Culture Shock

Greg Medcraft, the Chairman of the Australian Securities and Investments Commission (ASIC), in a recent speech reiterated ASIC’s focus on the importance of culture within corporate organisations.

In a previous blog, Organisational culture: ASIC's renewed focus, we discussed Commissioner, Greg Tanzer’s, earlier speech on the importance of organisational culture, and hinting at a renewed emphasis by ASIC to target poor culture.  Mr Medcraft has now re-affirmed ASIC’s targeted focus.

Regulatory intervention

Mr Medcraft acknowledges that culture cannot be regulated with black letter law.  Instead, it will be incorporated into ASIC’s risk based surveillance reviews.

Coinciding with his speech, ASIC also released ASIC report 474, which focuses on corporate culture within the funds management industry.  The report pinpoints several indicators of culture which will likely be at the forefront in ASIC’s surveillance.  ASIC notes that, while the indicators are not necessarily indicative of poor conduct, they may be suggestive of circumstances when ASIC may intervene.  These indicators include:

Organisational culture: ASIC’s renewed focus

Commissioner Greg Tanzer, on behalf of the Australian Securities and Investments Commission (ASIC), recently delivered a speech about the importance of organisational culture, hinting at a renewed focus to target poor culture, with reference to recent concerns in the financial services sector.

Of course, Commissioner Tanzer’s comments on culture do not just apply to financial services, having relevance to businesses across a range of sectors. 

Drivers of culture

Organisational culture refers to a set of shared values and assumptions that underpin the fundamental way in which it operates.  Among other things, it can influence staff in their thoughts, attitude and behaviour, and in particular their approach to customers and vital organisational issues such as compliance.  The Criminal Code 1995 (Cth) (Criminal Code) defines ‘corporate culture’ as including attitude, policy, rules, and a course of conduct or practice.

Commissioner Tanzer argues that some of the key drivers of culture are:

• having a board and senior management that is willing to take responsibility and ensure good outcomes for customers
• ensuring a company’s values and beliefs are widely known and understood throughout each area of the organisation
• enforcing an understanding that employees will be personally accountable for their actions, whether that be being rewarded for positive outcomes through promotion or awards, or not in the case of negative outcomes
• promoting a culture of open and honest communication, whereby employees are encouraged to take part in constructive engagement and
• promoting, and continually monitoring and assessing, an organisation’s culture, to ensure that appropriate changes are made and implemented where necessary.

The potential for criminal liability

Section 12.2 of the Criminal Code provides that in the event of the commission of an offence by an employee, agent or officer of a body corporate acting within the actual or apparent scope (or authority) of their employment, it can be attributed to the ‘employer’ body corporate.  ASIC Chairman Greg Medcraft has made clear that this extends to a company being held responsible as an accessory for a breach of certain Commonwealth laws by its employees if the company’s culture either encouraged, or otherwise tolerated, that breach.

According to Mr Medcraft, in ASIC’s view, the power to take action in such a case should extend further to apply to civil penalties and administrative sanctions.

ASIC’s concern with culture

ASIC contends that a negative organisational culture drives bad conduct, going so far as to say that bad conduct may even be rewarded in organisations where a negative organisational culture is evident.  Accordingly, ASIC considers poor culture to be a key risk area which it will seek to address in its role as regulator, and it is clear that there will be an increased focus by ASIC on culture in the future.

In light of these comments, it is a good time for all businesses to consider whether they have laid the foundations for a strong organisational culture.  Not only does this include taking steps to implement appropriate governance policies and related procedures, but also ensuring those policies and procedures are fully understood and embedded in the workings of the organisation.

Changes to the taxation of employee share schemes

Legislation enacting proposed changes to the taxation of interests in Australian employee share schemes (ESS), intended to ‘bolster entrepreneurship and innovation in Australia’ is now in force and applies to shares and options issued on or after 1 July 2015.

One month in to the new regime, it is a good time for companies to consider whether they are eligible to take advantage of the new start up concessions and whether offering ESS interests is an appropriate tool to reward employees.

Concessions for start ups

The legislation implements the concessions allowing ‘start-ups’ to issue shares at a discount of up to 15% to market value, or grant of ‘out of the money’ options in circumstances where employees will potentially pay no tax – unless and until those interests are ultimately sold.

To qualify, the employer company must:

• be unlisted and hold no interests in listed entities
• be an Australian resident company with an aggregated (i.e. group) turnover in the previous tax year of up to $50 million
• be incorporated for less than 10 years at the time the option is granted, and
• not be part of a group which includes entities more than 10 years old.

For the scheme, the general conditions that currently apply to all ESS concessions must be satisfied and the scheme must require employees to satisfy a 3 year holding period in relation to the interests acquired (unless employment ceases earlier).

On sale, the shares will be subject to capital gains tax (potentially providing access to the CGT 50% discount).

Newer private companies are likely to qualify where the turnover limit is met however it is important to be mindful of older companies in the group which may mean that the group is precluded from accessing the ‘start up’ concessions.

