KMK Law Corporate & Securities Blog

On July 1, 2015, the U.S. Securities and Exchange Commission proposed rules which would require exchange-listed companies to adopt a policy for the recovery of incentive-based compensation in the event of an accounting restatement. These rules would implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposed rules are broader in scope than Section 304 of the Sarbanes-Oxley Act of 2002, which applies only to chief executive officers and chief financial officers, requires a finding of material noncompliance resulting from misconduct, and can be used only to recover compensation paid in the year following the financial misstatement.

Under the proposed rules, each listed company would be required to adopt a compliant clawback policy within 60 days after the effective date (not likely to be soon-- see below) of the applicable securities exchange’s listing standards. Even if a company has proactively implemented a clawback policy, it will likely have to adopt a new or amended policy that complies with the final rules. Specifically, the policy must provide for the recovery of all excess incentive-based compensation received by any current or former executive officer that results from attaining a misstated financial reporting measure for any fiscal period ending on or after the effective date of the final rules, regardless of whether there is any fault or responsibility on the part of such executive officer. The clawback policy would be triggered in the event that the company is required to prepare a restatement to correct an error that is material to previously issued financial statements, but not by corrections resulting from new accounting principles, changes in the company’s internal organizational structure or reclassifications due to discontinued operations.

The proposed rules define “incentive-based compensation” as any compensation that is granted, earned or vested based on the attainment of any financial reporting measure. Service-based awards (whether equity or cash), awards based on strategic or operational metrics, discretionary compensation and base salary are excluded from this definition. The amount of incentive-based compensation that is recoverable is the difference between the compensation received by the executive officer based on the materially incorrect financial statements and the amount such executive would have received had the compensation been determined based on the financial statements as restated. This “excess” compensation would be recoverable for a look-back period of three fiscal years.

Each listed company would be required to file its clawback policy as an exhibit to its Annual Report on Form 10-K.  Separately, if a company either prepares a restatement that resulted in clawback enforcement or there remained an outstanding balance of excess incentive-based compensation relating to a prior restatement, the company will have additional disclosure obligations.

The rules will not take effect for some time.  There is a 60-day comment period.  After the proposed rules are adopted, the national securities exchanges would have 90 days to propose new listing standards, which would be subject to an additional comment period. Listed companies would be required to comply with the new disclosure requirements in proxy or information statements and periodic reports filed on or after the effective date of the new listing standards.