On July 1, the Securities and Exchange Commission proposed for public comment a new rule and rule amendments to implement provisions of Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In particular, proposed Rule 10D-1 under the Securities Exchange Act of 1934, as amended (Exchange Act), would require national securities exchanges to adopt listing standards that require listed companies to develop, implement and disclose incentive-based executive compensation recovery (clawback) policies. Under the proposed rule, a company would be subject to delisting if it did not adopt a clawback policy that complies with the applicable listing standard, properly disclose the policy or comply with the policy’s clawback provisions.
Under Rule 10D-1, national securities exchanges would establish listing standards that would require listed companies to adopt a clawback policy to recover from any current or former executive officer who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement to correct a material error. Recovery under the rule would be on a “no fault” basis, without regard to the executive officer’s misconduct or responsibility for the erroneous financial statements. The definition of “executive officer” is modeled after the definition of “officer” for purposes of Section 16 under the Exchange Act, and includes the company’s president, principal financial officer, principal accounting officer, any vice president and any other person who performs policy-making functions for the company.
Such clawback policies would require a listed company to claw back the amount of incentive-based compensation received by an executive officer that exceeds the amount the executive officer would have received had such compensation been calculated based on the restated financial statements (referred to as “excessive incentive-based compensation”). Incentive-based compensation that is granted, earned or vested based on the achievement of any financial reporting measure would be subject to recovery under the proposed rule. Companies would be permitted to use a reasonable estimate of the effect of the accounting restatement in the case of incentive-based compensation based on stock price or total shareholder return. In determining the incentive-based compensation subject to recovery with respect to equity awards, the recoverable amount for awards still held at the time of recovery would be the number of shares or options received in excess of the number that should have been received based upon the restated financial statements. If options or stock appreciation rights (SARs) have been exercised, but the underlying shares have not been sold, the recoverable amount would be the number of shares attributable to the excess options or SARs based upon the restated financial statements. If the shares issued upon exercise of such options have been sold, the recoverable amount would be the sale proceeds received by the executive officer with respect to the excess number of shares.
In general, under the proposed rule, listed companies would have only limited discretion in regards to recovery of “excessive incentive-based compensation.” Listed companies would, however, have discretion not to claw back the “excess incentive-based compensation” received by an executive officer if the recovery would be impractical because the direct expense of enforcing recovery would exceed the amount to be recovered or, in the case of a foreign private issuer, when the clawback would violate applicable home country law. The listed company would first need to make a reasonable attempt to recover the excessive incentive-based compensation before it could determine that such recovery would be impractical.
Rule 10D-1 would require a listed company to file its clawback policy as an exhibit to its Form 10-K (or other annual report) filed under the Exchange Act. If a listed company prepared an accounting restatement that required recovery under its clawback policy or it had an outstanding balance of excess incentive-based compensation relating to a prior accounting restatement, such company would also need to disclose with its other executive compensation disclosure (typically included in annual meeting proxy statements):
- the date it was required to prepare the restatement, the aggregate dollar amount of excess incentive-based compensation attributable to the restatement and the aggregate dollar amount that remained outstanding at fiscal year-end;
- a list of persons from whom the listed company decided not to pursue recovery, the amounts due from each such person and the reason the company elected not to pursue recovery; and
- 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 company’s fiscal year end.
Under the proposed rule, exchanges would be required to propose listing rules within 90 days following the publication of adopted Rule 10D-1, and each listed company would be required to adopt a clawback policy no later than 60 days following the effective date of the applicable exchange’s listing rule. The proposed rule would require listed companies to recover excessive incentive-based compensation received on or after the effective date of Rule 10D-1 that results from financial information for a fiscal period ending on or after the effective date of Rule 10D-1. It would also require listed companies to comply with the proposed disclosure requirements in annual reports and proxy or information statements filed on or after the effective date of the applicable exchange’s listing rule.
Comments on Rule 10D-1 are due within 60 days following the publication of the proposed rule in the Federal Register.