Summary of reforms for all ESS

In addition to the reforms noted above, there has also been a number of changes to the general ESS rules which apply to all entities.  In particular, the ESS rules now:

• allow certain rights schemes to access deferred taxation treatment even where they do not contain a ‘real risk of forfeiture’ (for example, where the scheme genuinely restricts an employee from immediately disposing of their rights and expressly states that it will be subject to deferred taxation)
• double the existing significant ownership and voting rights limitations from 5% to 10% (but ensuring all interests are taken into account, even those which may not have been exercised)
• amend the provisions entitling employees to a refund of tax paid on the grant of options in circumstances where the employee chooses not to exercise that right, and
• extend the maximum tax deferral period from seven to 15 years. 

Integrity provisions and the up-front $1,000 tax concession for employees who earn less than $180,000 per year (introduced as part of the last reforms to the ESS rules in 2009) have been retained.

As part of this process, the Government has released updated safe harbour valuation tables (used in valuing unlisted rights issued under employee share schemes).  Approved safe harbour market valuation methodologies (to reduce compliance costs in maintaining an employee share scheme and valuing unlisted shares) have also now been released.

Implications

Be aware of the following considerations:

Tax liability becomes payable only when exit is possible

An ESS which exposes employees (particularly those of unlisted companies) to material tax costs prior to the employee having an ability to sell the shares are unlikely to be popular.  Although valuation difficulties have all but been removed for ‘start ups’, where the only taxing point is the ultimate share sale, for companies which do not fall within the ‘start up’ concessions it will be important to ensure that employees are not exposed to significant tax costs prior to realisation of the shares.

Aligning employee ownership and corporate control

Private groups should carefully balance employee ownership and incentives against the potential impact of an employee owner exiting the business.  In these circumstances, a robust ESS designed to take advantage of the relevant concessions should also provide a framework that mitigates unintended dilutions of control.

Long-term succession planning

The increased significant ownership and voting rights limitation (from 5% to 10%) now provides some potential for succession planning, where multiple key employees take a 10% interest in the company, with future transfers or exit strategies in mind.

Not a start up?

Deferral is now more generous for rights and options, however full taxation will still arise upon exit of employment.

There are also other alternatives, including loan plans and phantom schemes which may be more appropriate for certain companies to consider.

Key corporate reforms enacted as '100 member rule' finally abolished

On 2 March 2015, the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 (Cth) (Bill) was passed by the Senate and is now awaiting Royal Assent.

The Bill makes several significant changes to the Corporations Act 2001 (Cth) (Act) of which directors, shareholders and practitioners need to be aware. 

Abolition of the ‘100 member rule’

The Bill removes the ability for 100 or more of a company’s members to require directors to call and hold a general meeting at the company’s expense.

The so-called ‘100 member rule’ had previously been widely criticised on the basis that it allowed a very small proportion of a company’s members to disrupt management and impose significant transaction costs on the company even where the resolutions to be considered at a general meeting had little chance of being passed. 

The 100 member rule has not been abolished for managed investment schemes. 

Further, 100 or more of a company’s members are still able to:

• propose resolutions for inclusion on the agenda of general meetings, and
• require the distribution of statements, at the company’s expense, in relation to a proposed resolution or a matter that may be considered at a general meeting. 

The ability for members holding at least 5% of the votes that may be cast at a company’s general meeting to require directors to call and hold a general meeting also remains.

Reporting of executive remuneration

The Bill alters reporting requirements for executive remuneration in an effort to reduce compliance costs and red tape for companies. 

Unlisted disclosing entities no longer need to prepare a remuneration report.  While listed disclosing entities are still required to prepare a remuneration report, in relation to lapsed options, those entities are now only required to disclose the number of options granted to key management personnel as part of their remuneration that lapse during the financial year and the year in which the lapsed options were originally granted.

'Streamlining' amendments

Shortening the financial year

Under the Act, directors can reduce the ordinary 12 month financial year period for the company if the reduction is made in good faith in the best interests of the company, provided that the company’s financial year has not been shortened on that basis alone in any of the previous 5 financial years.

 

For the sake of clarity, the Bill states that, in determining whether a company’s financial year has been shortened in any of the previous 5 financial years, previous reductions of 7 days or less or that were required to synchronise the reporting period of controlled entities to provide consolidated financial reports (also allowed under the Act) are not to be considered.  

 

Auditors for companies limited by guarantee

The Bill clarifies that small companies limited by guarantee and companies limited by guarantee that elect to have their accounts reviewed rather than audited are not required to appoint or maintain an auditor.  This is a logical amendment consistent with provisions of the Act designed to reduce the regulatory burden on companies limited by guarantee.

 

Other amendments

The Bill also enables:

• the Remuneration Tribunal to determine the remuneration of the Chair and members of the Financial Reporting Council, the Australian Accounting Standards Board and the Auditing and Assurance Standards Board, and
• Takeovers Panel members to perform their functions while overseas.

Dividend requirements

The original exposure draft of the Bill contained provisions which:

• introduced a pure solvency test for the declaration and payment of dividends, and
• clarified that a company could make a capital reduction by way of a dividend payment, without the need for shareholder approval, so long as there was an equal reduction to all shareholders. 

Although these provisions were omitted from the Bill as passed, they are likely to be revisited by the Government after further consultation in the future. 

