been paid on the basis of results that subsequently are shown to have been mis-stated, the company should look to recover such amounts from executives. Clearly this would be a very exceptional set of circumstances!
- Pensions
There are two new elements of guidance in relation to pensions.
a) Remuneration Committees are reminded to consider pension costs as an element of fixed remuneration costs, rather than as a separate item. Accordingly pension costs should be factored into consideration of the balance between fixed and variable remuneration available to executives.
b) The ABI have expressed a strong preference for pensions paid on early retirements to be subject to abatement. The ABI's expectation is for this to apply to new executive directors' service contracts and, where such provisions exist in current contracts, for these to be disclosed in Remuneration Committee reports. This appears to be evidence of a push by institutional investors to get companies to change their practice voluntarily in relation to pensions payable on early retirement even when this is an existing contractual term. Investors have previously undertaken such campaigns (with success) in relation to service contract notice periods of more 12 months and the retesting of performance conditions on share plans.
Although not covered in the guidelines, the ABI have said that they expect the guidelines on pensions to be subject to a wider review in 2007. The ABI and its members' view is that it will take both the 2006 and 2007 reporting years for companies to fully disclose the changes that have been made to executive directors' pensions as a consequence of A Day. Consequently, the expectation is that the guidelines to be published in December 2007 will comment on such changes.
- Share Plans
The guidance on share plans is materially unchanged. However, there are five points of detail that are worth noting:
a) The ABI have given encouragement to Remuneration Committees to consider applying performance periods for long term incentives that are more than the normal three years. The ABI's view is that this would be consistent with the new statutory requirement on directors to consider the long term consequences when fulfilling the directors' duty to promote the success of the company.
b) In previous years' guidelines there has been an extensive section on the circumstances in which it may be possible to apply pre-grant performance conditions to share awards, rather than having performance conditions apply between grant and vesting. This section has been replaced with a succinct statement that pre-grant performance is generally not suitable.
c) Leavers' rights – The guidelines no longer make any distinction between the treatment of leavers by reason of retirement and other "good leavers". This is in order to address age discrimination concerns. The ABI's preference in all such good leaver situations is for there to be time pro-rating of awards for the period to leaving and for performance conditions to apply either over the original performance period or over the shortened period to leaving.
d) Dilution limits – The main 5% (executive plans) and 10% (all plans) dilution limits remain unchanged. However the flexibility for very small plcs to apply only the 10% limit has been extended from companies of up to £5m total market cap to companies of up to £10m market cap.
e) Share Plans in subsidiary companies
The revised guidance restates the ABI's long standing position that establishing share plans in subsidiary companies is generally viewed as undesirable by investors. However, almost certainly in response to the new plan introduced by Cable & Wireless this year, there is new guidance on those requirements that the ABI's members would expect in relation to a share plan established over a subsidiary company's shares where this may be justified "in terms of contribution to overall value creation". These requirements include:-
- The plan being limited to people who work for the subsidiary and the exclusion of parent company directors;
- Full disclosure on the accounting treatments used to recognise the cost of options or awards;
- Appropriately challenging performance criteria;
- Dilution in the subsidiary to be disclosed in relation to the parent company's share plans dilution;
- Disclosure of how the subsidiary's shares are to be valued and disclosure of how volatility will be measured;
- Any entitlement to convert to parent company shares should also be disclosed.
Interim Management Statements and financial reports – final rules and guidance notes still awaited
Having been trailed by the Financial Services Authority for publication in November, the latest suggestion is that the final changes to the Disclosure and Listing Rules which include the new regime for interim management statements and financial reports, will not be published until just before Christmas, together with the promised guidance on them.
Until we have the final Rules, we have to make do with the "near final" Rules published back in October and available on the FSA's website at http://www.fsa.gov.uk/pubs/policy/ps06_11.pdf – see Appendix 1, Annex A, for proposed changes to the Disclosure Rules, and Annex C for proposed changes to the Listing Rules (but note these are not necessarily the final versions of the Rules and so it is unsafe to rely on them until the definitive Rules are published).
It is rule 4 of the new Disclosure Rules, derived from obligations in the European Union's Transparency Directive, which sets out the requirement for interim management statements (popularly known as quarterly reports) and the reduction in the time allowed for publishing full year and half year results. Note that this applies only to companies on the Full List.
These requirements will first apply to financial years starting on or after 20 January 2007, so for companies with a 31 March year end, these new rules will be relevant to the financial year starting 1 April 2007. (For financial years starting before 20 January 2007, the old rules continue to apply.)
The new regime means that a company on the Full List must publish:
- its annual financial report (comprising the audited financial statements, management report and responsibility statements) no later than four months from the year end;
- a half-yearly financial report (comprising condensed financial statements, an interim management report and responsibility statements) no later than two months after the half-year end;
- interim management statements during the first and second six month periods.
