Evolution of SEC clawback provisions
October 2015 | FEATURE | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
For top executives, ‘clawback’ provisions have been an uncomfortable but unavoidable feature of the corporate landscape for some time. The Securities and Exchange Commission (SEC) has had clawback rules in place for more than a decade, considering them a necessity following a spate of major accounting scandals, most notably those involving Enron and WorldCom in the early 2000s.
Controversially however, the SEC is preparing to implement new, more stringent clawback provisions in the months ahead. In July, the Commission proposed to expand the circumstances under which companies must clawback performance-based bonuses awarded to executive officers, particularly for executives from public companies that are required to re-state their financial results.
Until now the SEC has not required compensation to be returned in cases where no misconduct was detected. Nevertheless, in an open meeting at the beginning of July, the SEC voted three to two to propose the implementation of Section 954 of the Dodd-Frank Act, known as the clawback provision.
The new provision would hit a great number of firms. According to data from Audit Analytics, companies restated financial results 831 times in 2014, and consequently around 42 percent of those restatements impacted upon the company’s bottom line. The others did not affect the company’s earnings but required correcting balances for shareholders’ equity, cash flow or other accounts.
Though the SEC has been pushing the implementation of the new provisions, it is not blind to the questions and challenges posed by their adoption. Not only would the SEC be affected, but also the wider financial sector. Accordingly, the Commission solicited comments on 101 questions related to the proposal over the summer. Comments were due to be returned to the Commission by 14 September 2015.
Under the proposed provision a clawback would be triggered by an accounting restatement, with executives required to pay back the difference between what they would have received under the restatement and what they actually received. “The objective of this rule is an important one,” SEC Chair Mary Jo White said on 1 July. “Simply put, executive officers should not be permitted to retain incentive-based compensation that they should not have received in the first instance, but did receive because of material errors in their companies’ publicly reported financial statements.”
The SEC’s decision to implement this change in focus is very much in keeping with the global regulatory sentiment toward clawback provisions. In 2014, the Financial Reporting Council in the UK introduced changes to its corporate governance code which requires UK listed companies, on a ‘comply or explain’ basis, to ensure that executive remuneration is designed to promote the long-term success of the company and to demonstrate more clearly to shareholders how this goal is being achieved.
The UK’s revised clawback provisions go deeper than those proposed by the SEC. They apply to 10 years’ worth of bonuses for senior management and seven years worth of bonuses for other ‘material risk takers’. The SEC’s provisions, by comparison, look back over the last three years only.
Once implemented, the SEC’s revised plans will seek compliance from public companies of all sizes, and will apply to any executive officer who performs policymaking decisions and who has received incentive compensation, including stock options. Previous rules governing clawback provisions were limited only to chief executive officers and chief financial officers. US stock exchanges would also be required to incorporate the clawback requirements into their listing standards. Under the new provision, companies would be obliged to recover any amount of incentive compensation that exceeds the amount an executive officer would have received based on the accounting restatement.
Though the SEC’s revised plan won overall approval, implementing it will present a number of significant challenges. For some commentators, the SEC’s revised provisions go too far. Others believe that the plans should not target smaller companies. “The broad approach of today’s proposal is likely to impose a substantial commitment of shareholder resources and, unintentionally, result in a further increase in executive compensation,” SEC Republican commissioner Mike Piwowar said in prepared remarks concerning the SEC’s decision.
The SEC’s decision to extend the rule to cover other ‘executive officers’ may present a number of issues. The existing provision has a slightly different definition of an ‘executive officer’, so adoption of the proposed rule would require some issuers to amend their recoupment policies in order to conform to the SEC’s chosen definition. The SEC’s new provisions also conflict with a number of state laws regarding whether the new rules will, or could have pre-emptive effects.
For some analysts, these questions are just the tip of the iceberg. Clearly, the SEC has a long road ahead when it comes to implementing the provisions. Companies may look to circumvent the new rules, perhaps by adjusting their compensation packages so that executives receive more fixed pay and less in bonuses. But this tactic is unlikely to win popular support among shareholders, who generally favour bonuses tied to performance instead of large fixed salaries. As a result, there may be some degree of resistance.
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