SEC Proposes Requiring Clawback Policies on Executive Pay

By Stephen Miller, CEBS July 8, 2015

The U.S. Securities and Exchange Commission (SEC) issued a proposed rule on July 2, 2015, requiring publicly traded companies to adopt policies that require executives to pay back bonuses and other incentive-based compensation that is found to have been awarded erroneously, as mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Under the proposed Rule 10D-1, Listing Standards for Recovery of Erroneously Awarded Compensation, national stock exchanges must adopt listing standards that require public companies to develop and enforce recovery policies that, in the event of an accounting restatement, “claw back” from current and former executive officers incentive-based compensation they would not have received based on the restatement.

The proposal defines incentive-based compensation as “any pay that is granted, earned or vests based wholly or in part upon the attainment of any financial reporting measure.” Recovery would be required without regard to fault.

The proposal also would require disclosure of listed companies’ recovery policies, and their actions under those policies.

“These listing standards will require executive officers to return incentive-based compensation that was not earned,” said SEC Chairwoman Mary Jo White, in a released statement. “The proposed rules would result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”

Among North America companies, 36 percent plan to increase the use of clawbacks on vested awards, according to Mercer’s latest Financial Services Executive Compensation Snapshot Survey, released in July 2015.

Tying Pay to Performance

Under the SEC's proposed clawback rule:

Incentive-based executive compensation must be tied to accounting-related metrics, stock price or total shareholder return (TSR).

Recovery of incentive payments would apply to excess incentive-based compensation received by executive officers in the three fiscal years preceding the date a company is required to prepare an accounting restatement.

A publically traded company would be required to file a recovery policy as an exhibit to its annual report under the Securities Exchange Act, and to disclose its actions to recover incentive payments in its annual report and any proxy statement that requires executive compensation disclosure.

Current and Past Executives

The clawback policies apply to executive officers, which “would be the issuer’s president; principal financial officer; principal accounting officer (or if there is no such accounting officer, the controller); any vice-president of the issuer in charge of a principal business unit, division or function (such as sales administration or finance); any other officer who performs a policy-making function; or any other person who performs similar policy-making functions for the issuer,” explained Steve Quinlivan, an attorney with Stinson Leonard Street, in a blog post.

An online post from law firm Ropes & Gray noted that “Former executive officers would include any individual who served as an executive officer at any time during the performance period for the affected incentive-based compensation.”

Ambiguities Remain

Under the proposal, “a clawback policy would apply if the issuer was required to prepare an accounting restatement to correct an error that was material to previously issued financial statements,” noted an online alert from law firm McGuireWoods. “The proposed rules do not attempt to define when an error would be considered ‘material’ for this purpose, instead leaving it up to the issuer to determine in light of the facts and circumstances and in accordance with applicable regulatory guidance and legal precedents.”

Regarding another gray area, Michael S. Melbinger, a partner at law firm Winston & Strawn, commented in a blog post:

[C]ompanies must clawback compensation paid “during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement.” The proposed rules provide that the date on which a company is required to prepare an accounting restatement is the earlier of…the date the board of directors (or a committee) concludes, or reasonably should have concluded, that the company’s previously issued financial statements contain a material error; or the date a court, regulator or other legally authorized body directs the company to restate its previously issued financial statements to correct a material error.

Sadly, inclusion of the phrase “or reasonably should have concluded” in the proposed rules may continue the ambiguity on this critical issue.

“Going forward, we may see heightened pressure (if such a thing is possible) to avoid restatements, to classify a restatement as not required, or to argue that the restatement was not due to material noncompliance with any financial reporting requirement under the securities laws,” an analysis by law firm Jenner & Block concluded.

The comment period for the proposed rules end 60 days after publication in the Federal Register.

Other Pay vs. Performance Disclosures

The new proposed rule follows on the heels of a separate SEC proposed rule to implement a provision of the Dodd-Frank Act. Issued on May 7, 2015, the Pay Versus Performance Rule would require public companies to disclose the relationship between compensation paid to executives and the company’s financial performance in proxy and other information statements.

“The proposed rule would also require disclosure of the TSR of those companies in the peer group identified by the company in its stock performance graph or in its Compensation Discussion and Analysis section” of its proxy statement, according to an analysis by Buck Consultants.

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow Me on Twitter.

Related Resource:

Proposes Rules on Clawback Policies on Executive Compensation, PricewaterhouseCoopers, July 2015

Related News Article:

‘Clawback’ Could Backfire, New York Times, July 2015

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