Risk Management

SEC Proposes to Vastly Expand Clawback Rules

The proposal makes executives subject to pay clawbacks even when there was no misconduct, but doesn't say how to measure the value of equity compen...
David McCannJuly 1, 2015
SEC Proposes to Vastly Expand Clawback Rules

The Securities and Exchange Commission, as expected, proposed on Wednesday to expand the circumstances under which companies must “claw back” performance-based bonuses awarded to executive officers. The proposal, aimed at implementing the clawback provisions of the Dodd-Frank Act, did contain at least one surprise, however.

Circaetus_gallicus_clawThe main feature of the proposed rules is that officers would be subject to clawbacks even when there was no misconduct. Upon a restatement of financials, if the new accounting would not have triggered a bonus, or would have triggered a lower bonus, had it been correct in the first place, the excess amount paid would go back to the company regardless of whether the accounting error was intentional.

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The SEC has had clawback rules in place for more than a decade, following the spate of major accounting scandals, including those at Enron and WorldCom, that came to light in the first few years of this century. But the commission hasn’t required compensation to be returned in cases where there was no misconduct.

“Executive officers should not be permitted to retain incentive-based compensation that they should not have received in the first instance,” SEC Chair Mary Jo White said in a statement.

The SEC opted not to detail how companies should measure gains in the value of unexercised or unvested equity awards. “That was a big surprise to us,” Steve Seelig, executive compensation counsel for consulting firm Towers Watson, tells CFO. “There are all sorts of mechanical questions about how to count it, when it vests, whether to use grant-date value and other measurement issues that the SEC basically punted on.”

The proposal itself was not published by press time, and the equity-measurement issue was not addressed in a press release and fact sheet the SEC released shortly after its vote on the rule proposal Wednesday morning. But Seelig, who attended the meeting, said the commission’s staff “stated affirmatively that they’re going to leave the measurement up to companies.”

What officers would be subject to the proposed rules was not much of a surprise, but the roster would be significantly expanded. Presently, only CEOs and CFOs are subject to clawbacks. Under the proposal, a company’s “president, principal accounting officer, any vice president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company” would also be on the hook.

That portion of the proposal reflects the way the Dodd-Frank Act’s clawback provision was written. “It was very broad and was criticized at the time for applying to people who are not responsible for presenting financials,” says Seelig. “Let’s say you run a division. You are required to deliver the results for that division. But while you might or might not have to sign off on those financials, you’re absolutely not presenting financials for the whole company. You’re not the one who’s making decisions as to when revenue should be recognized, or whatever convention it is that could be subject to a restatement.”

A Bloomberg article erroneously stated that the new rules “would claw back pay from any executive involved in preparing erroneous figures.” As Seelig notes, its application is much broader than that.

According to Bloomberg, which cited an April report by Audit Analytics, in 2014 companies restated financial results 831 times, 42% of which reduced the company’s bottom line. The others didn’t affect the company’s earnings but required correcting balances for shareholders’ equity, cash flow, or other accounts.

The largest restatement in 2014 was KBR Inc., which was forced to reduce net income for 2013 by $154 million, Bloomberg reported.

Technically, the proposal, which for which there will be a 60-day comment period, would require national securities exchanges and associations to establish listing standards requiring companies to develop and implement clawback policies that comply with the proposed rules.

Image: Emlok, Wikipedia, CC BY-SA 3.0