 

For further details on changes under the Bill, please refer to the recent article by Dr Kai Luck.

An overview of securities class actions

Since the first class action in Australia was brought in 1991, class actions have quickly become part of the Australian legal landscape.  Securities class actions in particular have become ‘big business’.  It is prudent now more than ever to review your governance procedures to mitigate the risk of a securities class action. 

A securities class action allows investors of an entity who share common ground for complaint to pursue a claim against the entity through a representative.  The popularity of such actions is at least in part because they allow investors to pursue a claim generally without risk to the investors of an adverse judgment, where they would not otherwise, individually, have the means for doing so.

In Australia, a class action may be brought by seven or more plaintiffs with claims arising out of the same or similar circumstances with a substantial common issue of fact or law – a relatively low threshold comparative to other jurisdictions.  Typically securities class actions are based on the argument that investors either:

• acquired or sold securities where they would not have but for the alleged conduct of the entity, or
• acquired or sold securities at a different price than they would have otherwise acquired or sold securities but for the alleged conduct.

These arguments are most frequently based on two causes of action, often pleaded together:

• misleading or deceptive conduct under section 1041H Corporations Act, by way of inaccurate or incomplete statements, or a failure to disclose or correct information in a timely fashion, and
• in the case of listed entities, breach of continuous disclosure obligations under section 674(2) Corporations Act and ASX Listing Rule 3.1, by way of a failure to disclose information where a reasonable person would expect that information to have a material effect on the price or value of securities in the entity.

Since 1999 there have been 30 securities class actions in Australia, of which only four have proceeded to trial and none to judgment.  Entities and their investors often elect to settle early due to the costs of litigation and the uncertainties as to the outcome of a judgment, particularly as the required evidence to establish causation in a securities class action has not yet been considered by the courts. 

A key feature of the Federal class action regime is that it is designed to allow an applicant to represent an ‘open class’ of investors without the need for investors to take steps to ‘opt in’ to proceedings.  Every person who satisfies the class definition as described in the originating process is represented in the proceeding subject to a right to opt out by a fixed date.  However, the inherent difficulties ascertaining the number of investors and the quantum of their cumulative damages means the open class model leads to a lengthy, uncertain litigation process.  The alternative approach adopted in some cases is a ‘closed class’ action, where the class is limited to those who have retained a specific law firm and/or entered into a funding agreement with a particular litigation funder.

Several circumstances have given rise to an increase in securities class actions in Australia.  Firstly, there has been an increase in the number of plaintiff law firms focusing on securities class actions, especially in the wake of a decline in personal injury practice following legislative reforms.  Secondly, there has been a steady increase in third party funding of securities class actions spurred by the High Court’s approval of such funding in Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd [2006] HCA 41.  Anyone can now fund litigation except the lawyers involved in the case, with IMF (Australia) Ltd, Legal Funding LLC, International Litigation Partners Pte Ltd and Harbour Litigation Funding facilitating some of the major class actions in the last decade.  Thirdly, there is a growing focus on private litigation as a means by which to enforce good corporate governance rather than relying on regulatory bodies.  Increased institutional investor participation, particularly in listed companies, will only heighten this focus.

Several entities have been the subject of multiple securities class actions, emphasising the need for entities to take precautions to protect themselves against the risk of litigation from investors.  Some common issues that have prompted securities class actions and that should be on the radar for entities include:

• lack of reasonable grounds for statements in financial reports about expected profitability of the entity ¹
• failure to properly disclose to the market the full extent of costs increases and delays associated with an entity’s projects²
• failure to disclose to the market the full extent of an entity’s debt obligations and refinancing options,³  and
• failure to disclose price-sensitive information relevant to an entity’s significant earnings downgrade.⁴

Securities class actions is a developing area of law that underlines the need for entities to be accountable to their investors.  Continuous disclosure obligations place listed entities in particular at risk of a securities class action and, as such, listed entities should have appropriate procedures in place to monitor and anticipate potential issues.  These procedures may include:

• maintaining an up to date, comprehensive and easily understandable continuous disclosure policy for the company
• establishing effective internal reporting networks to ensure price sensitive information is quickly communicated to the board, senior managers and other decision makers in the company, and
• ensuring that the board regularly considers information that may need to be disclosed to the market, such as by including continuous disclosure as a standing item on the board agenda.

 

1. Aristocrat; Sigma Pharmaceuticals; River City Motorway Group. 
2. Downer EDI; Multiplex.
3. Centro.
4. GPT.

Ten tips for AGM season

With the AGM season in full swing, we felt it was timely to highlight some key considerations in the lead up to, and when conducting, your AGM.

While for many, conducting an AGM is a straight-forward process, there are times when contentious issues arise.  Set out below are ten tips for managing an effective AGM, and strategies for dealing with anticipated and unexpected issues.

1. Be prepared

By now the location and timing of the meeting will be set (see our earlier post: Time to start thinking about your AGM), but the preparations for the AGM will be ongoing.  In addition to addresses from the chairman and CEO, this may include preparing a chairman’s script for the formal part of the meeting and considering responses to key questions that may be asked of directors and management, and potentially the auditor.  Hot topics this year include:

• board performance and review processes
• excessive remuneration
• independence of directors - including long standing directors, substantial shareholders or those who have commercial dealings with the company, and
• effective contribution of directors who hold multiple board roles.

