Essential Corporate News: Week ending January 10, 2020

FRC: Annual review of the UK Corporate Governance Code

On January 9, 2020, the Financial Reporting Council (FRC) published a report which both assesses corporate governance in the UK by considering the quality of reporting against the 2016 UK Corporate Governance Code (2016 Code) and comments on the FTSE 100 “early adopters” of the UK 2018 Corporate Governance Code (2018 Code). The report notes that the FRC expects to see a much greater focus in future annual reports on the activities and outcomes of implementing the Principles of the 2018 Code, particularly on the board’s effectiveness and decision-making, and how this has led to sustainable benefits for shareholders and wider stakeholders.

2016 Code compliance

Key points to note include the following:

• Compliance with the 2016 Code – This remains high. Provisions B.1.2 (at least half the board, excluding the chair, should be independent) and A.3.1 (where the chair did not on appointment, meet the independence criteria set out in the Code or where the CEO goes on to be chair) were the Provisions least complied with. The FRC reminds companies that an explanation for non-compliance with Code Provisions should set out the background, provide a clear rationale for the action being taken, and describe any mitigating activities. Explanations should also be sufficiently clear to be convincing and understandable to all shareholders without the need to contact the company.
• Relations with shareholders and Provision E.2.2 in the 2016 Code - The FRC is concerned that there are several “repeat offenders” on the Investment Association’s Public Register (companies who have appeared on the Public Register for two consecutive years). The FRC notes that it expects improvements in 2020 in relation to the increased disclosure required by Provision 4 of the 2018 Code and the FRC expects companies to view all types of votes (including abstentions) when considering whether there has been any significant minority dissent to a resolution.
• Viability statements - The FRC notes that since the introduction of the Provision requiring companies to consider how solvency, liquidity or other risks may impact the long-term viability of the business, reporting against the relevant Provisions has not produced the future insights the FRC envisaged. It strongly suggests that companies take time to consider the Financial Reporting Lab Report “Risk and viability reporting” to assist future reporting and notes that it will be reviewing its own guidance on Risk Management, Internal Controls and Related Financial and Business Reporting following the reviews by Sir John Kingman and Sir Donald Brydon which both made recommendations in relation to the viability statement.

Early adoption of the 2018 Code

Key points to note include the following:

• Purpose and culture - In terms of the “purpose of a company,” the FRC notes that the best reporting described purpose by considering it alongside culture and strategy in a way that demonstrated the company had thought about purpose effectively. In relation to corporate culture, the FRC notes that it was disappointing that only a small number of boards disclosed that they already receive reports on culture to aid discussions. Some companies reporting on their behaviours referred to requirements in their Code of Conduct. The FRC would like companies to consider whether these are seen by employees as a set of rules to follow rather than aspirations that achieve a healthy culture. Annual reports should demonstrate that such Codes of Conduct articulate the values that companies wish to foster in both leaders and employees and in doing so define appropriate behaviours. The report notes that overall, there was limited discussion of assessing and monitoring cultures. The FRC expects that work on assessing and monitoring culture would have been further considered during 2019 and so there should be more details in future annual reports.
• Workforce engagement - The report notes that reporting on current approaches to engagement was wide-ranging, with companies explaining that many different approaches were used, from staff surveys to annual general meetings, to inviting employees to attend board meetings to discuss specific issues. Where companies stated which method they will use for engagement with the workforce, it was not clear that much thought had been given to the effectiveness of the method chosen. For example, where companies reported that site visits were a good way to increase engagement by non-executive directors, there was limited disclosure of how the information gleaned from such visits was fed into wider board discussion and whether it impacted on future strategy, culture, risk or other such matters. When the FRC analyses reports in 2020, it will be looking to determine how effective engagement with the workforce has been. 2020 reports should make it clear how the methods used have achieved the objective of Provision 5 in the 2018 Code and include details or examples of what a company has done to consider and if appropriate, take forward the matters raised by the workforce.
• Section 172 reporting - Most companies reviewed identified their key stakeholders, reported on their engagement with communities and their work on sustainability, detailed engagement with specific events or offered support across a community. Many also highlighted the use of customer satisfaction surveys to gather stakeholder data. However, there was limited discussion of the issues that were important to or raised by stakeholders and consequently to what extent boards had considered these and the impact they had made to strategy. Reporting must cover the concerns raised by stakeholders, how companies have understood the issues, and how they have thought carefully about how these impact on the long-term success of the company.
• Succession planning - The reports reviewed by the FRC lacked detail on this, with many companies focusing on their appointment process rather than providing information on how they plan for the various types of succession that exist. In justifying the re-election of board members in AGM notices, many notices simply listed the biographies of each individual. The FRC notes that the best notices clearly outline the reasons for an individual’s re-election, specifically linking their contributions to company strategy, risks or similar key issues referenced in the annual report and the FRC will expect more companies to consider Provision 18 of the 2018 Code in detail for 2020 AGM notices.
• Diversity - The FRC notes that in the annual reports reviewed, it was not always clear whether there were targets related to diversity at board and senior management level and, if so, what actions were being taken to achieve these targets or wider objectives. This is something that the FRC will look more closely at in light of the requirements in Provision 23 of the 2018 Code. The FRC also notes that there was limited reporting of diversity beyond gender. It will expect to see a more detailed commentary on all aspects of diversity in future disclosures.
• Remuneration - In some of the reports reviewed, there was movement toward use of additional non-financial metrics, such as diversity, culture and health and safety targets, in relation to the measurements for annual bonus and LTIP awards. Better practice examples included strategic or individual non-financial KPIs that aligned with long-term horizons and specified the use of vesting periods for incentives. The FRC encourages the inclusion of non-financial metrics as a valuable measurement to achieve long-term success. In relation to Provision 33 of the 2018 Code, the FRC notes that a clear majority of companies sampled did not provide any information in their annual reports about engagement with the wider workforce in terms of executive remuneration. The 2020 annual report should offer much more detail on both the way in which remuneration committees have engaged with the workforce, and importantly the effectiveness of this engagement.
• Pension arrangements - The FRC expects change in this area given that many remuneration policies will be put to shareholders for approval in 2020. In the context of Provision 38 of the 2018 Code which requires pension contribution rates for executive directors, or payments in lieu, to be aligned with those available to the workforce, the report notes that some companies have outlined their pension contribution rates but not explained how they will align them with their workforce or what their workforce’s pension contribution rate is. Others are yet to disclose the pension contribution rates of their executive directors of their workforce.

