In this article, the second in our series on Executive Remuneration, we provide guidance for organisations considering new senior appointments, potentially to take a new direction in the wake of COVID.
With news of a vaccine breakthrough, optimism in the UK has risen and Boards are turning to plans for 2021. Many seek solutions to counter the unprecedented effects of COVID. Amidst strategies to pivot, diversify or restructure, appointments to the Board and other senior roles may be high on the agenda. However, this is a decision which cannot be taken lightly: a considered approach is needed.
When selecting a candidate, the impact on the long-term success of the organisation is key and the ability to drive a top-down healthy culture is an important attribute. Compliance with the organisation’s many obligations, particularly when listed or regulated, while also factoring in mandatory timescales is critical. This article is an overview of the main legal and regulatory points, but also addresses topical issues and practicalities relevant to making a senior appointment in the current climate.
A raft of requirements
Before making any senior appointment there are lots of things to consider.
When making changes to its Board, UK listed companies must to adhere to the Listing Rules of the Financial Conduct Authority (FCA) and the UK Corporate Governance Code of the Financial Reporting Council (FRC). The applicability of the Market Abuse Regulation (MAR) should also be considered (as details of a senior appointment would likely count as inside information). More generally, and particularly when appointing new directors, it is important to remember the Companies Act 2006 compliance requirements, which sit alongside (and are not replaced by) the Listing Rules. If a UK company is owned by a company that is listed overseas, it is likely to be subject to the overseas listing rules.
If a UK entity is regulated by the FCA or PRA, there are also regulatory requirements, including those under the Senior Managers and Certification Regime (SMCR) relating to fitness and propriety assessments and applicable remuneration requirements. If a company operates in a sector that has a regulator other than the FCA or PRA (e.g. water or electricity), then it may also be subject to additional (usually regulator set) rules.
And on top of all of this, a fair, non-discriminatory hiring process must be followed in accordance with the Equality Act 2010.
A diverse pool of candidates
Let’s start at the very beginning which we hear is a very good place to start! Are you drawing from a diverse candidate pool? Historically, diversity has been the domain of HR, but it is now a Board issue too. Driving a diverse and inclusive culture should now feature on your agenda. The commercial risks of inertia in this space have increased as momentum on diversity-related matters gathered pace in 2020.
In July, the FCA warned that director appointments could be blocked if companies fail to hire more women and ethnic minority candidates in senior roles. In December, the NASDAQ exchange operator in the US proposed new rules that would require Boards of its listed companies to meet certain minimum diversity requirements or explain in a public disclosure why they aren’t doing so. Given this trajectory, Boards may need to embrace inclusion and diversity initiatives with renewed rigour in 2021.
Accordingly, when appointing Board members or executives, selecting a shortlist from a diverse candidate pool with an eye on their ability to promote a positive organisational culture is crucial. This is a topic in itself, so look out for a separate article later in the series.
An appropriate offer
Have you identified a strong candidate? If so, let’s move on to making them an offer. What is appropriate, in the current climate? There is no easy answer. The perpetual challenge of securing top talent with an attractive financial package, simultaneously designed to motivate and stimulate growth whilst rewarding actual performance, remains prevalent. Arguably, this tension is now more acute as remuneration committees increasingly have formal responsibility for all senior management remuneration.
The trick is to strike a balance between attracting and incentivising a candidate, on one hand, and adhering to the company’s reward structure and cultural fit, on the other hand, although there is no universal solution that does this. Transparent structures and open dialogue with shareholders and other key stakeholders remain more important than ever.
Hot topics around executive pay that remuneration committees grappled with pre-COVID have not gone away. They include CEO pay ratios and alignment of executives’ pensions contributions with those of the wider workforce. In some ways, COVID has brought perceived disproportionality of executive pay into focus, fuelled by media assertions of “unfair” reward packages. Controversial headlines regarding payouts of high value senior LTIP or bonus awards, despite much of the workforce being furloughed, echo the media backlash in the wake of the 2008 financial crash, when companies were accused of paying “fat cat” packages, despite Government bailouts.
Accordingly, matching executive reward packages with robust approval processes, is important – particularly for remuneration committees. This, coupled with flexibility in the drafting of senior employee service agreements to ensure absolute discretion on bonus and incentive arrangements, is key to protecting companies in this space.
Short-term gain, long-term commitment
How can you incentivise now to inspire growth later? Pre-COVID, incoming executives often received an offer package including a “buy out” of the unvested stock awards that they were leaving behind, in the form of high-value sign-on bonuses and/or share awards with vesting dates to mirror forfeited stock. We anticipate that these will continue to be deemed a justifiable cost of “landing” the best person for the role, and therefore seen as being in the interests of the company and shareholders. This is especially so in sectors like life sciences that have profited from COVID, although not in all circumstances. For example, there could be adverse publicity if it were to become public knowledge that a company taking advantage of tax breaks and furlough payments terminated the employment of an executive, paid them a generous termination package, and then hired a new executive, rewarding them with a large buy-out payment.