2. Review your meeting procedures

In addition to a refresher on some of the relevant provisions of the constitution; it is worth reviewing some of the general commentaries on procedures for conducting the meeting.  For example, the ‘rules of debate’ or procedural motions (see Chapter 11 of The Chairman’s Red Book) can greatly assist in managing questions and discussion at the AGM.  

3. Get to the point

The ‘point of order’ is a particularly useful tool for alerting the chairman to a matter requiring their attention or correction during the AGM.  It takes precedence over the discussion taking place and must be ruled on by the chairman immediately.  For example, alerting the chairman to a reference to a special resolution which is actually an ordinary resolution.

4. Take the AGM notice as read

It is generally no longer necessary to ask a shareholder to move a resolution and ask another to second the motion.  At the beginning of the meeting the chairman should confirm their intention to ‘take the notice as read (unless shareholders object)’.  This assists to streamline the consideration of resolutions. 

5. Understand the voting exclusions

Understand the voting exclusions that apply to each resolution under the Corporations Act, the Listing Rules (if applicable) and, potentially, the company’s constitution.  This is likely to be particularly important for the remuneration report (for a listed company) and other remuneration-related resolutions.  The chairman should be advised and understand who are the ‘key management personnel’ in the room excluded from voting on such resolutions.

6. Plan for spills

The remuneration report – although now a familiar process for many in the listed environment, for companies that may face a ‘second strike’ at the AGM, processes should be in place for considering and voting on a spill resolution at the AGM.

7. Disclose proxies

Monitor and disclose proxies as an early warning signal of a potentially contentious item of business.  Disclosure of proxy results (e.g. on a PowerPoint) can also assist in reducing protracted debate in the room (e.g. if it is clear that the proxies are overwhelmingly in favour).  This may also include engagement with voters in the lead up to the AGM, such as if the usual participants have not returned their proxies.  At the same time, knowing who is in the room is also vital, with voting more commonly conducted on a show of hands at the AGM.

8. Be prepared for a poll

For listed companies and large unlisted companies, your share registry should be on hand to assist with a poll, but it is also good for the chairman to understand when it is best for a poll to be called and the key steps involved in the process (e.g. the requirement for an adjournment for the poll to be counted).  The timing of the poll is often essential to ensure that shareholder engagement is maintained.

9. Consider the timing of questions

This may include taking questions as each resolution is considered, during or after the addresses of the chairman and CEO, and/or deferring to the end of the meeting.  Although shareholders as a whole should be given a reasonable opportunity to participate and ask questions at the meeting, the chairman should be wary of a shareholder that seeks to dominate proceedings and know when to bring an end to discussions or limit the number of questions.  A useful method can be to refer a shareholder to appropriate board members or executives for further clarification following close of the meeting.

10. Consider your compliance requirements

For listed companies, ensure any presentations or addresses are released prior to the start of the meeting and the results of the AGM made available as soon as practicable following the close of the meeting.

Finally, this year has illustrated the ongoing importance of engaging with institutions and their proxy advisers.  This is often left too late and can result in adverse ‘strikes’ on the remuneration report or votes against director re-elections.  Post-AGM may be a good time to review any proxy patterns and the quieter time between AGM seasons more conducive to constructive discussion.

Time to start thinking about your AGM

Although it may seem that the AGM season is still some months away, for companies with a 30 June year end, the lead up to calling the AGM is fast approaching.

Set out below are some key considerations, tips and timeframes to think about when preparing for your AGM.

Corporations Act changes

This year has seen comparatively less regulatory change.  Accepted market practices have now developed around disclosure of chairman, ‘key management personnel’ and proxy voting restrictions.  However, practices for meeting procedures continue to evolve (including polling on the ‘remuneration report’ and in some cases, all resolutions).  You should consider your preferred approach for your AGM. 

New ASX Corporate Governance Principles

The Third Edition of the Corporate Governance Principles and Recommendations were recently released by the ASX Corporate Governance Council as referenced in our earlier post.
 

Although the new Principles and Recommendations are effective from the financial year ending 30 June 2015 (for companies with a 30 June balance date), some companies are seeking to adopt the Principles and Recommendations at an earlier date. 

For early adopters, this may have repercussions for the AGM.  For example, there is now a requirement that background checks be completed on new directors with the outcome of those checks to be disclosed in the notice of meeting.  If applicable, you should allow sufficient time for these checks (which may include police checks) to be completed.

Key steps and timeframes

The time required for preparing a notice of meeting and coordinating the mail out to shareholders is often underestimated. 

The following timeline may assist as a quick reference for the relevant steps (set out in further detail below):  



AGM timeframes - click to view larger image

1. Preparing the notice
   Depending on the number of resolutions that are expected, a prudent approach is to allow 3 to 4 weeks to prepare the notice of meeting.  Some possible resolutions to consider are summarised further below.
    