(FRC, Annual Review of the UK Corporate Governance Code, 09.01.20)

FCA: Final notice for PDMR's failure to notify share dealings under MAR

On December 20, 2019, the Financial Conduct Authority (FCA) published a final notice in which it imposed a £45,000 penalty on Mr Kevin Gorman for failing to notify his employer, Braemar Shipping Services plc (a listed company) and the FCA of share dealings conducted on his own account in Braemar’s shares as required by Article 19(1) of the Market Abuse Regulation (MAR).

While not a main board director, Mr Gorman was a senior employee who was the managing director of one of Braemar’s divisions and who sat on Braemar’s Executive Committee. Braemar considered him to fall within MAR's definition of a person discharging managerial responsibilities (PDMR) in light of his regular access to inside information about Braemar, and informed him of this. The final notice states that, as a member of the Executive Committee, he received the Group Management Accounts monthly and board-level, confidential information was discussed at its meetings so he had or was likely to have inside information. In light of these facts the FCA considered that Mr Gorman was a PDMR for MAR purposes.

As a PDMR selling shares on three occasions between August 2016 and January 2017, Mr Gorman should have notified Braemar (and sought clearance to deal in accordance with its own dealing code and policies) and the FCA promptly and no later than three business days after each transaction. He failed to do so and only notified the third trade after Braemar reminded employees about its share dealing policy. The first two trades only came to light as a result of the FCA’s investigations.

Since the breaches of Article 19(1) MAR occurred while Mr Gorman was employed by Braemar, the penalty was determined by reference to his remuneration income during the 12 month period preceding the end of the breaches and it was assessed as 10 per cent of that figure. As a result, the penalty would have been £64,300 had he not qualified for a 30 per cent discount under the FCA's executive settlement procedures. One factor that mitigated the breach was the fact that he notified the third breach as soon as he was reminded of his obligations as a PDMR by Braemar (he claimed he thought the first trade occurred before he was identified as a PDMR and had forgotten about the second trade).

This is the first enforcement action taken by the FCA for a breach of Article 19(1) of MAR. The FCA stresses in the final notice the benefits that accrue from compliance with Article 19(1) to investors, an issuer’s shareholders and the FCA in meeting its statutory objectives.

(FCA: Final notice for PDMR's failure to notify share dealings under MAR, 20.12.19)

(FCA: Final notice for PDMR's failure to notify share dealings under MAR – press release, 20.12.19)