Will the SEC Finally Approve a Tougher Clawback Rule?

A 2015 proposal, never adopted, would put the incentive-based compensation of other executive officers at risk.
Vincent RyanOctober 7, 2021

During a recent speech, Securities and Exchange Commission Chair Gary Gensler said he would be pushing his staff to recommend rules for clawing back public company executive pay.

The idea that executives — initially, CFOs and CEOs — should return certain kinds of compensation to their publicly-held employers after restatements has a long history. The roots go back to the Sarbanes-Oxley Act of 2002 that passed in the wake of Enron and other financial scandals. SOX 304, as the operative section is termed, empowered the SEC to seek reimbursement from a CEO or CFO for their employer for any bonus or other incentive-based or equity-based compensation. The compensation had to have been received during the year after a filing that is later determined to require a restatement. Moreover, that restatement had to have been due to the company’s material noncompliance as a result of misconduct.

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In one case after another, the SEC brought actions against CEOs and CFOs to enforce SOX 304 even when the officers were not alleged to have engaged in any wrongdoing themselves. 

Left without a defense based on their innocent conduct, some CEOs and CFOs have defended themselves in court by arguing with the SEC about issues such as whether the restatement resulted from their employer’s misconduct or whether their employer’s violations were material.

While the SEC has wielded SOX 304 aggressively, the statute’s narrow scope has prevented the SEC from seeking clawbacks against officers other than the CEO and CFO or in cases involving restatements without company misconduct.

Flash forward to the financial crisis of 2007 and 2008 and the corresponding legislative reaction, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Dodd-Frank instructed the SEC to adopt rules that would address the clawback issue more broadly but only indirectly — the rules would require securities exchanges to force their listed companies to implement specific policies.

Five years later, in 2015, the SEC did, in fact, propose a rule that would have obligated exchanges to require listed companies to adopt and disclose clawback policies to recover incentive-based compensation from current or former executive officers. The compensation would have to have been received during the three fiscal years preceding the date on which the company was required to restate due to a material error.

Dodd-Frank and the SEC’s proposed 2015 rule went much further than SOX. No longer would clawbacks be limited to CEOs and CFOs.  Other executive officers’ incentive-based compensation would also be at risk. No longer could an executive argue that a restatement was not due to their employer’s misconduct.  No longer would clawback enforcement responsibility fall solely on the SEC; now, the public company itself would have responsibility for clawback enforcement.

But after the SEC proposed the rule in 2015, the commission never finalized it.

If and when the SEC finalizes its clawback rule, look for any straggler companies to implement and start enforcing these policies. And look for executives to challenge the rule and its application in court…

And this is where Chair Gensler’s recent comment comes in. It is difficult to know how seriously to take the chair’s comments on this issue; the agency seems to have many priorities other than Dodd-Frank clawbacks, including, among many other things, special-purpose acquisition companies, cryptocurrencies, U.S.-listed Chinese companies, and cybersecurity breaches. And although Gensler chaired the Commodity Futures Trading Commission from May 2009 to January 2014, when Dodd-Frank also required that agency to implement scores of rules, the CFTC has still not completed adoption of Dodd-Frank rules.

In the meantime, even in 2015 when the SEC proposed its Dodd-Frank clawback rule, more than 80% of companies in the Fortune 100 already had some type of clawback policies in place (and those voluntary adoption numbers have only increased since then), perhaps taking some urgency out of the SEC’s sails.

If and when the SEC finalizes its clawback rule, look for any straggler companies to implement and start enforcing these policies. And look for executives to challenge the rule and its application in court, particularly when companies require the return of compensation after a restatement even though the company committed no wrongdoing, the executive committed no wrongdoing, and the executive had nothing to do with the company’s financial reporting.

Nicolas Morgan is a partner in the litigation department at law firm Paul Hastings LLC.

Photo by Chip Somodevilla/Getty Images