SEC Proposes Clawback Rules Mandated Under Dodd-Frank

SEC Proposes Clawback Rules Statutorily Mandated Under Dodd-Frank Act

July 15 2015

PDFExecutive Summary
On July 1, 2015, the Commissioners of the SEC voted three-to-two along party lines to propose a rule implementing the listing standards for recovery of erroneously awarded compensation (“clawback”) policies mandated under Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Proposed Rule”). This marks the final compensation-related item required under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 “Dodd-Frank Act”.

As a reminder, Section 954 of the Dodd-Frank Act required the SEC to direct exchanges to modify listing standards to prohibit listing of issuers not complying with the requirement to recover compensation erroneously awarded. Pursuant to the requirement, each issuer is required to develop and implement a policy providing

  • 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; and
  • That, in the event of an accounting restatement due to material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover from any current or former executive officer of the issuer who received incentive-based compensation (including stock options awarded as compensation) during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

The Proposed Rule requires exchanges to establish listing standards requiring listed issuers to adopt and comply with written clawback policies. Clawback polices must require companies to recover excess incentive-based compensation received by executive officers based on erroneously reported financial information in the three fiscal years prior to the date it is determined that a material restatement is necessary. Importantly, incentive-based compensation is defined to include pay determined in whole or in part by non-financial metrics such as stock price and total shareholder return.

The Proposed Rule provides very little room for discretion on the part of the board or company to determine whether to pursue a clawback, from whom or how much, and applies to virtually all companies listed on US exchanges, including foreign private issuers, regardless of whether the listing is equity, debt or preferred securities.

Under the Proposed Rule, companies will be required to disclose both their clawback policies, as well as details about how those policies are applied in practice. For U.S. companies, in the event of a restatement requiring the clawback of erroneously awarded incentive-based compensation, the disclosure will also include details about the date on which the company was required to prepare a restatement, the aggregate amount of excess compensation erroneously awarded and the aggregate amount that remains to be collected at fiscal year end. Companies will also need to provide disclosure regarding how the amount of excess compensation to be recovered was determined. Finally, should a company decide, in very narrowly defined circumstances, not to pursue a clawback from a particular person, the names of these individuals, as well as the amounts forgone and the reason why, must also be disclosed.

The Proposed Rule requests extensive and detailed comments, including responses to the 101 questions specifically asked by the SEC Staff. Comments will be due September 14, 2015.

We will be submitting a comment letter in response to the Proposed Rule and we welcome any thoughts, comments or concerns that you would like to share with us as we prepare our response. Please contact Nora McCord at 212-488-5400 or

To whom does the proposed rule apply?
The Proposed Rule will apply to all listed issuers, including emerging growth companies, smaller reporting companies, foreign private issuers and controlled companies. Limited exceptions will apply only to those organizations where the compensation structures of issuers render the Proposed Rule unnecessary, including security futures products, standardized options and securities of registered investment companies only to the extent to which they pay executives incentive-based compensation.

Additionally, the requirements will apply regardless of whether the issuer is listing equity, debt or preferred securities.

What type of restatement will trigger a clawback?
A clawback will be triggered in the event that a company is required to prepare a restatement to correct an error that is material to previously issued financial statements.

The SEC specifically notes that changes in financial statements related to retrospective application of a change in accounting principle, revision to reportable segment information due to a change in the internal structure of an organization, reclassification due to a discontinued operation, application of a change in reporting entity, adjustment to provisional amounts in connection with a prior business combination and revisions for stock splits will not serve as triggers for the clawback policy.

What date triggers the three-year look back requirement?
The three-year look-back for the clawback will be triggered on the earlier of

  • The date the company’s board of directors, committee of the board of directors, or the officer or officers of the company authorized to take such action 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.

The SEC notes that this is generally expected to coincide with the 8-K filing disclosing this decision, but that this is not a prerequisite. The SEC also notes that it is possible that this date may occur before the full amount of the error has been determined.