The requirement for an interim management statement (IMS) is entirely new but the FSA emphasizes that it is not a quarterly report. Companies traded in New York will be used to producing quarterly figures and commentary under SEC rules but the requirement here is for no more than:
- an explanation of material events and transactions that have taken place during the relevant period and their impact on the financial position of the issuer and its controlled undertakings, and
- a general description of the financial position and performance of the issuer and its controlled undertakings during the relevant period.
Note that if the company is under a separate obligation to produce a quarterly financial report under overseas rules (or even if it does it on its own initiative), it will not also have to produce an IMS.
Perhaps the more difficult aspect is the timing of the IMS. It does not relate to a specific three month period in the way that the half year report relates to the first six months of the financial year. Instead, the requirement is to produce the IMS at any time during a window which opens ten weeks after the beginning of the relevant six month period and closes six weeks before its end.
To give a concrete example, for a financial year beginning 1 April 2007 the first IMS will be due in the ten week period between 10 June and 19 August 2007; and the second IMS will be due in the ten weeks between 10 December 2007 and 18 February 2008. Because the statement does not relate to a specific three month period, the explanation and description will relate to the period between the beginning of the relevant six month period and the date of publication.
The existing obligation to make a preliminary announcement of full year results within 120 days of the year end disappears because it is likely to coincide with the date for the following year's first IMS. But companies can continue to make a preliminary announcement if they wish.
The FSA have promised guidance on what is not required in an IMS and we will add to this note in a future Update when that guidance is published.
In the meantime, note that it is likely there will be additional close periods of four weeks before an IMS is published, prohibiting those covered by the Model Code from dealing in their company's shares. This will need further consideration by companies planning the timetable for their share plan grants and also in the context of maturities of existing awards. Go back
Disclosure of major interests in shares – details of total voting rights in issued share capital to be released by 31 December 2006
The same delay reported above in relation to the FSA's final Disclosure Rules and promised guidance applies also to the new regime for reporting major interests in a company's shares. Scheduled to become effective on 20 January 2007, there is one provision which applies before then to all companies with shares traded on the Full List, AIM and PLUS Markets (the old Ofex).
By 31 December 2006 the following companies must release to a regulated information service (RIS) details of the total number of voting rights for each class of issued share capital admitted to trading on a regulated market or a UK prescribed market. They also need to identify the number of voting rights attached to shares held in treasury. Any changes in the share capital between the RIS announcement and 20 January must also be announced to the market. Publication of those figures will allow shareholders to calculate whether they have hit the 3% plus thresholds in the Disclosure Rules. The companies due to make this announcement are:
- UK companies on the Full List
- other companies whose home member state is the UK with securities admitted to a regulated market
- UK companies with securities traded on AIM and PLUS Markets.
Note that, with the Christmas and New Year holidays, the effective deadline for the release of this information is going to be 13:30 on 29 December because no RIS announcements will be made between that time and 2 January 2007.
The new disclosure rules will be dealt with in a separate Update in January once we have the final version of both the rules and the accompanying guidance. Go back
A number of significant changes are currently being made to the share plan accounting regime, including the issue by the International Accounting Standards Board of a revised Share Based Payment Accounting Standard "IFRS2". This will make important changes to the accounting consequences of the surrender or modification of options and the definition and treatment of vesting conditions. We will be issuing a separate bulletin on these matters in the New Year. Go back
Recent case law – Commerzbank AG v James Keen
Although not directly concerned with share plans, the judgement in this case concerning burden of proof where an employee challenges an exercise of discretion may be just as relevant in the context of share plan discretions as it is for discretionary bonuses.
This case concerned an employee of Commerzbank who received bonuses pursuant to a discretionary bonus scheme in 2003 and 2004 which were lower than he had expected. Further, he received no bonus at all in 2005, when he left employment before the bonus year was completed. The Court of Appeal considered two issues, each of which is outlined below.
Exercise of discretion
Previous case law has established that an employee may have a claim against an employer if, in operating a discretionary bonus scheme, the employer acts in an irrational or perverse manner. It has also been established that the employer should be able to justify the level of bonus awarded in order to resist any such claim.
Whilst the decision of the Court of Appeal in this case confirms that position, it is helpful to employers insofar as it indicates that the burden of proof falls on the employee to demonstrate irrationality or perversity – in other words, that no rational employer in a similar organisation would have exercised its discretion in this manner. On the facts, Commerzbank had a very wide contractual discretion under the terms of the bonus scheme, and therefore the burden of proof was a particularly high one.
Unfair Contract Terms Act 1977 ("UCTA")
The bonus for 2005 was unpaid when the employee left the bank part way through the bonus year, as permitted under the rules of the bonus scheme. The employee argued that this exclusion clause was void under UCTA as it did not satisfy the requirement of reasonableness.
The Court of Appeal held that the relevant section of UCTA did not apply in this case. The section required either that the employee was dealing with the employer as "a consumer", or on its written standard terms of business.
It has previously been established that UCTA would not apply to exclusion clauses in non-cash-based bonus schemes (such as share awards), and following this decision, the position is now the same where bonuses are cash-based. However, employers do still need to be aware of UCTA, which may apply in some circumstances in the context of employment contracts. Go back
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