Key Takeaways

  • The Securities and Exchange Commission (SEC) reopened the comment period on proposed rules requiring exchanges to adopt standards mandating that companies develop recovery or “clawback” policies on erroneously awarded incentive-based compensation.
  • The SEC is seeking comments and data related to the definition and interpretation of key terms that could, among other things, trigger when and how the clawback policy is applied.
  • The comment period will remain open until Nov. 22, 2021.

On Oct. 14, 2021, the SEC reopened the comment period on proposed rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Proposed Rules). The Proposed Rules, originally issued on July 1, 2015, would require the national securities exchanges to adopt listing standards mandating that listed companies develop and comply with a policy to recover from current and former executive officers any incentive-based compensation based on financial information that was subsequently corrected in an accounting restatement.

The SEC decided to reopen the comment period in light of the increase in the number of issuers that have adopted clawback policies.

  • Proposed Rules

The Proposed Rules, available here, would apply to almost all categories of listed issuers, including smaller reporting companies, emerging growth companies, foreign private issuers, and controlled companies, with limited exceptions for registered investment companies that do not use incentive compensation and unit investment trusts. The clawback policy would apply to each issuer’s “executive officer” as defined in Rule 16(a) under the Securities Exchange Act of 1934, regardless of whether the executive officer had any role in the preparation of financial statements.

The required clawback of erroneously awarded incentive-based compensation would be triggered by an accounting restatement that is attributable to an error that is material to previously issued financial statements. “Wrongdoing” is not required as it is under the Sarbanes-Oxley clawback provision. The amount to be recovered would be the difference between what the executive received during the three fiscal years preceding the date the issuer is required to prepare a restatement and what the executive would have received had the incentive-based compensation been based on the restated financial statements. Issuers would be required to comply with their recovery policies except to the extent it would be impracticable to do so, such as where the direct expense of recovery would exceed the amount to be recovered.

The Proposed Rules require clawback policies to be filed as an exhibit to issuers’ annual reports on Form 10-K and would require proxy statement and 10-K disclosure if the issuer completed a restatement that required recovery or there was an outstanding balance of compensation that required recovery.

  • Topics for Additional Comment

In reopening the comment period, the SEC requested comment on the following 10 areas, in addition to any other comment on the original proposing release issued in 2015.

Interpretation of Accounting Restatement: The SEC asks whether the interpretation of “an accounting restatement due to material noncompliance” should be expanded to include all required restatements made to correct an error in previously mentioned financial statements. This interpretation would pick up restatements required to correct errors that were not material in previously issued financial statements but would result in a material misstatement if (a) the errors were left uncorrected in the current report or (b) the error correction was recognized in the current period.

Three-Year Lookback Period: The Proposed Rules provide that the date on which an issuer would be obligated to restate its financial statements for purposes of the three-year “lookback” would include the date the issuer’s board, a committee of the board, or authorized officers, if board action is not required, conclude or reasonably should have concluded that a restatement is required. The SEC is considering removing or changing the “reasonably should have concluded” standard in order to remove uncertainty concerning the determination of the three-year lookback period.

Defined Terms: The SEC is seeking comment on whether to remove defined terms for “accounting restatement” and “material noncompliance” included in the Proposed Rules or rely on existing guidance and literature. Additionally, the SEC is seeking comments on whether guidance should be provided regarding when incentive-based compensation is “received” if the rules do not provide a specific definition of the term.

Changes to Form 10-K Cover Page: The SEC is considering adding to the cover page of Form 10-K check boxes that would indicate separately (a) whether the previously issued financial statements included in the filing include an error correction and (b) whether any such corrections are restatements that triggered a clawback analysis during the fiscal year.

Cost and Benefits: Given the increase in voluntary adoption and disclosure of clawback policies, the SEC is requesting data and estimates that would shed light on the cost and benefits of issuers’ current clawback policies and how they might differ under the Proposed Rules.

Materiality Analysis: The SEC acknowledges that issuers, when conducting a materiality analysis relating to errors, consider whether any misstatement of previously issued financial statements had the effect of increasing management’s compensation. Accordingly, the SEC is assessing to what extent those evaluations can be leveraged in connection with determining the need for and the amount of any clawback. More generally, the SEC is asking whether changing the scope of the Proposed Rules to encompass additional accounting restatements could affect how an issuer conducts those evaluations.

Disclosure of the Recoverable Amount: The SEC recognizes that in calculating the recoverable amount, issuers can rely on several possible methods to reasonably estimate the effect of an accounting restatement on stock price, with varying levels of complexity and a range of related costs. Under the Proposed Rules, there is no requirement to disclose how issuers calculate the recoverable amount. The SEC is seeking comment on whether additional disclosures should be required.

Investment Companies: The SEC is seeking comment regarding any changes or developments since the Proposing Release with respect to payment of incentive-based compensation by listed registered management investment companies that should affect how those companies are treated under the Proposed Rules.

XBRL: The SEC proposed to require that new compensation recovery disclosures be block-text tagged using XBRL. The SEC is currently considering requiring that specific data points within the new compensation recovery disclosure be separately detail tagged using Inline XBRL instead of, or in addition to, the proposed block-text tagging.

Additional Developments: The SEC is inquiring into any other developments since the Proposing Release that should affect its consideration of the Proposed Rules or their potential economic effects.

The comment period will remain open until Nov. 22, 2021. The SEC has confirmed that previously submitted comments are not required to be resubmitted and will be considered.