SEC Agrees to Board Discretion on Method of Recoupment in New Clawbacks Rule

Following hot on the footsteps of August’s Pay Versus Performance rule, the SEC finalized the Dodd-Frank Clawback rule this week, voting 3-2 on party lines. The meeting was announced last week, and here is the press release, final rule and fact sheet. The Center’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.

We are still reviewing the 230-page document and will provide an executive summary and compliance guide to Center members soon. In the meantime, here are the nuts and bolts of the rule.

• Summary. The final rule will require stock exchanges to adopt listing standards requiring all issuers to adopt a no-fault, mandatory clawback policy in compliance with the rule and provide extensive disclosures regarding restatements, erroneously delivered compensation, and recoupment efforts – for both “big R” and little r” restatements.
  
  
• No discretion to claw back. The rule provides only very limited avenues for the board to decline to pursue a clawback. For example, 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 took the Center’s advice 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 NEOs but 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.