By a vote of three to two, the SEC approved a proposal to adopt listing standards for the mandatory repayment by executive officers of erroneously awarded compensation. The proposal would direct national securities exchanges and associations to establish the standards, and companies to adopt policies that obliged their executive officers to repay inapposite compensation that was intended to be incentive-based. It is the final proposal involving executive compensation rules to be required by Dodd-Frank.
The proposal creates Rule 10D-1 requiring listed companies to develop and enforce recovery policies that would, in the event of accounting restatements, “claw back” from current and former executive officers any incentive-based compensation that the restatements show to have been awarded based on previous accounting errors. Requirements of the policies in the proposal include the following:
- recovery must be on a “no-fault” basis from current and former executive officers who received incentive-based compensation during the three fiscal years preceding the date on which a company is required to prepare an accounting restatement to correct a material error;
- companies must recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the officer would have received if the compensation had been based on the accounting restatement;
- companies have discretion not to recover excess incentive-based compensation received by executive officers if the direct expense of enforcing recovery would exceed the amount to be recovered or, for foreign private issuers, in specified circumstances where recovery would violate home country law; and
- a firm would be subject to delisting if it did not adopt a compensation recovery policy in accordance with the SEC rules.
The proposed rules also include a definition of “executive officer” that is distinct from that of “officer” under Exchange Act Section 16. The proposal specifies that the positions defined by “executive officer” include the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company.
Additionally, the proposed rules would require a firm to file its compensation recovery policy as an exhibit to its Exchange Act annual report. If during its last completed fiscal year a listed company either (i) prepared a restatement that required the recovery of excess incentive-based compensation, or (ii) carried an outstanding balance of excess incentive-based compensation relating to a prior restatement, then the company would be required to disclose:
- the date on which it was required to prepare each accounting restatement, the aggregate dollar amount of excess incentive-based compensation attributable to the restatement, and the aggregate dollar amount that remained outstanding at the end of its last completed fiscal year;
- the name of each person who was subject to recovery and from whom the company decided not to pursue it, the amounts due from each such person, and a brief description of the reason the company decided not to pursue recovery; and
- if amounts of excess incentive-based compensation are outstanding for more than 180 days, the name of each person so compensated and the amount due from them at the end of the company’s last completed fiscal year.
Commissioner Michael S. Piwowar issued a statement that called into question whether the “broad approach” of the approval would “impose a substantial commitment of shareholder resources and, unintentionally, result in a further increase in executive compensation.” He warned that a recovery policy would create uncertainty among executives regarding the amount of incentive-based compensation that they would ultimately retain. The uncertainty in compensation levels, according to Commissioner Piwowar, could increase total executive compensation. He asked the public to comment on (i) whether recovery policies should be voluntary for emerging and smaller companies; and (ii) if it would be better to take a more comprehensive approach to providing interactive data contained in the proxy statement, as well as in the non-financial section of the annual report on Form 10-K, rather than requiring individual items to be added in an ad hoc manner.
Commissioner Daniel M. Gallagher issued a statement of dissent in which he explained that the proposal puts “corporate boards not just in handcuffs but in a straitjacket,” and added that the proposal reflects the view that a corporate board is the enemy of the shareholder.
Lofchie Comment: Although this rule proposal seems to have a sound and objective basis (why should an executive object to repaying money that was not genuinely deserved, since the amount was based on flawed accounting?), the determination of whether an accounting restatement may be required in any particular instance is, in many cases, subjective. Accordingly, a corporation might be far more likely to issue a restatement of its accounting when there is a change in leadership, and the new management may have an incentive to reduce or claw back compensation that was paid to old leadership. The new rule is also likely to serve as a substantial disincentive to companies going public. As more and more companies of significant size are able to raise sufficient capital in the private markets and so avoid the expenses and burdens (such as Sarbanes-Oxley) of going public, this rule will only discourage emerging issuers even more from going public. Is the rule worth the costs? The answer is not obvious and the question poses yet another question: Would it have been better to adopt a narrower rule that required issuers to seek restitution only from the top few executives, and only in the event of demonstrated malfeasance?