2. Meeting venue
   Many public companies tend to convene their AGM toward the end of November each year, which means adequate venues can be in short supply, particularly where large numbers of shareholders are expected to attend.  Brisbane based companies should also be aware that the G20 Summit in November will place additional demands on venues and accommodation.  You should ensure to book an appropriate venue well in advance of the preferred meeting date to avoid disappointment. 
    
3. Auditor
   A company’s auditor needs to be present at the AGM and available for a reasonable time for questions from the shareholders.  This means auditors will be attending a number of AGMs for other public companies in October and November.  You should make arrangements with your auditor early to avoid conflicts.
    
4. ASX review
   For a listed company, it is likely that the notice will need to be lodged with ASX for review before it is finalised and posted to shareholders.  ASX requires a minimum of five business days for its review.
   
   ASX becomes particularly busy toward the final five to six weeks of the AGM season and lodging documents early will ensure that sufficient time is provided for the ASX review.
    
5. ASIC review
   Certain matters of special business, including proposed related party benefit and/or financial assistance transactions, may require the notice and other documents to be given to ASIC for review.  ASIC generally has 14 days for its review. 
   
   For listed companies, an additional complicating factor is ASIC’s insistence on ‘final’ signed documents being lodged, which requires ASX’s review (5 business days) to occur before lodgment with ASIC.
    
6. Printing and postage
   Sufficient time also needs to be given for printing (e.g. 3 to 5 days) and postage (e.g. 2 to 3 days) and you should make appropriate arrangements with your share registry, public relations firm or printers (as required) at an early stage.
    
7. Notice period
   For a listed company, 28 clear days notice is required.  For an unlisted company it is 21 clear days.  For clear days you do not count the day of the mail out or the last day of the notice period (so, for example, 21 clear days is actually 23 days).

Resolutions

In addition to the usual resolutions (financial statements and reports, and retirement, appointment and/or re-election of directors), some other possible resolutions are: 

• related party benefit and/or financial assistance approvals
• increasing the directors’ fee pool, and
• pre-approval for any termination benefits for directors or key management personnel (e.g. the issue of performance rights, where such a benefit might trigger on termination in excess limits allowed by the Corporations Act).

 

For listed companies, also consider resolutions for:

• adoption of the remuneration report – this resolution will vary depending on whether the company has received a strike on its remuneration report at the prior AGM
• any issue of securities above the company’s 15% placement capacity (Listing Rule 7.1) or the ratification of previous allotments to refresh this capacity (Listing Rule 7.4)
• for companies outside the S&P/ASX 300 that also have a market capitalisation of $300 million or less, whether approval is sought for the additional 10% placement capacity (Listing Rule 7.1A) -  this requires a special resolution, which can only be obtained at the AGM, and
• any issue of securities to directors, which requires the approval of shareholders (Listing Rule 10.11, Listing Rule 10.14 and/or related party provisions of the Corporations Act).

No news is not good news - reform of Employee Share Scheme rules

Despite industry hopes that this year’s Federal Budget would include announcements on the Abbott Government’s plans for the overhaul of taxation on employee share schemes (ESS) in Australia the Government has delayed any announcement until later this year.

It is widely considered across the industry that existing barriers to the use of employee share schemes to reward employees (particularly in Australia’s technology and innovation sector) place companies operating in Australia at a competitive disadvantage to their overseas counterparts and that removing those barriers is critical to development of the industry in Australia. 

An effective employee share scheme regime allows start-ups to attract and retain talent at a time when they are cash poor.  Usually for these types of companies it is simply not possible to reward staff with salary commensurate with that offered by established businesses or industries and offering any salary shortfall in equity both rewards the employee (allowing them to share in the future success) and fosters a sense of ownership and participation. 

The intricacy surrounding the existing employee share scheme regime in Australia is not just a barrier to the use of such schemes for companies in the technology and innovation industries.  Companies in a range of industries all across Australia are hampered by the inherent complexity in the rules.

Overview of the current rules

The default position under the current rules is that each employee who is issued a share or a right to acquire a share (ESS interest) at a discount to market value must include that discount in their ordinary assessable income and pay tax on this amount at their marginal tax rate.

The time at which the ESS interest is taxed may, however, be deferred in certain circumstances – most commonly, where there is a real risk that the employee may forfeit or lose the interest.

The advantage of having a small amount taxed upfront upon the grant of the options is that once this occurs, the ESS tax provisions will no longer apply.  Instead, the capital gains tax (CGT) provisions will operate from that point forward.  This has two benefits:

• where the taxpayer is an individual or individual beneficiary of a trust, the CGT discount can be accessed for future increases in value (i.e. beyond that already taxed upfront under the ESS rules) subject to meeting the normal discount conditions, and
• any future taxing point will only arise when a CGT event occurs (normally when there is a disposal or other ‘cash-out’ event) and if this does not occur, deferral can be indefinite.

This may be contrasted with the deferral position.  When deferral ends (and the discount is potentially much higher, due to growth of the business) the discount is included in the employee’s assessable income and subject to tax at their marginal rate.

Importantly, the current regime does not allow the employee to choose upfront taxation in circumstances where the conditions for the deferral concession are satisfied (although it is possible to structure schemes that take advantage of the benefits of upfront taxation at a time when the value is low).

