On July 1 2015, the Securities and Exchange Commission, by a 3-2
vote, proposed new rules requiring public companies to
"claw back" executive compensation mistakenly awarded due
to accounting errors. The proposed rules—10D-1 under the
Securities Exchange Act of 1934—satisfy the last of the
SEC's rulemaking obligations under the Dodd-Frank Wall Street
Reform and Consumer Protection Act. The finalized rules will
join Section 304 of the Sarbanes-Oxley Act and Item 402(b) of
Regulation S-K, which already impose reporting and clawback
requirements on certain executive officers for compensation
received as a result of misconduct.
The SEC's latest attempt to regulate executive compensation
paints with a broader brush than those that precede it. Not only
would the rules require clawback from a much broader range of
executive officers, they would also remove the requirement that, to
trigger clawback, an accounting error must result from executive
misconduct. The proposed rules apply to all public companies,
despite fears of disproportionate burdens on emerging growth
companies, smaller reporting companies, and foreign private
issuers.
The rules mandate that all national securities exchanges require
listed companies to adopt clawback policies for mistakenly awarded
incentive-based compensation. Listed companies must comply with
these requirements—by drafting, disclosing and enforcing
their own compensation recovery policy—or risk delisting.
Though the responsibility for implementing clawback policies lies
with public companies and with the securities exchanges, the SEC
has provided extensive guidance for how these policies should
look.
First, new policies should apply to current and past high-level
executive officers (serving during the three-year look-back period
described below); such officers include the president, principal
financial officer, principal accounting officer, any vice-president
in charge of a business unit, and any other person who performs
policy-making functions for the company. This broad coverage
drastically expands the list of employees subject to clawback.
Under the Sarbanes-Oxley Act, only a public company's Chief
Executive Office and Chief Financial Officer risked losing
compensation due to inaccuracies in accounting. If 10D-1 is
finalized in its present form, all policy-making employees would be
potentially subject to clawback; the SEC does not clarify what
positions it considers to be policy-making. Identifying, monitoring
and recouping compensation from such an expansive and ill-defined
group of employees could force companies to shoulder substantial
compliance costs.
Second, compensation clawback must be triggered by any accounting
restatement issued "due to material non-compliance of the
issuer with any financial reporting requirement under the
securities laws." Unlike previous clawback policies, the new
rules require clawback even where there is no showing of executive
misconduct. Some commenters have expressed concern that the lack of
a strictly defined triggering event may encourage companies to
treat all restatements as "material" to avoid any risk of
delisting. The SEC, however, specifically excludes restatements
prepared pursuant to generally accepted accounting standards (like
the application of a change in accounting policy) from the
compensation clawback requirement.
Finally, under the proposed rules, clawback policies must cover
all incentive-based compensation that was granted to, earned by or
vested in an executive officer due to the attainment of a
"financial reporting measure." Such measures include:
stock price, total shareholder return (TSR), and any other measure
based on accounting principles used in preparing financial
statements. Service-based awards given solely for completion of a
service period, retention bonuses, discretionary compensation and
salaries do not qualify as incentive-based compensation for the
purposes of these proposed rules.
The notice and comment period on these newest SEC rules will
extend 60 days past the date of the
publication rules in the Federal Register. Comments will
likely focus on the more controversial provisions described above,
particularly the lack of exceptions for smaller and foreign
companies and the lack of guidance on how to calculate clawbacks
for awards based on TSR or stock price.
Companies should begin contemplating how to comply with the
heightened clawback and reporting requirements of these new rules.
Once the rules are finalized, likely later this year, securities
exchanges will have 90 days to propose their new listing
requirements and one year before those requirements must be
effective. Companies then must adopt a complying clawback policy
within two months or risk delisting.
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.