Which executives are subject to the clawback policy?
The clawback will apply to “executive officers” of the company, defined by the SEC to include the company’s president, principal financial officer, principal accounting officer (or if there is no such accounting officer, controller), any vice president in charge of a principal business unit, division or function, any other officer or person who performs a policy-making function for the company. Executive officers of both parents and subsidiaries would also be deemed executive officers of the company if they perform policy making functions within the company.

The clawback policy would apply to incentive compensation received by any individual who served as an executive officer at any time during the performance period for that incentive-based compensation. The clawback would also apply to awards authorized before the individual becomes an executive officer and sign-on awards in new-hire situations, as long as the individual served as an executive officer at any time during the award’s performance period.

What kinds of compensation are subject to the clawback policy?
While the SEC has proposed a principles-based definition of “incentive-based compensation”, under the Proposed Rule it is defined as “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure (emphasis added by SH&P).”

This proposed definition also clarifies that 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 derived wholly or in part from such financial information, and stock price and total shareholder return (emphasis added by SH&P).”

In deciding to include compensation earned or vested based on stock price and total shareholder return, the SEC took the position that Congress had intended the policy to be applied broadly, that TSR is a common metric in executive compensation, and that excluding it would likely be inconsistent with Congress’ intent. Furthermore, it did so even as it acknowledged the potential administrative burdens that this requirement might impose, as well as the “significant technical expertise and specialized knowledge” and “substantial exercise of judgment” that might be required to determine the stock price impact of a material restatement. The SEC has taken the position in the proposing release that these challenges will be offset by the permission to use “reasonable estimates” when determining the impact.

The clawback will not apply to all incentive-based compensation, however. Incentive awards that are granted, earned or vested based solely upon the occurrence of non-financial events (such as opening a specified number of stores, regulatory approval of a product, consummation of merger or divestiture, completing a restructuring plan or financing transaction) are exempt from clawback. Time-vested restricted stock and options are also exempt, provided that the grant is not contingent upon any financial reporting measure performance goal and vesting is contingent solely upon the passage of time (and/or the achievement of a non-financial reporting measure). As a practical matter, though, we note that companies making equity awards based on an assessment of the performance of the company and the executive over the past year, and in expectation of expected future contributions, may need to consider whether or not the assessment of company-based performance is based in whole or in part on financial reporting measures.

How will compensation subject to clawback be determined?
The company will be required to clawback excess incentive-based compensation received during the three completed fiscal years prior to the trigger date of the restatement.

When is incentive-based compensation “received”?
Incentive-based compensation would be deemed received in the fiscal year during which the financial reporting measure specified in the incentive award is attained, even if payment or grant occurs after the end of that period.

The SEC explicitly states that not all conditions to an award must be satisfied for it to be deemed “received” for purposes of the clawback policy. For example, a performance share unit which is earned based upon the achievement of a financial reporting metric, and then subject to an additional time-based vesting period is “received” when the financial reporting metric is attained, even though the executive may have only a contingent right to receive the award.

How is “excess compensation” determined?
The amount subject to clawback (the recoverable amount) is defined as “the amount of incentive-based compensation received by the executive officer or former executive officer that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the accounting restatement.”

To determine this amount, companies must

  • Recalculate the applicable financial reporting measure and determine the amount of incentive-based compensation earned based on the recalculated value; and
  • Determine whether or not the executive received greater incentive compensation than would have been received applying the recalculated financial reporting measure, taking into account any discretion that the compensation committee had applied to reduce the amount originally received

Recoverable Amounts Determined on a Pre-Tax Basis
To ensure that the company recovers the full amount of incentive-based compensation due, the recoverable amount will be calculated on a pre-tax basis. The SEC notes that this also absolves the company of the need to determine the particular tax circumstances of individual executive officers.

Incentive-Based Compensation Based In Part on Financial Reporting Performance Measures
For awards based only in part on the achievement of a financial reporting performance measure, the company must first determine what portion of the award was based on the financial reporting performance measure before calculating the difference between the two values before and after the restatement.

Incentive-Based Compensation Based on Stock Price or Total Shareholder Return
For incentive-based compensation based on stock price or TSR, the recoverable amount may be determined based on a reasonable estimate of the effect of the accounting restatement on the applicable measure. The SEC provides a detailed discussion of how these “reasonable estimates” might be calculated, and acknowledges that the expense of determining a “but for [the restatement]” stock price might be considerable.

Regardless of the approach taken to estimate the amount of compensation that should have been received, companies will be required to maintain documentation of the determination of the reasonable estimate and provide that documentation to the relevant exchange.

Cash Awards Paid from Bonus Pools
For cash awards paid from bonus pools, the SEC has proposed that companies first re-calculate the size of the aggregate bonus pool from which individual bonuses are paid based on the restated financial reporting measure, determine the aggregate excess amount of compensation paid, and finally apply the excess amount on a pro rata basis.

Equity Awards
With regards to recovering equity awards, the company must first determine the number of shares, options or SARs that were received in excess of what would have been received under the restated financial measure.

If the shares, options or SARs are still held by the executive, the recoverable amount is the number of shares received in excess of the number that would have been received under the restated financial reporting measure.

If options or SARs have been exercised, but the underlying shares not yet sold, then the recoverable amount would be the number of shares underlying the excess amount of options or SARs received.

If the shares have been sold, the recoverable amount would be the sale proceeds received by the executive officer with respect to the excess number of shares.

Does the board have discretion regarding whether to seek a clawback?
No, but there are two exceptions. The Proposed Rule requires that an issuer must recover erroneously awarded compensation in compliance with its clawback policy, except to the extent that

  • Clawbacks would be impractical because it would impose undue costs on the issuer or its shareholders (namely, costs of pursing a clawback would be in excess of the amount to be clawed back); or
  • Would violate home country law (which, the SEC further stipulates, must be in place at the time the Proposed Rule is published in the Federal Register, so as to avoid any countries’ attempts to intentionally circumvent this policy).

The SEC explicitly states that it is of the view that companies should pursue a clawback in most instances, and certainly regardless of whether or not the executive in question may be responsible for the financial statement errors requiring the restatement.

Before making the final determination to rely upon one of these exemptions, the company must first

  • Make a “reasonable attempt” to clawback the excess compensation, document those attempts and provide the documentation to the exchange, and disclose in subsequent SEC filings why it determined not to pursue recovery; or
  • Obtain an opinion of home country counsel that a clawback would result in a violation of that country’s laws.

To prevent conflicts of interests, only the compensation committee of the board (or absent a committee, a majority of the independent directors of the board) can determine that seeking a clawback would be impractical.

Does the board have discretion regarding the amount of the clawback?
No. Under the Proposed Rule, the board will not be permitted to pursue differential clawbacks among executive officers, even those awarded under “pool plans” where the board may have exercised discretion in determining how much to award each executive officer. The SEC argues that this approach ensures that the clawback policy is applied on a no fault basis, as was intended by Congress, and preserves the spirit of the regulation, namely that executive officers not be entitled to keep compensation erroneously awarded to them.

Does the board have discretion regarding the means of recovery?
Yes. The Proposed Rule does provide for board discretion to determine the means of recovery because the most appropriate means of recovery may vary by company and by type of compensation arrangement.

Regardless of the manner selected, the SEC stipulates that companies should recover the excess compensation “reasonably promptly” and that undue delay would constitute non-compliance with the company’s clawback policy.

What happens if a company doesn’t comply with its clawback policy?
Any company not in compliance with its clawback policy would be subject to delisting.

The Proposed Rule provides exchanges with the authority to determine whether or not the company is in compliance with its policy.

How will a company disclose its clawback policy?
In general, the Proposed Rule requires disclosure intended to inform both shareholders and the listing exchange about

  • The substance of a company’s clawback policy; and
  • How the company implements that policy in practice.

Any U.S. company which, at any time during its most recent fiscal year, had either a restatement that required a clawback of excess compensation or, alternatively, had an outstanding balance of excess compensation to be recovered must disclose

  • The date on which the company was required to prepare an accounting restatement;
  • The aggregate dollar amount of excess incentive-based compensation attributable to such accounting restatement;
  • The aggregate dollar amount of excess incentive-based compensation that remains outstanding at the end of the last completed fiscal year;
  • The estimates used to determine the excess incentive-based compensation attributable to such accounting restatement if the financial reporting measure was related to a stock price or total shareholder return metric;
  • The name of each person subject to clawback, if any, from whom the company decided not to pursue a clawback, the amount forgone and the reason why a clawback wasn’t pursued; and
  • The name of, and amount due from, any person from whom, at the end of the last completed fiscal year, excess compensation had been outstanding for 180 days or longer since the date the amount owed was determined.