With regard to longer-term remuneration, potential opportunities to earn high value cash awards are likely to be minimised. Forward-looking reward packages, including long-term incentives coupled with short-term performance targets linked to a successful COVID-recovery strategy, may hit the mark. Care should also be taken to ensure that long-term incentive arrangements do not unduly reward executives for any post-COVID rebound in share prices and remuneration committees should ensure that they have the power to cap future pay-outs.
Shareholder advisory bodies will no doubt continue to shine a light on generous long-term incentives that are not subject to stretching performance targets. We anticipate that there will be greater focus on the use of targets that measure corporate social performance, particularly around diversity and environmental credentials. In appropriate circumstances, there may also be calls to move away from performance-based awards to consider less generous restricted share plans that reward loyalty and long-term, sustainable performance.
For more information on determining a senior executive’s reward package in light of COVID, see our previous Executive Remuneration Law-Now.
Announcements – when the time is right
If the offer is accepted, can you get news of your exciting new hire “out there”? Not yet. Well-timed internal and external comms are always advisable, but particularly so in an unstable market where employee and media relations are sensitive. Board level comings and goings can have huge PR implications and affect staff morale, investor relations and share price. The arrival of a new “boss” is also likely to lead to uncertainty and nervousness on the part of their reports. So, planning when and how to go public is key. There are some clear legal and regulatory factors which will impact on timing.
Listed companies are subject to two specific obligations to disclose the details of changes to Board-level (and arguably senior management) roles. Under the MAR, the basic obligation is to announce inside information ASAP. Under the Listing Rules, the obligation is to announce appointments or removals ASAP or by the end of the business day following the decision (with prescribed information about the individual to follow within 5 days).
Listed companies therefore have to manage the process of new hires and departures carefully to avoid required announcements. This is another delicate balancing act. Determining when to go public on a new senior appointment involves balancing the obligation to announce inside information against a desire to have everything sorted before doing so. There is a clear requirement to announce the appointment as soon as it is ‘decided’, although there is a lengthy decision-making process leading to a final decision so there is an area of grey to navigate. Triggering public announcements at inopportune moments, and particularly before all the terms and conditions of the new appointment (along with those of exits or sideways moves to make way for the new hire) have been agreed is certainly to be avoided.
Regulatory check points
Do the regulators need to know? Yes. In the UK, FCA/PRA regulated entities must be satisfied as to the executive’s fitness and propriety before appointing them. For all new hires, and for certain internal transfers, regulatory references must be obtained. Under the SMCR, if the role is a Senior Management Function regulatory approval is also needed before the individual carries out any regulated functions. The FCA must grant or refuse approval within 90 days and this cannot be expedited (although the clock “stops” if an application is incomplete). In practice, it will often take the FCA less than 90 days, but remember to factor this period into the timing of a senior appointment to avoid releasing misleading announcements pre-approval.
This doesn’t need to hold you up though. Provisions in the offer letter stating that the appointment is subject to regulatory approval and regulatory references will enable other aspects of the hire to progress in tandem. In some cases, full Board approval of the appointment will be needed, so check the dates of pre-diarised Board meetings well in advance to get this on the agenda in good time. For listed companies, it may also be prudent to seek advance feedback on a candidate through shareholder consultation, which would also need to be built into the timeline.
Employment law angle
Can your star hire start right away, potentially bringing their team with them too? Unlikely. When it comes to these sorts of practicalities, care must be taken not to induce a breach of restrictive covenants owed by the candidate to their former employer, particularly non-compete or non-solicitation obligations. You could face a costly injunction if you don’t. Check notice obligations and whether there is any period of garden leave when planning lead-in time.
As mentioned, paving the way for a new senior appointment may include the sideways move or exit of an employee currently in the role who will owe similar obligations to your organisation. Dealing with this commercially may involve sensitive negotiations, which can become protracted if not managed properly.
Lastly, what are the contractual terms you should really care about? When drafting the new service agreement, the most important general provisions will be those protecting your business interests, e.g. director’s duties, notice/termination provisions, preservation of confidential information and post-termination restrictive covenants. From an executive remuneration perspective, contractual documentation should always align with plan rules and cross-refer to “eligibility for” (over “entitlement to”) incentive awards, applying absolute discretion wherever possible. This prevents the organisation from being contractually bound to making future awards, which always brings peace of mind – whether you are battling a global pandemic or not.
When making a senior appointment do not act in haste and repent at leisure! Instead:
1. Address specifics of the role and ability to drive positive organisational culture of inclusion and diversity at the outset when dealing with recruiters.
2. Plan for the practicalities presented by overlapping legal and regulatory requirements and align timescales accordingly.
3. Consider reward in the short-term and long-term to make an appropriate offer, adhering to responsibilities of the organisation and the remuneration committee in doing so.
4. Announce the appointment (in accordance with timing requirements), preferably with any incumbent exiting the business under the terms of a settlement agreement. For more on this topic, look out for our next article in the Executive Remuneration series which will cover senior exits.