The Securities and Exchange Commission (SEC) recently proposed rules requiring national securities exchanges such as the New York Stock Exchange and NASDAQ to establish listing standards requiring publicly traded companies to adopt, enforce, and disclose written “clawback” policies to recoup incentive-based compensation "erroneously" paid to current and former executives. Under proposed Rule 10D-1, recovery as a result of a material error or misstatement in the company’s financial statements would be required without regard to fault. 

Rule 10D-1 would establish a three-year look-back period from the date on which a public company files a restatement of material non-compliance with financial reporting requirements. The company would be required to “claw back” from current and former executive officers incentive-based compensation that would not have been paid based on the restatement. Public companies would only be exempted from the requirement to recoup covered incentive-based compensation if doing so would (i) be impracticable because it would impose undue costs on the company or its shareholders or (ii) violate non-U.S. home country law.

Further, the proposed rules would require publicly traded companies to disclose whether a triggering restatement had occurred within the last year, the aggregate dollar amount of excess incentive-based compensation attributable to such restatement, and the aggregate dollar amount of such compensation that remains outstanding at the end of the last fiscal year.

According to the SEC, “the proposed rules [will] result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”

Section 304 of the Sarbanes-Oxley Act of 2002 currently empowers the SEC to force public companies to claw back bonuses, other incentive- or equity-based compensation, and profits on sales of company stock earned by chief executive officers (CEOs) and chief financial officers (CFOs) within the 12-month period following such company’s public release of financial information, if there is a restatement because of material non-compliance due to misconduct with financial reporting requirements under the federal securities laws. 

Proxy advisers and shareholder activists have advocated for more stringent clawback rules and requirements because Section 304 does not extend to senior officers other than CEOs and CFOs, fails to define misconduct, and does not provide a private right of action to companies or shareholders. In 2015, the two most prominent proxy advisory services in the world, Institutional Shareholder Services, Inc., and Glass, Lewis & Co., LLC, updated their proxy voting guidelines to encourage public companies to establish policies to recoup certain compensation during a three-year look-back period as required under Section 954 of the Dodd-Frank Act. Further, in a 2015 proxy disclosure study, PricewaterhouseCoopers reported that a significant number of public companies were adopting more stringent clawback policies in anticipation of the SEC’s proposal of new rules.

Rule 10D-1, if adopted, would apply to all listed issuers, including emerging growth companies, smaller reporting companies, foreign private issuers and controlled companies, and issuers of listed debt. Limited exceptions would be established for issuers of securities futures products or standardized options, unit investment trusts, and registered management investment companies that have not awarded incentive-based compensation to any executive officer in the last three fiscal years.

All current and former executive officers would be subject to the required clawback policies, with “executive officer” defined substantially the same as the definition applicable to reporting obligations under Section 16 of the Securities Exchange Act of 1934.

Incentive-based compensation subject to mandatory clawback under the proposed rules would include compensation that is granted, earned, or vested based wholly or in part on attainment of any “financial reporting measure.” Under the proposed rules, “financial reporting measures” include (i) any accounting-based measures presented in a company’s financial statements, (ii) any financial measures derived in whole or in part from such financial information (whether or not contained in any SEC filing or presented in the company’s financial statements), (iii) stock price, and (iv) total shareholder return (TSR). Under the new rules, clawback policies would not be required to apply to (i) salaries, (ii) bonuses paid for the achievement of subjective standards or strategic or operational goals, (iii) time-based equity awards, and (iv) bonuses paid solely at the discretion of the compensation committee that are not paid from a bonus pool.

The proposed rules, if adopted, will impact how public companies structure their incentive compensation recoupment policies and practices. Many public companies have preemptively adopted clawback policies, but many companies deferred changing their provisions and policies in anticipation of SEC guidance on the Dodd Frank clawback requirements. Depending on how several uncertainties and ambiguities in the proposed rules are ultimately resolved, public companies will need to adopt or revise their provisions and policies accordingly. Rule 10D-1 is subject to a 60-day comment period. Once finalized, the national securities exchanges must propose corresponding listing rules within 90 days and issuers will have 60 days to comply.

If you have questions about these proposed rules, please contact Gerald J. Guarcini at 215.864.8625 or guarcini@ballardspahr.com, Justin P. Klein at 215.864.8606 or kleinj@ballardspahr.com, Katayun I. Jaffari at 215.864.8475 or jaffarik@ballardspahr.com, Mary J. Mullany at 215.864.8631 or mullany@ballardspahr.com, Diane A. Thompson at 424.204.4334 or thompsonda@ballardspahr.com, Peter W. Hennessey at 215.864.8354 or hennesseyp@ballardspahr.com, Peter Jaslow at 215.864.8737 or jaslowp@ballardspahr.com, Kimberly W. Klayman at 215.864.8792 or klaymank@ballardspahr.com, or the Ballard Spahr attorney with whom you work.


Copyright © 2015 by Ballard Spahr LLP.
www.ballardspahr.com
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

Related Practice

Securities