Barriers to implementation

The current complexity and regulation of the rules is the most significant barrier to the wide adoption of employee share schemes in Australia.  While there are some alternatives that can allow effective remuneration of key employees for start-ups or companies with high growth potential, due to their complexity (and cost) such plans are not effective to encourage broad participation by employees.

Although the rules provide valuation mechanisms, these cannot always be used.  In circumstances where the employer is not listed, the company needs to obtain a business valuation each time it wishes to issue shares to employees.  Obviously obtaining valuations of many start-ups is problematic or, at the very least, expensive.  Further, where incentive arrangements satisfy the conditions for the deferral concession to apply, there can be multiple valuation points, meaning significant compliance costs in obtaining valuations of the relevant interests at each time a deferral period ends for an employee.

The fact that employees are likely to be taxed upfront on the value of their shares, of itself, provides significant disincentive.  Where there is no market for those shares, the employee is stuck with an upfront tax liability in respect of an unrealised (and potentially unrealisable) investment.  Particularly relevant to start-ups is the risk that an employee will be left with an upfront tax liability in respect of a venture that may fail and shares that are ultimately worthless. 

Even in circumstances where the employee is able to sell shares to meet any upfront tax liability the result is equivalent to paying a cash bonus or salary and the executive using the after cash amount to fund an acquisition of shares at market price.  While this may well be the economic goal of the provisions, it is hardly a means to encourage share ownership.

Whilst this scenario is problematic for a listed company, it is even worse for a private company or entity in which there is no liquidity or available market to dispose of the shares.  In either case, the use of employee share schemes to provide significant benefits to employees that do not qualify for the deferral concession are rare.

Although it is possible to structure an employee share scheme around the obvious complexity in the existing regime, this of itself can produce a scheme that is both costly, complex and in certain industries, may not provide employees with the incentive sought by implementation of the scheme in the first place.

Where to from here?

Treasury released a discussion paper in August 2013 seeking input in respect of the application of the employee share schemes for ‘start-up companies’.  While the paper originally had a closing date for submissions of 30 August 2013, the consultation process was put on hold due to the Federal election and there has been no further announcement from the Government as to the proposed time line for reform of the employee share scheme regime.

Arguably, the proposals in the paper remain highly restrictive when compared to international comparisons (with which the measures are designed to compete for attraction and retention of talent).  In any event, the paper focuses only on the use of employee share schemes by start-ups with the concessions proposed restricted to businesses with a turnover of less than $5 million and 15 or fewer employees meaning that concessions are effectively restricted to ‘small businesses’.

If the Government did proceed with the arrangement and sought to implement some or all of the proposals in full, there would still remain a substantive competitive disadvantage of Australia compared to other overseas incentives, such as those in the UK, US and Singapore: 

• in Singapore a 75% exemption is provided for up to SGD$10 million in value received by an employee over a 10 year period
• in the UK, the concession allows up to £120,000 per employee and £3 million per employer to be granted without tax and without National Insurance Contributions paid on exercise, and 
• the US employee share arrangements (which are not limited to start up or speculative companies) provide for options of up to $100,000 a year per employee to be issued and stock purchase plans of $25,000 per year per employee, which are not taxed when granted or exercised.  Taxation only occurs when the stock is sold and, if held for one year from the date of purchase and two years from the date of granting in respect of options, CGT rates are available.

 

It goes without saying that both the current and proposed employee share scheme tax incentives in Australia are substantially more restrictive and less generous than a number of our overseas peers and a full review of the regime is warranted.

 

It is envisaged that the Government will announce proposed changes to the rules later this year.  For companies that do not have the luxury of waiting this long, there are still structures available to optimise the effectiveness of an employee share scheme and tailored advice should be sought prior to implementation.

Melinda Peters, Hayden Bentley

ASX releases new Corporate Governance Principles

Yesterday, the ASX Corporate Governance Council released the third edition of its Corporate Governance Principles and Recommendations.  The new principles will take effect for a listed entity's first full financial year commencing on or after 1 July 2014.

The release marks the first major revision of key Australian corporate governance principles since the GFC and follows the issuing of draft principles and a consultation process examined in an earlier post last August.

The Corporate Governance Principles and Recommendations are available to view at:
http://www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-3rd-edn.pdf.

The new Australian Privacy Principles – Is your organisation compliant?

On 12 March 2014, fundamental changes to Australian privacy laws will take effect. The changes introduce new rules about how organisations collect and store personal information.  With penalties up to $1.7 million enforceable for serious breaches, organisations must act now to ensure compliance. 

As part of the privacy law reform process, the Privacy Amendment (Enhancing Privacy Protection) Act 2012 (Privacy Amendment Act) was introduced to Parliament in May 2012  marking significant changes to the Privacy Act 1988 (Cth) (Privacy Act).

The changes to the Privacy Act include a new set of harmonised privacy principles that regulate the collection and handling of personal information called the Australian Privacy Principles (APPs) applying to most organisations who turn over $3 million or more annually, and to Commonwealth Government agencies.  The APPs will replace the National Privacy Principles that apply to businesses and the Information Privacy Principles that apply to Government agencies.