The SEC has proposed that the disclosure be separate from the CD&A, since it will apply to all executive officers, rather than just named executive officers, although companies will have the option to include the information in the CD&A.

Will Summary Compensation Table values be modified to reflect clawbacks?
Companies will reduce the amounts reported in the Summary Compensation Table so that the table reflects incentive-based compensation that would have been received if the amounts had been determined correctly. Any such reductions will be footnoted.

Will the required disclosure be provided in XBRL format?

Disclosure Requirements for Foreign Issuers
Foreign issuers will have similar disclosure requirements as part of their Form 20-F filing, and data would generally be required to be tagged in the XBRL format.

Can a company protect an executive officer from personal liability associated with clawbacks?
No. In the Proposed Rule, the SEC takes the position that any indemnification arrangements which might protect the executive from clawbacks are inconsistent with Congress’ intent, and such arrangements are expressly prohibited.

While the SEC acknowledges that there is nothing to preclude an executive from securing third-party insurance policy to fund any potential clawback obligations, the company may not pay for or reimburse the executive for any premiums.

Transition and Timing
While the proposed release did not specify an effective date, it appears unlikely that such rules will become effective until nearly 1.5 years after the final rule is published in the Federal Register, suggesting that the requirement won’t be effective until 2017 at the very earliest. The exchanges must implement listing exchange rules within 90 days of publication of the final rule, which must become effective no later than one year following that date. Companies must then comply with the listing exchange rules within 60 days of the effective date.

Companies will be required to clawback all erroneously awarded incentive compensation received by executive officers as a result of attainment of a financial reporting measure for any fiscal period ending on or after the effective date of the final rule and that is granted, earned or vested on or after the effective date of the company’s clawback policy.

Companies will be required to file the mandated disclosure in SEC filings on or after the date the exchange rules become effective.

Our View
While we recognize the complexity of the original Dodd-Frank requirement, as well as the comprehensive nature of the Proposed Rule, we are troubled by the prescriptive nature of most aspects of this Rule, and the fact that the exercise of board or compensation committee judgment or discretion is essentially precluded. We remain in favor of a principles-based approach which provides companies with the flexibility needed to remain most true to the spirit of the Rule given their particular facts and circumstances, and believe that detailed disclosure of policies and approaches taken will mitigate against any malfeasance on the part of companies in the application of the Rule.

We are also particularly troubled by the SEC’s decision to include incentive compensation received based on attainment of stock price or total shareholder return goals. We are not moved by the SEC’s rationale that the ability to use “reasonable estimates” to determine the excess amounts received is sufficient to mitigate the substantial burden placed on companies who will be tasked with determining such amounts.

We are also concerned with the practical implications of determining how much to clawback from awards, particularly equity awards, that may have been determined at least in part on company performance broadly defined, including reported financials which may be subsequently restated, triggering the clawback requirement. In our experience, these assessments of performance are holistic and discretionary, and often include a review of a whole host of factors, both quantitative and qualitative in nature, including the companies reported financials, an assessment of market conditions and company performance in light of those conditions and the individual performance of a particular executive. In many cases, we find the compensation committee does not assign any particular relative weighting to each of these factors, and in fact, may make different decisions on an executive-by-executive basis. As a practical matter, we believe it will be important for companies to consider whether or not this will be an issue for them, and for the SEC to clarify how such a scenario ought to be handled. 

About Steven Hall & Partners
Steven Hall & Partners is an independent executive compensation consulting firm, specializing exclusively in the areas of executive compensation, board remuneration, non-profit compensation and related governance issues. By focusing solely on this critical and complex segment of the human resources arena, we are able to provide our clients with the highest quality expertise and best counsel available on a practical basis. For more information, please visit and follow us on Twitter @SHallPartners.

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