[co-author: Xavier Thomas-Hughes]
Key points to remember
- The Securities and Exchange Commission (SEC) has reopened the comment period on proposed rules forcing exchanges to adopt standards that require companies to develop clawback or “clawback” policies on wrongly awarded incentive compensation.
- The SEC is seeking comments and data regarding 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 November 22, 2021.
On October 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 published on July 1, 2015, would require national stock exchanges to adopt listing standards requiring listed companies to develop and comply with a policy to recover from current and former executives any incentive compensation based on financial information which was then corrected in an accounting restatement.
The SEC has decided to reopen the comment period in light of the increase in the number of issuers that have adopted clawback policies.
The proposed rules, available here, would apply to almost all categories of listed issuers, including small reporting companies, emerging growth companies, foreign private issuers and controlled companies, with limited exceptions for registered investment companies that do not no use incentive pay and mutual funds. The clawback policy would apply to the “officer” of each issuer as defined in Rule 16 (a) of the Securities Exchange Act of 1934, regardless of whether or not the officer played a role in the preparation of the financial statements. .
The required recovery of incentive compensation awarded in error would be triggered by an accounting restatement attributable to a material error in previously published financial statements. “Wrongdoing” is not required as is the case 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 on which the issuer is required to prepare a restatement and what the executive would have received if the incentive compensation had been based on the statements. retired financiers. Issuers would be required to comply with their collection policies, except to the extent that it would be impossible to do so, for example when the direct collection costs would exceed the amount to be collected.
The proposed rules require that clawback policies be filed as an attachment to issuers’ annual reports on Form 10-K and would require a management proxy circular and 10-K disclosure if the issuer makes a restatement requiring a collection or s ‘there was an unpaid pay balance which needed recovery.
- Topics for further comment
By reopening the comment period, the SEC has requested comments on the following 10 areas, in addition to any other comments on the original proposal release issued in 2015.
Interpretation of accounting restatement: The SEC asks if the interpretation of an “accounting restatement due to material non-compliance” should be broadened to include all required restatements made to correct an error in the aforementioned financial statements. This interpretation would include the restatements necessary to correct errors which were not material in the previously published financial statements but would result in a material misstatement if (a) the errors were not corrected in this report or (b) the correction of errors were recorded in the current period.
Three-year analysis period: The proposed rules provide that the date on which an issuer would be required to restate its financial statements for the purposes of the three-year “look back” would include the date on which the issuer’s board, a committee of the board or authorized officers, if the board no action is required, conclude or reasonably should have concluded that a restatement is required. The SEC is considering removing or amending the “reasonably concluded” standard to remove uncertainty regarding the determination of the three-year retrospective period.
Defined terms: The SEC is seeking comments on whether to remove the defined terms for “accounting restatement” and “material non-compliance” from the proposed rules or to rely on existing guidance and literature. Additionally, the SEC is seeking comment on whether guidance should be provided regarding when incentive compensation is “received” if the rules do not provide a specific definition of the term.
Changes to the cover page of Form 10-K: The SEC is considering adding checkboxes to the cover page of Form 10-K that would separately indicate (a) whether the published financial statements previously included in the filing include an error correction and (b) whether such corrections are restatements that triggered a recovery analysis during the exercise.
Cost and benefits: With the increase in voluntary adoption and disclosure of recovery policies, the SEC requests data and estimates that would inform the costs and benefits of current issuer recovery policies and how they may differ depending on the proposed rules.
Materiality analysis: The SEC recognizes that issuers, when performing an error materiality analysis, consider whether a misstatement in previously published financial statements has resulted in increased executive compensation. Therefore, the SEC assesses the extent to which these valuations can be exploited to determine the necessity and amount of any clawback. More generally, the SEC questions whether changing the scope of the proposed rules to include additional accounting restatements could affect the way an issuer conducts these valuations.
Disclosure of recoverable amount: The SEC recognizes that in calculating recoverable amount, issuers may rely on several possible methods to reasonably estimate the effect of an accounting restatement on the share price, with varying levels of complexity and a range of costs. associates. Under the proposed rules, there is no requirement to disclose how issuers calculate the recoverable amount. The SEC is seeking comment on whether additional disclosure should be required.
Investment companies: The SEC seeks comments on any changes or developments since the publication of the proposal regarding the payment of incentive compensation by listed listed management investment firms that are expected to affect how such companies are treated under the proposed rules .
XBRL: The SEC has proposed requiring that new information on claims collection be tagged in block text using XBRL. The SEC is currently considering requiring that specific data points in the new compensation recovery disclosure be labeled separately using Inline XBRL instead of, or in addition to, the proposed block-of-text labeling.
Further developments: The SEC is investigating any further development since the publication of the proposal that is expected to affect its review of the proposed rules or their potential economic effects.
The comment period will remain open until November 22, 2021. The SEC has confirmed that previously submitted comments should not be resubmitted and will be considered.