To some extent, the APPs are based on the existing privacy principles but now impose additional obligations on organisations when dealing with personal information.  In particular, the APPs require organisations to provide additional discloses in their privacy documentation and internal procedures and policies ensuring the protection and ongoing quality of personal information that they use and store. 

APPs are legally binding principles and aim to be the cornerstone of the privacy protection framework in the Privacy Act, by setting out uniform standards for dealing with personal information.  The APPs are structured to reflect the personal information life cycle and are grouped into five parts, including:

• the consideration of personal information
• collection of personal information
• dealing with personal information
• integrity of personal information, and
• access to, and correction of personal information. 

Under the Privacy Amendment Act, the Information Commissioner receives new powers to seek civil penalties of up to $1.7 million from organisations who commit serious or repeated breaches of privacy. The Information Commissioner may also conduct ‘own motion’ privacy investigations on organisations without first receiving a privacy complaint from a member of the public.  

The Privacy Amendment Act also implements changes to credit reporting laws, including the introduction of more comprehensive reporting about an individual’s current credit commitments and repayment history information.  The credit reporting changes are also supplemented by a new credit reporting code. 

While the Office of the Australian Information Commissioner has released APP guidelines to assist organisations with the transition to the APPs (which must occur on or before 12 March 2014), it will be interesting to see how and when the Information Commissioner exercises its new powers in relation to privacy compliance.  Under the APPs, it will therefore be important for relevant organisations to consider their existing information policies, review and update their privacy documents and develop internal procedures to ensure compliance by 12 March 2014.

Alex Hutchens, Stephanie Parkin

ASX to introduce online processing for certain corporate actions

In an effort to streamline the announcement process for certain corporate actions, for listed entities, the ASX is proposing the introduction of an online straight-through processing (STP) facility, replacing the current practice of requiring corporate actions to be completed on ASX forms and uploaded as PDF documents.  The initiative will require a change in process for listed entities for the announcement of certain events such as the announcement of a dividend/distribution or a reorganisation of capital. 

Once a corporate action is submitted, the system will automatically generate a PDF and release the announcement to the market.  With more than 110,000 corporate actions announced each year, it is hoped the STP facility will improve the efficiency and timely release of the relevant company data.

The proposed implementation date for the STP is 14 April 2014 (with a six-month grace period in which ASX will encourage, but not enforce, use of the online forms).  ASX will also offer listed entities a facility to test the new system in January and February 2014.

For further details, please refer to the ASX website.

Directors entitled to defence cost coverage under D&O insurance

Company directors and officers can take some comfort that the Australian courts have recognised their entitlement to access insurance cover for defence costs in the event of a claim under Directors and Officers Liability (D&O) insurance policies. 

The Chairman’s Red Book (page 67) made reference to the New Zealand judgment in Bridgecorp which held that a charge could be brought by plaintiffs in class action proceedings to preserve the funds available under D&O insurance for their potential benefit.  The application of such a charge would deny the defendant directors and executives access to insurance cover for defence costs incurred in defending the class action proceedings.  This judgment was overturned on appeal with the NZ Court of Appeal recognising the two distinct limbs of cover applicable under D&O policies - being defence costs cover and the legal liability cover for damages, judgments or settlements.

These cases were relevant to directors and officers in Australia because the same legislative provisions applicable in New Zealand, to enable a charge to be imposed on the proceeds of an insurance policy, are applicable in New South Wales, Tasmania and the ACT.

On 11 July 2013, the NSW Court of Appeal considered the opportunity for class action plaintiffs to bring a charge over the proceeds of D&O insurance policies held by directors and executives of the now collapsed Great Southern Group.  Beneficially, the Court drew a clear distinction between the two separate covers under D&O insurance policies and recognised the importance of directors and officers accessing defence costs under D&O policies.

The Court did not entirely rule out the possibility for a charge to be imposed over the proceeds of a D&O policy.  However, it noted that any award of damages against a director or officer covered under a D&O policy would necessarily follow the incurring of defence costs to which a director or officer was entitled to cover in priority to the proceeds subject to a charge.  The Court also recognised that a director’s entitlement to insurance cover to mount a vigorous defence to legal proceedings, and potentially reduce or eliminate any ultimate award of damages against the director, was equally advantageous for insurers who advanced the defence costs coverage.

While this most recent judgment has provided clarity on the issue of directors and officers entitlement to defence costs under D&O policies, it has also highlighted the necessity for directors and officers to be aware of potential ‘internal’ competition to the limited amount of cover available under these policies.

D&O policies rarely contain a priority of payment or preservation provision to ensure cover is always available for directors and officers.  This is especially critical if the D&O policy also affords cover to the corporate entity, as well as the directors and officers, which is often the case.  Similarly, the D&O coverage may ‘compete’ for or be tied to a limit of liability which is also applicable to professional indemnity, crime or other classes of insurance.

For these reasons, directors and officers should investigate and have a clear understanding of the cover, placement and structure of their D&O insurance policy.

Diana Masen

Diana is a Senior Associate at McCullough Robertson

Update to ASX Corporate Governance Principles and Recommendations – overhaul of approach or maintaining the status quo?

