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SEC Floats Compensation Clawback Rules

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The Securities and Exchange Commission has moved forward on proposed rules that would require companies to develop and implement policies to “claw back” incentive-based executive compensation that later is shown to have been awarded in error. 

“The objective of this rule is an important one,” said SEC Chairwoman Mary Jo White, reading from her prepared statement during an SEC open meeting on Wednesday. “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 proposed rules are designed to prevent that from happening.”

During the meeting on Wednesday morning, the commission approved the proposal for publication with a 3-2 vote. The SEC will now seek comment on the proposed rules, which will be published on the SEC’s website and in the Federal Register.  The comment period for the proposed rules will be 60 days after publication in the register.

This proposal, often referred to as the “clawback” rule, was the last of the Dodd-Frank Act executive compensation rulemakings remaining for the SEC to propose. 

According to White, these proposed rules would “increase accountability and bring greater focus to the quality of financial reporting.”

Under the proposed rules, national securities exchanges and associations will have to establish listing standards that would require companies to adopt and comply with a compensation recovery policy. Additionally, recovery would be required from current and former executive officers who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement to correct a material error.

The proposed rules define “incentive-based compensation” to include performance-based compensation paid to executives based on a company’s stock price and/or total shareholder return.

According to Commissioner Luis A. Aguilar, a study released on June 4 showed that approximately 51% of the top 200 public companies making performance-based grants for executive compensation based it on a total shareholder return measure.

“In today’s corporate world, many executives are earning eye-catching sums,” Aquilar said during the open meeting. “Much of the increase in executive compensation is commonly attributed to the impact of incentive-based compensation, including equity and other performance-based compensation plans.”

However, the SEC’s definition of “incentive-based compensation” does not include all forms of executive compensation. It does not include bonuses paid solely at the discretion of a company’s board of directors, or equity awards that vest solely upon completion of a specified employment period.

The proposed rules, which would apply to all listed companies except for certain registered investment companies that do not provide incentive-based compensation to their employees, would be required on a “no fault” basis — without regard to whether any misconduct occurred or an executive officer’s responsibility for the erroneous financial statements.

Commissioners Daniel Gallagher and Michael Piwowar disapproved of the proposed rules on clawbacks.

Gallagher, who has been a longtime vocal opponent to the Dodd-Frank Act, said at the meeting that staff hours could have been better spent on more “meaningful projects” like the disclosure review project instead of clawbacks.

 “We are unveiling our most recent Goya,” Gallagher said, likening the proposed rules to the famous artist. He called the proposal “tortured.”

Gallagher’s problems with the proposal include a too-broad definition of “executive officer.”

According to the SEC, an “executive officer” includes all of the following: the company’s president; principal financial officer; principal accounting officer; any vice president in charge of a principal business unit, division or function; and any other person who performs policymaking functions for the company.

Gallagher said he could have approved the proposed rules “if it included the relief valve that I requested to avoid unjust results.

“Specifically, we could have given boards of directors broad discretion to the clawbacks allowing the boards to determine whether to pursue a clawback, whether to settle a clawback obligation for less than the full amount, whether there is a minimum amount of compensation that is not worth pursuing or whether to recover through an alternative method,” he said during the meeting. “Sadly the proposal does not take that approach.”

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