Best practice for executive directors in UK-listed companies is that they are now required to retain a substantial holding in their former employer’s stock when they leave. Over 75% of the FTSE 350 companies who held a policy vote in 2020 adopted post-cessation shareholding policies of some form in accordance with the July 2018 U.K. Corporate Governance Code which requires companies to have a policy on post-cessation shareholdings.

The Investment Association (“IA”) recommends that executive directors hold shares for two years post-employment, at least equal to the minimum in-employment shareholding requirement at the time of departure (or the holding at cessation if lower). The IA expects structures will be implemented to operate and enforce this.  Most of the policies adopted so far have followed the IA guidance, although some Remuneration Committees have chosen to taper the holding down over the two years, only impose a one-year holding period or impose a lower post-cessation shareholding requirement than the in-employment shareholding requirement.

Whilst this demonstrates companies’ compliance with the requirement to adopt a policy, there remain a number of sometimes challenging issues to be considered carefully in order to implement the requirement effectively. It is a sensible approach to consider the in-employment and post-cessation requirement together when determining some of the details; however there will be additional factors to navigate post-cessation. We set out below some of the key questions which companies will need to work through to put the requirement into practice. 

When should the post-cessation holding period take effect?

In most cases, the executive will step down from the Board and immediately cease employment or will do so very shortly afterwards, but there may be cases where the two events do not align. This raises the question of when the two-year period should start? It will usually be appropriate for the two-year period to start when the executive ceases to be an executive director, even if they continue to be employed in a different capacity.

What factors will companies need to consider to determine the required level of shareholding?

The starting point for setting the post-cessation requirement will be the in-employment requirement, which will normally be a multiple of base salary. 

However, to determine which share price to use, practices may then diverge. For the in-employment requirement, companies will monitor the value of the shareholding at the prevailing share price on a regular basis (e.g. annually) to ensure the requirement is met. For the post-cessation requirement, the share price might be fixed at the date of cessation, on the basis this is considered to provide a fair reflection of share price performance up to the end of the executive’s term of office. The executive remains exposed to the share price after leaving, but does not need to buy more shares if the price falls and equally cannot sell part of the holding if the price rises. It also has the advantage of providing certainty both for the executive and the company over how many shares need to be held after cessation.

The salary reference point to calculate the post-cessation requirement would typically be the base salary at the date of cessation. 

Which shares count towards the requirement?

Shares the executive holds personally as well as those held in a spouse’s name or in a personal trust will usually count towards the requirement.

The IA recommends that only shares which are not subject to further performance conditions should count towards the requirement. Awards that remain subject to performance conditions may not vest, so it would be inappropriate to include them in the holding. This means good leavers’ LTIP awards that continue in force subject to performance conditions post-cessation would be excluded from the holding. If, however, performance is tested under a plan at cessation and shares vest on a pro rata basis at cessation (although this approach is increasingly rare), these shares could count.

Deferred shares awarded under annual bonus schemes can usually be counted on a net-of-tax basis. Companies can also count shares which are subject to post-vesting holding periods. 

What about shares purchased from the executive’s personal resources?

Some have argued that shares purchased by an executive from their own resources, rather than being received from the vesting of share awards, should be exempt from the post-cessation holding requirement. They argue that including purchased shares could deter purchases.

Investors generally encourage executives to purchase shares from their personal resources, to further align their interests.  

LGIM advised in both its September 2019 and October 2020 Principles on executive remuneration that any shares purchased by the director might be excluded from the post-exit shareholding requirement. In 2019 LGIM suggested that if purchased shares were to be excluded from the post-exit shareholding requirement, only 25% of these shares could be counted to meet the in-employment shareholding requirement. However in its October 2020 update, LGIM has removed the 25% threshold and instead suggest that if purchased shares are used to make up the in-employment requirement, these should be replaced when shares vest from incentive arrangements. This guidance might be considered to acknowledge there may be different considerations which will apply in-employment and post-employment and therefore the interaction between the in-employment and post-cessation requirements will need some careful thought.  

A simple approach might be to treat purchased shares similarly in relation to both the in-employment and post-cessation holding requirements. However, there are also examples of Remuneration Committees differentiating in their approach by including purchased shares in the in-employment requirement but not the post-cessation requirement.

Are there circumstances in which the requirement might be reduced or even waived before the expiry of 2 years?

Companies should consider whether there could be any exceptional circumstances in which the Remuneration Committee might wish to exercise discretion to reduce the requirement. These circumstances would need to be limited; an example might be death or substantial financial hardship. 

An executive might also ask a Remuneration Committee to waive the post-cessation requirement if they have joined a competitor where they have an obligation to build a new shareholding, and where retaining a substantial holding in their former employer’s shares might be seen as a potential conflict. However, in such a case waiving the requirement would likely be seen as jeopardising the principles underlying the policy.

How should the in-employment & post-cessation requirements be enforced?

There are a variety of approaches. We expect that the need for a longer-term enforcement mechanism post-cessation will encourage the adoption of formal written policies and agreements instead of unwritten “good faith” agreements. The benefit of a written policy, to which the executive signs up, is that it clearly communicates the company’s expectations.  There may still be practical difficulties in ultimately enforcing the requirement, where the shares are held outside a company-sponsored vehicle. The IA suggests companies might consider nominee accounts or employee ownership trusts to hold the shares and maintain the requirement.

How we can help

As executive compensation advisers, we have extensive experience in advising clients on the policy and implementation of in-employment and post-employment shareholdings. We can help formulate and document your requirements.