SEC Flash Report - July 2015

July 2015

SEC Proposes Rules Requiring Clawback of Executive Compensation

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On July 1, 2015, the Securities and Exchange Commission proposed a rule which would require national securities exchanges to establish standards for listed companies that would require the clawback of erroneous executive compensation. The rule would implement provisions mandated by Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  These standards would force listed companies to establish and enforce policies that require executives to pay back certain incentive-based compensation that was erroneously awarded. Proposed Rule 10D-1 would substantially increase the existing requirements covering recovery of executive compensation in Section 304 of the Sarbanes-Oxley Act, which requires the CEO and CFO to reimburse an issuer for certain compensation when an accounting restatement which resulted from misconduct occurred during the preceding twelve months. 
The clawback provisions of Rule 10D-1 would require a listed company, upon restating its financial statements, to calculate the difference between the amount of incentive-based compensation awarded to an executive and the amount that would have been awarded had the financial statements properly reflected the restated amounts.  This calculation would be performed for the three fiscal years prior to the date that a restatement was required.  The excess amount that was erroneously awarded would be recovered from both current and former executives of the listed company.  The population of “executives” from which recovery would be required is broader than under the Sarbanes-Oxley Act and includes any person who performs policy-making functions for the company.  For example, roles such as the company’s president, principal financial officer, principal accounting officer, and any vice-president in charge of a principal business unit, division or function would be included in the definition of an executive. The proposal takes a “no fault” approach. There is no consideration of whether there was any misconduct by an executive or whether an executive had responsibility for the erroneous financial statements.
Incentive-based compensation subject to recovery includes compensation that was determined based upon the attainment of financial reporting measures.  Financial reporting measures are those based upon accounting principles used in preparing the financial statements, any measures derived from that financial information, stock price, and Total Shareholder Return (TSR).  Other compensation, such as compensation based upon continued employment and compensation awarded at the discretion of the board of directors, would be excluded from this provision.  A company would be required to make a reasonable estimate of the effect of the erroneous accounting on the stock price and TSR.
A company that does not adopt a policy for the recovery of erroneously awarded incentive-based compensation, enforce the policy, and comply with the disclosure provisions of the rule would be subject to delisting.

Other Highlights of the Proposed Rules

  • Proposed Rule 10D-1 would apply to all listed companies, except for certain registered investment companies that do not provide incentive-based compensation to their employees.  Smaller reporting companies, emerging growth companies, and foreign private issuers (“FPIs”) would all be subject to the new listing standards.
  • A company would have the discretion to not enforce the recovery of incentive-based compensation only if the costs related to the recovery are expected to exceed the amount to be recovered or, for FPIs, if the recovery violates home country laws.
  • Executives could not be indemnified.
  • Other proposed rule changes would require companies to disclose their recovery policies and how they have applied them. The recovery policy will be filed as an exhibit to the annual report.  Additional disclosures would be required in annual reports and proxy statements when a restatement occurred or there is a continuing outstanding balance of excess incentive-based compensation that has not been recovered.  These additional disclosures include:
    • Date of restatement
    • If restatement is subject to recovery
    • Amount of the excess balance to be recovered
    • Amount remaining outstanding
    • How estimates of stock price and TSR were calculated
    • Name of individual for which the Company chose not to pursue collection
    • Name of individual that hasn’t paid within 180 days
  • The disclosure will be block tagged in an interactive data format using eXtensible Business Reporting Language, or XBRL.
  • Following the publication of the adopted version of Rule 10D-1, the exchanges would have 90 days to file their proposed listing rules and those listing rules would be required to become effective within one year of the date Rule 10D-1 is published.  The recovery policy for each listed company must be adopted within 60 days after the exchange’s rule becomes effective.  All excess incentive-based compensation received by current and former executives on or after the effective date of Rule 10D-1 would be subject to recovery.
The proposing release is available here.  Comments on the proposed rules should be provided within 60 days after the proposing release is published in the Federal Register.

For questions related to matters discussed above, please contact Jeff Lenz or Brandon Landas.