Some five years ago, Section 954 of the Dodd-Frank Act instructed the SEC to adopt rules mandating that national securities exchanges require listed companies to implement incentive compensation recovery (or clawback) policies. Last week, the SEC proposed the long-awaited new rules, which SEC Chair Mary Jo White described as “the last of the Dodd-Frank Act executive compensation rulemaking.”

Since Dodd-Frank was enacted, the clawback picture has become somewhat muddled. The Sarbanes-Oxley Act, of course, already contains a limited clawback policy applicable solely to CEO and CFO compensation and triggered by financial restatements resulting from “misconduct.” Also, many companies adopted “voluntary” clawback policies in response to Dodd-Frank in an effort to achieve what they perceived to be “best practices” in that area of corporate governance (an estimated 23% of all filers and 50% of S&P 1500 companies).

The SEC’s proposed new Rule 10D-1 under the Securities Exchange Act would substantially broaden the scope of Sarbanes-Oxley clawbacks and would, no doubt, differ from existing voluntary policies. Therefore, companies must re-examine their current positions regarding clawbacks, as well as begin to prepare for the rule’s inevitable adoption. (See the suggested action steps below.)

A brief summary of the proposed new rule…

Companies listed on a national stock exchange (excluding investment companies) would be required to adopt clawback policies designed to recover incentive-based compensation awarded to a current or former executive officer during the three-year period before the year in which it was required to restate its financial statements due to material noncompliance with financial reporting requirements. The clawback would apply without regard to whether there was misconduct by the executive officer in question, persons he or she supervised, or otherwise.

The clawback policy would cover incentive-based compensation granted, earned or vested based on the attainment of any financial reporting measure (including accounting metrics, stock price and total shareholder return). The amount recovered would equal the excess of such incentive-based compensation actually paid during the applicable fiscal period over what would have been paid had the financial statements been correct. However, no recovery would be required if the compensation committee determines, after a reasonable attempt at recovery and properly documenting those attempts, that pursuing recovery would be impracticable because the direct expense would exceed the recoverable amount.

Companies may not indemnify an executive officer for losses due to erroneously awarded incentive compensation, nor may they pay the premiums for any related insurance.

Companies would be required to disclose in the compensation sections of their proxy statements:

• the recovery of excess compensation during the last completed fiscal years,
• any outstanding balance of excess compensation from a prior restatement, and
• instances where recoverable compensation was not repaid within 180 days or the company decided not to pursue recovery.

The company’s clawback policy must be filed as a Form 10-K exhibit.

Proposed timing of the new rules…

The good news is that there is plenty of time to prepare for the final rules. Companies would not be subject to the new requirements until the stock exchanges revise their listing standards in response to Rule 10D-1. The SEC’s proposal must go through the comment (and possible revision) process before being finalized. Then the exchanges must propose and finalize their rules.

After that, listed companies would have 60 days to adopt their clawback policies. At that point, companies would be required to recover excess compensation received on or after the effective date of Rule 10D-1 that results from financial information for any fiscal period ending on or after that effective date. The new disclosure requirements would kick in for proxy statements and Form 10-Ks filed on or after the effective date of the new listing exchange standards.

All of this means that it is highly unlikely that the new listing standards will be in effect any time soon—probably not until late 2016 or beyond.

A few observations…

• This was another split decision (three to two) by the Commission. The dissenting Commissioners (Gallagher and Piwowar) noted a variety of concerns, including the broader definition of executive officer, the no-fault feature, the scope of compensation covered, exceeding Dodd-Frank’s mandate, and an odd criticism of the workings of the Commission’s internal review and vetting process.
• It probably won’t be hard for a compensation committee to conclude, in many cases, that the direct cost of seeking recovery of unearned incentive compensation will exceed the amount to be recovered. Note, however, that such a decision must be disclosed in the company’s proxy statement and, therefore, should not be taken lightly.
• Certain retrospective changes to the financial statements would not trigger recovery, including a change in accounting principles, revision to reportable segment information, reclassification due to discontinued operations, a reorganization of entities under common control, adjustment to provisional amounts in connection with a prior business combination and stock splits.
• The trigger date for recovery (i.e., when the company is required to prepare a restatement) is expected to coincide with the event described in Item 4.02(a) of Form 8-K.
• The definition of executive officer is modeled on, though not identical to, the definition of “officer” in Rule 16a-1(f)—as if we needed yet another definition of executive officer to deal with.

Current action steps…

Despite what feels like a long lead time for the new rule, there are certain things listed companies should be doing now since this could impact behaviors and decisions over the next year or so:

• If you have a current clawback policy, review it to determine what changes are likely to be required under the SEC’s proposal.
• Consider whether any aspects of your company’s compensation programs should be modified in light of the proposal.
• Be sure your compensation committee is well informed before it makes its next round of compensation decisions.
• Consider whether any existing executive officer employment agreements will need to be revised to reflect the proposed new rules, particularly with regard to the company’s indemnification or premium reimbursement responsibilities.
• Review your executive officer determinations to see if any changes are advisable. For example, should the number of executive officers be reduced to exclude persons with limited involvement in financial statement oversight or input?
• Evaluate the consequences of the proposed new rule when analyzing any pending or future financial restatements. Consider the extent to which executive officers may have a conflict of interest related to any such determinations and take appropriate safeguards.