On 16 August 2013, as has been anticipated, the ASX Corporate Governance Council (CGC) released a consultation paper for a draft third edition of its Corporate Governance Principles and Recommendations (Principles and Recommendations).  This was released together with a separate consultation paper on Proposed Changes to ASX Listing Rules and Guidance Note 9, to supplement the proposed new Principles and Recommendations.

Although there have been some amendments to the second edition of the Principles and Recommendations (e.g. in relation to diversity initiatives), the draft third edition represents the first comprehensive review of the Principles and Recommendations since 2007 and, importantly, represents the first major redraft of key Australian corporate governance principles since the GFC.

The impact of the GFC is clearly seen in the new draft Principles and Recommendations, with an overarching focus by CGC on risk management and the importance of the board of directors having a greater degree of involvement and oversight in the adoption and implementation of corporate governance policies and procedures.  There is also a focus on encouraging the availability of corporate governance materials on a company’s website, rather than as a prescriptive requirement for the annual report.

The eight key principles enshrined in the Principles and Recommendations, together with the ‘if not, why not’ approach to reporting on corporate governance practices, have been retained in the draft third edition.  The overarching approach to corporate governance issues is therefore unlikely to alter.  However, the amendments to certain key principles and the approach to disclosure of corporate governance practices have received detailed attention, and it is worth reviewing the respective consultation papers to get a feel for these changes.

Some of the key proposed and/or interesting changes are:

To the Corporate Governance Principles and Recommendations:

• A new recommendation 1.2(a) requiring a listed entity to undertake appropriate checks for an incoming director and to provide shareholders with all material information relevant to that person’s appointment.  This will act to supplement the relatively new admission requirement that a listed entity must show each director or proposed director is of ‘good fame and character’.

• The diversity-related recommendations have been moved from principle 3 to principle 1 (relating to laying foundations for management and oversight), as CGC considers that the previous location of these recommendations resulted in confusion.  This is to be supplemented with a requirement that an entity report on the proportion of female employees in the whole organisation, in senior executive positions and on the board of directors.

• More extensive guidance in relation to the ‘independence’ of directors has been included, to specifically include close family ties and service on the board for more than 9 years as indicators that a director may not be independent. 

• Wording has been included in principle 3 on the importance of an entity promoting decision-making that creates ‘long-term value’ for security holders.  Combined with a new recommendation 7.3, relating to a listed entity disclosing how it has regard to environmental and social sustainability risks, there is a clear focus by the CGC on a move towards integrated financial reporting, as has recently been a focus of ASIC (see our comments in the blog dated 2 July 2013).

• Principle 4 has been updated to provide for ‘formal and rigorous’ processes for financial reporting (which we expect is derived from recent cases such as the Centro decision). 

• In relation to remuneration, CGC has provided a new recommendation for implementation of a ‘clawback policy’, which sets out when an entity may clawback performance-based remuneration for its senior executives (e.g. if there is a material misstatement of financial results).  This reflects relatively recent legislation proposed by the Australian Government.  The approach by CGC, that this is a matter best dealt with through an ‘if not, why not’ regime, rather than specifically through legislation, seems sensible – particularly in light of the complexities that have been faced by listed entities through the advent of the ‘two-strikes’ rule and other remuneration-related provisions of the Corporations Act.

To the ASX Listing Rules and Guidance Note 9:

• Listing Rule 4.10.3 is to be amended to give greater flexibility for listed entities to make their corporate governance disclosures either in the annual report or on their website, and to make clear that an entity should disclose if it has not followed a recommendation for any part of the reporting period.  There is also an added requirement for an entity to state that the corporate governance statement has been approved by the board of directors, to ensure it receives appropriate focus at board level.

• Perhaps the most significant change from an administrative viewpoint, is the proposed introduction of a new ASX form (Appendix 4G) to be completed and lodged with ASX each year (at the same time as the annual report).  This is intended to provide a key to assist investors and other stakeholders in locating an entity’s various corporate governance disclosures, recognising the flexibility being given by the amendments so that an entity’s corporate governance statements may not be in a single location on the company’s website or dealt with exclusively in the company’s annual report.  ASX has also indicated its hope that the Appendix 4G will act as a verification tool and reduce concerns in relation to standardised boilerplate documents.  We question whether the new Appendix 4G will achieve this outcome or simply become an additional administrative burden for entities during an already busy reporting period.

• Although not directly governance-related, ASX is proposing to introduce a new Listing Rule 3.19B requiring specific disclosure of on-market purchases of securities (i.e. through a trustee structure) on behalf of employees, directors or their related parties within 5 business days.  ASX has indicated that, although it does not consider security holder approval is required, it is appropriate for disclosure to be made to the market, for such transactions.

• Additional guidance has also been provided to highlight how the Principles and Recommendations apply differently to externally managed listed entities.

The majority of the changes are intended to become effective on 1 July 2014, with some of the amendments to the ASX Listing Rules to come in earlier (on 1 January 2014).  ASX and the CGC have asked for comments by 15 November 2013.  We will be collating any responses received from our clients on the consultation papers and considering appropriate submissions to make to ASX and CGC.  We will also continue to monitor and comment on the developments in this area, which will result in a revised Chapter 4 of The Chairman’s Red Book in due course.