Post-exit shareholding requirements

The majority of FTSE Main Market listed companies operate some form of post-cessation shareholding requirement for their executive directors. However, practice remains mixed as to how such provisions have been introduced and the extent to which they are legally enforceable. This briefing note has been prepared jointly by Ellason and the share plan implementation team at Pinsent Masons, to assist Remuneration Committees and HR teams in the design and implementation of post-cessation shareholding requirements.

What is the purpose of a post-cessation shareholding requirement?

The concept behind a post-cessation shareholding requirement is to encourage executives to have a focus on the long-term, sustainable performance of the company beyond their immediate tenure, by requiring them to continue to hold shares in the company for a period after they have left. The concept gained prominence in the UK in the mid-2010s after a series of high profile corporate collapses, and is designed to avoid executives being able to sell their entire shareholding immediately on departure.

Are such requirements mandatory?

The UK Corporate Governance Code, which operates on a ‘comply or explain’ basis, has since 2018 encouraged all premium-listed FTSE companies to have a formal policy in place on post-cessation shareholdings. This recommendation is also reflected in wider investor guidance on executive pay.

What is the guidance from the Investment Association?

The Investment Association’s Principles of Remuneration recommend that the post cessation holding requirement should apply for at least two years post cessation at a level equal to the lower of the shareholding requirement immediately prior to the departure and the actual shareholding on departure. IVIS will issue an ‘amber top’ for companies where this is not the case.

The latest Principles also encourage remuneration committees to ensure the enforceability of post cessation shareholding requirements, by incorporating the requirements into executive service contracts or the terms and conditions of long-term incentives.

What are most companies doing?

The majority of FTSE350 and SmallCap companies have adopted formal policies on post-cessation shareholdings, in most cases extending for two years following cessation of employment.

In the FTSE100, the majority of companies (c.81%) set the required holding level at the same level as the in-post holding requirement over the full two-year period. However, a sizeable minority of the SmallCap (c.34%) apply a lower holding requirement in the second year.

Some companies, typically where the in post requirement is higher than the norm, require a lower level of holding post cessation than the in-post requirement from the start.

Post-cessation holding requirements are not widely adopted by AIM companies.

Disclosure on how such requirements are to be enforced remains mixed at present, but greater transparency is expected as a result of the increasing focus on this area by the Investment Association and its members.

How should the requirements be enforced?

There are a variety of different approaches to enforcement.

As a minimum, companies should consider making the post-cessation holding requirement a binding, contractual arrangement. In line with the suggestion in the latest IA Principles, this can be achieved either by way of a specific contractual agreement with the relevant executives, or by amending the rules of any LTIP or deferred share bonus plans to make the post-cessation holding requirement an additional term of any vested LTIP or deferred share bonus awards.

However, merely placing the post-cessation holding requirement on a contractual footing will be toothless unless it is supported by a mechanism for enforcing compliance. Whilst it might be possible to sue a defaulting executive for breaching a contractual post-cessation holding requirement, it is not clear that the company would be able to demonstrate that it has suffered a loss as a result, which would be a pre-condition of a successful contractual claim. The Remuneration Committee will also need to consider whether it is in the best interests of the company to spend time, money and effort in pursuing a defaulting executive through the courts.

To mitigate the practical limitations of enforcing a contractual post-cessation holding requirement, many companies are also requiring executives to place any shares which they receive in connection with vested LTIP or deferred share bonus awards (up to the shareholding limit) into an employer-funded corporate nominee account and requiring those shares to be held in that account for the duration of the post-cessation holding period. Whilst the post-cessation holding requirement (and, for that matter, any in-employment holding requirement) applies, the company has oversight and control of any requested sales or transfers of the shares held within the nominee account. Alternatively, the company could require the legal title to the relevant shares to be held by the trustee of an employee benefit trust (acting as a bare trustee on behalf of the relevant executive) – most trustees are now offering this service. This has the advantage that, should the shares be forfeited for any reason (e.g. the application of clawback), they can then be held by the trustee as part of the general trust fund.

How should the shares be valued?

For in-post holding requirements, companies will often calculate the value of the holding by reference to the prevailing share price. For the post-cessation requirement, it is simpler to fix the holding as a specific number of the shares at the point of cessation. The executive remains exposed to the share price after leaving (by virtue of the set holding requirement) but does not need to buy more shares if the share price falls, or equally cannot sell shares if the price rises. This approach provides greater certainty for the company and the executive of the number of shares to be held. We are aware of some companies, however, who allow good leavers to sell shares in the event the share price rises after they leave.

Which shares should count towards the requirement?

The post-cessation holding requirement would typically cover all shares which have vested from incentive schemes (net of tax), including those that may still be subject to additional deferral or retention requirements (e.g. deferred share bonus or LTIP shares during the post-vesting holding period). It is worth noting that many companies have stated that the requirement would be enforced on only those share awards granted after the adoption of the requirement (rather than to all in-flight awards at the time).

Whilst shares that are still subject to performance conditions would typically be excluded from an in-post holding requirement, if an executive departs as a ‘good leaver’ and retains an entitlement to unvested share awards, it would be appropriate to include these in the post-cessation holding policy if the individual is below the guideline holding level at the point of departure.

Should shares purchased by the executive be included?

Most companies have excluded shares purchased by executives (from their own resources) from the post-cessation requirement, so as not to discourage personal investment in company shares in the future. Shareholders are generally accepting of this treatment, although some have suggested that if such shares are excluded from the post-cessation requirement, they should also be excluded from the calculation of the in-post holding.

Are there any tax issues to be aware of?

In a UK context, provided that appropriate tax elections are made when the shares are acquired, no tax issues should arise where shares are subject to a post-cessation holding requirement.

However, care should be taken where any post-cessation holding requirement applies to shares which are held by a non-UK tax resident.

When should the clock start ticking?

Executives sometimes step down from the Board but remain an employee of the company for a period. This raises the question of when the holding requirement should start. In our opinion, it would normally be appropriate for the time period to start when an executive ceases to be a director, even if they continue to be employed for a period thereafter.

Are there any circumstances in which it might be appropriate to waive the requirement?

The Remuneration Committee may wish to retain discretion to waive the requirement (in whole or in part) in certain circumstances; for example, death, terminal illness or to reflect a departing director’s specific circumstances. However, shareholders would generally expect this discretion to be used only rarely and in genuinely exceptional circumstances.

Is there anything else that remuneration committees should consider?
Shareholders want to see suitable disclosure in the directors’ remuneration report on the key terms of the post-cessation holding policy and the principles for its enforceability. We also seeing companies provide additional disclosure on the practical application of the policy at the time of an executive director’s departure, and expect growing investor focus on this over time.