United States: SEC's Proposed Incentive Compensation Clawback Rule

On July 1, 2015, the SEC issued proposed Rule 10D-1, as required by Section 954 of the 2010 Dodd-Frank Act. The Rule would direct national securities exchanges to establish listing policies that require companies to adopt a policy requiring recovery from executive officers of any erroneously awarded incentive compensation. Under the Rule, listed companies must adopt a written policy requiring, in the event of a material accounting restatement, the "clawback" (or recovery) from current or former executive officers of any incentive compensation they would not have received based on the restatement, regardless of their fault or other responsibility for the error.

Summary of the Proposed Rule

Each national securities exchange will have 90 days after publication of the SEC's final version of Rule 10D-1 to file their proposed listing rules, which must become effective within 12 months of publication of the final rule. Each listed company will then have 60 days to adopt a compliant clawback policy.

A company would be subject to delisting if it does not: (1) adopt a compliant clawback policy; (2) disclose the policy in accordance with SEC rules; and (3) comply with the policy's recovery requirements.

Under the Rule, each listed company required to prepare an accounting restatement because of a material financial error must recover certain excess incentive compensation awarded to current or former executive officers (Section 16 executive officers) during the preceding three fiscal years based on a "financial reporting measure" reported in error. These financial reporting measures include most accounting-based measures, stock price and total shareholder return. Incentive compensation does not include compensation based on non-financial reporting measures, such as the closing of a sale of a company division.

The recoverable amount is the excess over the incentive compensation that otherwise would have been earned had it been determined based on the accounting restatement. The company is required to recover the gross amount of the incentive compensation, not the net amount received by the executive after payment of taxes.

The Rule contemplates that the means of recovery may vary by issuer and type of compensation arrangement; however, the means should provide recovery reasonably promptly. Actions may include:

  • Forfeiture of earned but unpaid amounts;
  • Cancellation of unvested awards;
  • Offset from amounts otherwise payable to the executive officer; or
  • Executive officer's repayment.

Planning Considerations

Companies should: (1) review their current clawback policy and revise the policy to include a general provision that will pick up any new requirements of the final rule; (2) put executives on notice of the new, no-fault recovery requirements; and (3) revise existing compensation plans, award agreements and employment agreements to clearly permit enforcement of the clawback policy, including any future changes required to comply with the final rule.

Listed companies may also want to revise their executive compensation mix and performance metrics to minimize the potential clawback implications in the event of a material financial restatement. For example, a redesign of 162(m) awards could significantly reduce the likelihood of a required clawback.

Tax Considerations

Enforcement of a clawback policy can have significant tax implications for an impacted executive, particularly for amounts that have been deferred under a nonqualified deferred compensation arrangement subject to Internal Revenue Code Section 409A (409A). Compliance with the policy can impact the amount subject to the deferral election, can cause forfeitures under the arrangement and can create offset, acceleration and substitution concerns under 409A. A company will need to tailor enforcement of its clawback policy to ensure satisfaction of the requirements of 409A. In addition, companies should work closely with impacted executives to minimize the adverse tax consequences of a required repayment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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