- New rules. The U.S. SEC has voted to adopt new rules requiring securities exchanges to adopt listing standards that require issuers to develop and implement a policy providing for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers.
- What’s involved. Each listed issuer would be required to adopt a compensation recovery policy, comply with that policy and provide the required compensation recovery policy disclosures. An issuer would be subject to delisting if it does not adopt and comply.
- Understanding potential triggers. “Big R” restatements “correct errors that are material to previously issued financial statements,” while “little r” restatements “correct errors that are not material to previously issued financial statements but would result in a material misstatement.
- Time to refine. The final rules will become effective 60 days following publication of the adopting release in the Federal Register. Exchanges will be required to file proposed listing standards no later than 90 days following publication of the release in the Federal Register, and the listing standards must be effective no later than one year following publication.
On
Oct. 26, the U.S. Securities and Exchange Commission (SEC)
voted 3-2 to adopt
new rules requiring securities
exchanges to adopt listing standards that require issuers to develop and
implement a policy to recover erroneously awarded incentive-based
compensation received by current or former executive officers. According to reports,
the clawback requirements are meant to hold corporate leaders accountable for
the errors, whether they’re the result of fraud or simply mistakes.
As reported by CNBC, the rule,
which Congress mandated by the Dodd-Frank Act following the 2007-2009 financial crisis, was
left unfinished in 2015, but was revived by the SEC under Chair Gary Gensler
last year as part of a broader effort to crack down on corporate malfeasance by
strengthening the agency’s tools for penalizing executives.
“I believe that these rules will strengthen the transparency and quality of corporate financial statements, investor confidence in those statements, and the accountability of corporate executives to investors,” Gensler said in a statement. “Through today’s action and working with the exchanges, we have the opportunity to fulfill Dodd-Frank’s mandate and Congress’s intention to prevent executives from keeping compensation received based on misstated financials.”
In
August, the SEC also adopted final rules implementing the pay-versus-performance disclosure requirement as
established by the Dodd-Frank Act, which was intended to discourage financial
fraud and better align executive compensation with corporate
results.
The
newly announced clawback rules
would require exchanges to adopt
listing standards that will apply the
disclosure and compensation
recovery policy requirements to all listed issuers, with only limited
exceptions. Each listed issuer would be required to adopt a compensation
recovery policy, comply with that policy
and provide the required compensation recovery policy disclosures.
An issuer would be subject to delisting if it does not adopt and comply with a compensation
recovery policy that meets the requirements of the listing standards.
Although many companies have had some sort of clawback policy in
place, Steve Seelig, senior
director, executive compensation at Willis Towers Watson (WTW), said
one of the biggest changes with
the new rules will be what will
trigger the clawbacks, if any.
“This
will force changes in how
companies structure their executive
pay programs, so they understand
which elements are subject to
clawback and which are not,” he said.
For
example, the SEC asked whether the
clawback policy should be applied to both “Big R” and
“little r” restatements. According
to Cooley PubCo,
“Big R” restatements “correct
errors that are material to previously issued financial statements,” while “little
r” restatements “correct errors that are not material to 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 (commonly referred to as
‘little r’ restatements). A ‘little r’ restatement differs from a ‘Big R’
restatement primarily in the reason for the error correction (as noted above),
the form and timing of reporting, and the disclosure required.”
“By
expanding the scope of these triggers, the
SEC could potentially be turning ‘little r’ things to ‘Big R,’” said Deb
Lifshey, managing director
at Pearl Meyer.
The
good news for companies is that they have time to refine their clawback policy.
According
to the SEC, the final rules will become effective 60 days following publication
of the adopting release in the Federal Register. Exchanges will be required to
file proposed listing standards no
later than 90 days following publication of the release in the Federal
Register, and the listing standards must be effective no later than one year
following publication.
Both
Seelig and
Lifshey recommended companies start figuring out and planning
their policy at the start of 2023. Communication will play a big part in that strategy,
Lifshey said, because the plan
applies to compensation from current or former executives that was paid during
the three years before the time that a restatement was required.
“A
lot of work needs to take place,” Lifshey said. “But, once these rules are
published, the clock starts ticking.”
On
the flipside, Seelig said compensation committees will need to understand how
their clawback policy will work and
what goals it is attempting
to accomplish.
“Companies
will need to think about implications and what amount needs to be clawbacked, so they will need to make those decisions,” he said. “The SEC was not directive on how much to clawback, so they will need to move quickly to get the money back.”
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