PwC explains the key provisions of the Dodd Frank Clawback Rule proposed by the SEC and how it may impact your company.
On July 1, 2015, the SEC proposed various rules that will require all companies listed on a national securities exchange to have a policy to recover erroneously awarded compensation.
The proposal, also referred to as the “clawback rule,” was mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The proposal would require all listed companies to adopt and comply with policies to recover incentive–based compensation (as defined) when the company is required to restate its previously issued financial statements to correct a material error. This policy would be disclosed as an exhibit to the Annual Report. Additional disclosure would be required in the Annual Report if the company was required to recover incentive-based payments.
The proposal would apply to all companies that have any security – equity or debt - listed on a national securities exchange. There are no proposed exceptions for foreign private issuers, emerging growth companies, smaller reporting companies, or Canadian companies filing under the multi-jurisdictional disclosure system. The proposed rules would not apply to companies that are registrants, but whose securities trade in the over the counter market.
Applicability - the event
The proposal would require the recovery of incentive-based compensation (compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure) when a company is required to restate its previously issued financial statements due to a material error.
Financial reporting measures are measures that are (i) determined and presented in accordance with the accounting principles used in preparing the company’s financial statements, (ii) any measures derived wholly or in part from such financial information, and (iii) stock price and total shareholder return.
It would appear that the proposal would not be applicable to revisions because the effect to the financial statements is not considered to be material.
Applicability – the people
The requirement for recovery of excess compensation would apply to all current and former executive officers that received incentive-based compensation, including the President, CFO, CAO, vice presidents in charge of a unit, division or function, and any other officer that performs a policy making function. It is broader in scope than the existing definition of an executive officer in the Securities Exchange Act. Recovery is required even if the executive officer was not engaged in misconduct and even if they were not involved in the financial reporting process.
Determination of excess compensation
The amount of compensation that a company would need to recover is the amount of the incentive-based compensation received by the executive officers that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the accounting restatement. That is, the amount of incentive-based compensation attributable to the material error would need to be recovered. The amount would be calculated without regard to the impact of taxes.
For incentive compensation based on stock price and total shareholder return, calculating what the financial measure would have been absent the error may be complex. The proposal only provides broad guidance on how the effect on the stock price and total shareholder return should be determined. A company may need to hire an expert to assist in the determination of the impact.
The proposed rule would apply to incentive -based compensation received during the three completed fiscal years immediately preceding the date the company is required to restate its previously issued financial statements. The terms of some incentive-based compensation plans may require the company to determine the impact of the material error for more periods than will be disclosed in the annual report.
The comment period for the proposal ends 60 days after the date the rule is published in the Federal Register (the due date is expected to be early September). Stakeholders are encouraged to provide comments on the proposal.
If the Commission decides to issue a final rule, the national securities exchanges will have 90 days to publish changes to the listing requirements that will be effective no later than one year later. Each listed issuer will have to adopt a policy no later than 60 days after the exchange rules become effective.
PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams who have questions should contact the National Professional Services Group (1-973-236-7800).