Following hot on the footsteps of August’s Pay Versus Performance rule, the SEC finalized the Dodd-Frank Clawback rule, voting 3-2 on party lines.
The Center On Executive Compensation’s comment letters were cited 30 times, including a discussion of our survey which found that more than 90% of Center members already maintain a clawback policy. Further, the Center was successful in getting the Commission to agree to board discretion on how to recoup erroneously delivered compensation, such as cancelling unvested compensation awards or offsetting unpaid incentive compensation. The rule was announced on October 26. Here is the press release, final rule and fact sheet.
The final rule will require stock exchanges to adopt listing standards requiring all issuers to adopt a no-fault, mandatory clawback policy and provide extensive disclosures regarding restatements, erroneously delivered compensation, and recoupment efforts – for both “big R” and little r” restatements. The Center previously provided comments on “little r” restatements when the SEC re-opened the comment period in October 2021 with this surprising addition.
- No discretion to claw back: The rule provides only very limited avenues for the board to decline to pursue a clawback. For example, companies could decline to pursue a clawback if the costs paid to a third party (not including internal costs or defense of counter-claims) to recoup the money exceed the amount of the recoupment, and the company has already documented a reasonable effort to recoup the money, or if recovery would violate a home-country law passed before the rule was finalized. There is no de minimis threshold for clawbacks, which the Center and others had suggested in comments.
- Some discretion on how to claw back: As mentioned above, the SEC agreed with the Center’s recommendation to allow directors discretion to determine the method of recoupment, such as cancelling unvested stock, offsetting deferred compensation or unpaid bonus, or even future compensation obligations.
- Covered employees: The rule applies not only to named executive officers but also to “anyone who performs a policy-making function for the issuer regardless of involvement with the events leading to the restatement” (mirroring the definition for Section 16 Officers).
- Incentive-based compensation: The SEC declined to provide a “safe harbor” for companies estimating the impact of a restatement on stock price and TSR, instead providing that “reasonable estimates” are acceptable, as long as they are fully disclosed.
Timing: The exchanges are required to file listing standards within 90 days of publication of the rule in the Federal Register, and they must be effective within one year. Once effective, companies have 60 days to adopt a compliant policy, and disclosure should follow in the next proxy and annual report. This means that companies will likely have to adopt and disclose policies by the 2024 proxy season.
Outlook: Litigation in actual recoupment scenarios is certain. The Center will publish a compliance guide for employers by the end of the year addressing areas that we foresee as “sticky” for employers. For instance, in the case where TSR was the metric to determine the award, companies will need to estimate the impact in order to determine the amount of the clawback. We anticipate situations in which the executive disagrees with the owed amount based on this estimate. Interestingly, some executive compensation consultants have already questioned how the “no fault” rule may shape the future composition of executive compensation packages as performance-based incentive pay becomes less attractive when the earnout is subject to repayment for three years.
