Abstract: The SEC is moving forward with executive compensation rules, including so-called “clawback” rules, that remain unfinished under the Dodd-Frank Wall Street Reform and Consumer Protection Act. This article explains the proposed changes and how public companies can review their executive compensation policies and procedures based on the direction of the SEC.
The Securities and Exchange Commission (SEC) is moving forward with executive compensation rules, including so-called “clawback” rules, that remain unfinished under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). So far, SEC Chair Gary Gensler has taken a position that aligns with investor protection advocates.
What’s a clawback provision?
Section 954 of Dodd-Frank requires public companies to disclose their policies for paying stock options and other forms of incentive-based compensation, using financial information reported under U.S. securities laws. Clawback provisions also require current and former executive officers who receive incentive compensation to repay any excess amount that was paid due to erroneous financial data, in the event that the company is required to restate its financial results due to “material noncompliance” within a three-year period.
Although Dodd-Frank was signed into law in 2010, the clawback rules haven’t yet been finalized. In the meantime, many companies have voluntarily enabled or required themselves to implement them.
Proposed changes to the clawback rules were issued in July 2015. But Gensler’s predecessor, Jay Clayton, didn’t touch the proposal because it’s unpopular with most executives. Clayton, who was appointed by President Trump, sought to reduce government regulations. By contrast, Gensler, President Biden’s appointee, has been reversing course. In October 2021, the SEC put the proposal out for another round of comment before trying to move ahead with final rules.
What’s being proposed?
The proposed changes under Dodd-Frank are more stringent and broader in scope than the clawbacks under Section 304 of the Sarbanes-Oxley Act of 2002, which was passed in order to restore investor trust following accounting scandals at companies like Enron and WorldCom. Clawback requirements would be triggered by an accounting restatement and cover a wide group of executives, including:
- CFOs,
- CEOs,
- Accounting officers or controllers,
- Vice-presidents in charge of principal business units or divisions, and
- Any other high-ranking individuals who perform similar functions.
The clawback proposal wouldn’t require misconduct by those executives in order to recoup the money. If the proposal is approved, companies that fail to comply with the clawback rules would lose their listings on stock exchanges.
Are voluntary improvements enough?
The U.S. Chamber of Commerce issued a comment letter on the proposed changes, indicating that they’re unnecessarily complex and too prescriptive. The Chamber’s executive vice president Thomas Quaadman said that the number of public companies that have adopted a clawback policy has increased by almost 106% since the SEC first issued its clawback proposal in 2015.
Likewise, a comment letter from the Society for Corporate Governance shows that many companies already disclose their clawback policies, including:
- 81% of Fortune 100 companies,
- More than 90% S&P 500 companies, and
- Over 65% of companies in the Russell 3000 index.
“Companies have, as a matter of good governance, developed rigorous policies that have enabled effective clawbacks in the intervening period since 2015 without formal action from the [SEC],” Quaadman wrote. “Moreover … we encourage the SEC to take an approach to its responsibilities under Section 954 that maintains flexibility for companies that have developed effective policies; the SEC should not needlessly override effective clawback compensation processes.”
The Business Roundtable, an association of CEOs of America’s leading companies, wants the SEC to put out another round of proposal. This would delay the already slow-moving rulemaking process, according to the Council of Institutional Investors (CII). The CII, which has been pressing for completion of the rules, would prefer that the SEC move ahead without another round of public comment, calling the changes “long overdue.”
A comment letter from Sandra Peters, senior head for global financial reporting policy advocacy with the CFA Institute, says that investors need comprehensive disclosure about the nature of error and its materiality. “Because of the inherent estimates, judgements, and complexity involved, companies should disclose their evaluations, the process and assumptions used to determine whether the error(s) in question were material or immaterial, and why it decided the matter in this way,” Peters wrote. “Such disclosure should be thorough enough for investors to understand the material facts of the case, understand the reasoning behind such a decision, and make appropriate decisions about the board’s actions.”
Now or later?
While it’s unclear what the exact parameters will be, there’s no escaping it: The reopening of public comment on the proposal signals that the SEC under the Biden administration wants to finalize the clawback rules. Corporate boards should start getting ready for the upcoming requirements now.
Contact your CPA for the latest developments on this proposal. Public companies expect finalized rules to be in the works as soon as 2023.
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