On July 1, the SEC proposed rules under the Dodd-Frank Act directing securities markets to establish listing standards requiring companies to adopt policies that require executive officers to pay back incentive-based compensation that they were awarded erroneously.
The SEC’s proposed rules would require the disclosure of policies that would claw back incentive-based compensation that is based on financial information filed by the company in the event there is a material accounting restatement. Previously, the Sarbanes-Oxley Act only addressed clawbacks regarding executives that had committed fraud.
The proposed rules would also require disclosure of listed companies’ recovery policies and their actions under those policies. 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.
Recovery is required even if the executive officer was not engaged in misconduct and even if that person was not involved in the financial reporting process. 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.
“These listing standards will require executive officers to return incentive-based compensation that was not earned,” said SEC Chair Mary Jo White. “The proposed rules would result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”
Each listed company would be required to file its recovery policy as an exhibit to its annual report under the Securities Exchange Act. In addition, a listed company would be required to disclose any actions to recover erroneous compensation in its annual reports and any proxy statement that requires executive compensation disclosure if there was a restatement requiring recovery of excess incentive-based compensation.
The proposed rules’ public comment period ends September 14.
[For more information about the proposed clawback rules, read PwC’s In brief.]
Earlier this month, CalSTRS issued guidelines for what it considers to be the composition of a high-performing corporate board of directors.
Independent leadership, diversity, board succession planning, and accountability measures are among the sought-after qualities CalSTRS outlined in its publication, Best Practices in Board Composition. With regard to accountability, CalSTRS believes attendance and sufficient time commitment are needed to be a good director, specifically noting that a standing CEO should only sit on one outside board and that directors should not sit on more than four public boards. In addition, it focuses on the need for annual elections, suggesting that directors should be required to garner at least the majority vote of the shareholders.
CalSTRS Corporate Governance Director Anne Sheehan says that these best practices will help corporate leaders decide how best to structure their boards to optimize long-term corporate performance. The two-page publication details the expectations of long-term institutional investors to align the interests of the board with those of investors, she said.
As pointed out in PwC’s 2014 Annual Corporate Directors Survey (ACDS), one of the clearest examples of a governance trend is the focus by institutional investors on board composition. Effective oversight of public companies requires boards to collectively possess the skills to exercise their fiduciary responsibilities. And board composition is under pressure to evolve to meet new business challenges and stakeholder expectations. Today’s directors are more focused than ever on ensuring their boards have the right expertise and experience to be effective.
The SEC’s proposed pay vs. performance rule has gotten the attention of corporate secretaries and BlackRock Inc., the largest institutional investor.
As proposed in April 2015, the rules would require companies to disclose the relationship between executive compensation and the financial performance of a company. They would implement a requirement mandated by the Dodd-Frank Act, which is designed to provide greater transparency for shareholders for say-on-pay votes. The comment period for the proposed rules ended July 6. If finalized in 2015, it’s possible the new disclosures could be required in the 2016 proxy season.
Companies would be required to present the disclosure in a new table that would cover the last five fiscal years (three years for smaller reporting companies), showing:
In a comment letter, The Society for Corporate Secretaries and Governance Professionals urged the SEC to amend the proposal to provide companies with flexibility to define and disclose the relationship between pay and performance in a manner that is tailored to their unique facts and circumstances. Among many recommendations, the Society suggested replacing total shareholder return as the sole measure of financial performance with a principles-based approach, eliminating peer group disclosures, and adopting a principles-based approach for defining executive compensation actually paid.
BlackRock, which manages more than $4 trillion in assets, expressed similar views.
In its comment letter, BlackRock also supported a principles-based approach to pay vs. performance rules and is concerned about using TSR, which could lead to an excessive focus on short-term results at the expense of long-term interests.
“In our experience, the appropriate metrics and timeframes by which to measure performance vary across companies and industries,” the letter said. “We therefore favor a principles-based disclosure regime that sets forth a consistent framework for issuers to communicate the link between pay and performance. A principles-based framework should provide flexibility for issuers to report how incentive plans reflect company strategy and incorporate long-term shareholder value drivers, including through disclosure of the commensurate metrics and timeframes by which shareholders should assess performance.”
The Conference Board has released thought leadership that addresses risk culture oversight in the prism of the financial reporting failures and the financial crisis that have occurred over the past 15 years. The Director Notes publication The Next Frontier for Boards, Oversight of Risk Culture also offers a list of challenges and recommendations for boards.
Weak risk culture has been diagnosed as the root cause of many large and, in the words of the SEC Chair Mary Jo White, “egregious” corporate governance failures, according to The Conference Board paper. Deficient risk and control management processes, IT security, and unreliable financial reporting are increasingly seen as mere symptoms of a “bad” or “deficient” risk culture, it continues. The new challenge that corporate directors face is how to diagnose and oversee the company’s risk culture and what actions to take if it is found to be deficient.
The Conference Board authors, Parveen P. Gupta, chair and professor of accounting at the College of Business and Economics at Lehigh University, and Tim J. Leech, managing director at Risk Oversight Solutions Inc., offered the following recommendations for directors: