Yesterday the SEC approved proposed rules requiring companies to develop, disclose, and implement a compensation clawback policy as required by Dodd-Frank Act Section 954. I blogged on this yesterday, but had to leave out many details due to space constraints. Today I highlight a few other key issues, with more to come next week.

As readers know, yesterday the SEC approved proposed rules requiring companies to develop, disclose, and implement a compensation clawback policy as required by Dodd-Frank Act Section 954. I blogged on this yesterday, but had to leave out many details due to space constraints. Today I highlight a few other key issues, with more to come next week.

Compensation Subject to Recovery

I summarized the proposed rules on this point yesterday, but already two related questions have arisen. Here is the applicable definition from the proposed rule (page 184 of the pdf):

(4) Incentive-Based Compensation. For purposes of Section 10D (15 U.S.C. 78j-4), incentive-based compensation is any compensation that is granted, earned or vested based wholly or in part upon the attainment of a financial reporting measure. Financial reporting measures are measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measures that are derived wholly or in part from such measures, and stock price and total shareholder return. A financial reporting measure need not be presented within the financial statements or included in a filing with the Commission.

The first question relates to the last sentence of this definition. The statute reads: “For disclosure of the policy of the issuer on incentive-based compensation that is based on financial information required to be reported under the securities laws.” So how do the proposed rules apply to incentive-based compensation based on stock price or total shareholder return, which generally are not items of financial information required to be reported under the securities laws? The answer is: we are not sure, but expect many commenters to raise this same question. The SEC seems to be reaching beyond the language of the statute to cover the full intent of Congress.

The second question is: Are time-based restricted stock or RSUs considered “incentive-based compensation” that is subject to clawback? Once you have thrown overboard the plain language of the statute, one could read the definition above to include time-based RSUs and restricted stock because their value is based on the stock price. We are confident that time-based restricted stock or RSUs are not considered “incentive-based compensation” that must be subject to clawback under the SEC rules. During yesterday’s open meeting, while addressing the inconvenient language problem discussed in our first question, an SEC representative plainly said that awards that vest solely on the passage of time, such as restricted stock or RSUs, are not subject to the clawback rules.

The Date on Which a Company is Required to Prepare an Accounting Restatement

This is an important issue because companies 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 (regardless of whether of when the company filed an 8-K):

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.

Proxy Disclosure of Enforcement

The proposed rules describe a company’s disclosure obligations in the event that during its last completed fiscal year the company either prepared a restatement that required recovery of excess incentive-based compensation or there was an outstanding balance of excess incentive-based compensation relating to a prior restatement. The company would be required to disclose substantial detail on the restatement and the clawback, including:

  • The date on which the company was required to prepare the 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 subject to recovery from whom the company decided not to pursue recovery, the amounts due from said persons, and a brief description of the reason the company decided not to pursue recovery.
  • If amounts of excess incentive-based compensation are outstanding for more than 180 days, the name of and amount due from each person at the end of the company’s last completed fiscal year.

The proposed disclosure would be included along with the company’s other executive compensation disclosure in annual reports and any proxy or information statements in which executive compensation disclosure is required.