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US Securities and Exchange Commission

Like it or Not, Dodd-Frank Clawback Rule Coming

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

The SEC under the leadership of Chair Gary Gensler is expected to move forward with unfinished Dodd-Frank executive compensation rules, including so-called clawback rules. This is because Gensler has so far taken a position that aligns more with investor protection advocates than what corporations want. Sec. 954 of PL111-203

A clawback rule proposal was issued in July 2015, and Gensler’s predecessor, Jay Clayton, did not touch it as it is unpopular with executives. Clayton delivered on the promise for deregulation by the Trump administration.

By contrast, Gensler, President Biden’s appointee, has been reversing course. And the commission in October 2021 put the proposal out for another round of comment before trying to move ahead with final rules.

Thus, in the view of an executive compensation and corporate governance consulting firm Farient Advisors, the rule is coming, and corporate boards should start getting ready for it now.

“The Biden administration probably believes that this is the least invasive and probably shareholder-friendly adoption of the proposal that they can make, given that many companies have already put in clawback provisions within their programs, kind of knowing that this was a portion of Dodd-Frank,” Farient Advisors’s Partner and COO R.J. Bannister said in an interview. “We think sometime by year-end that they do come up with some type of adoption of a rule for consideration for ’23.”

Section 954 of Dodd-Frank mandated the SEC to adopt a rule requiring public companies to recoup bonuses paid to executives if the company is found to have misstated its financial results. It is intended to discourage executives from taking questionable actions that temporarily boost share prices but ultimately result in a correction of financial statements. Sec. 954 of PL111-203

Nonetheless, the U.S. Chamber of Commerce asked the SEC to write flexible rules. The proposal is more stringent and broader in scope than the clawbacks under Section 304 of the Sarbanes-Oxley Act of 2002, which was passed in order to restore investor trust following accounting scandals at companies like Enron and WorldCom.

The requirements would be triggered by an accounting restatement, cover a wider group of executives, not just CFOs and CEOs but also accounting officers or controllers, vice-presidents in charge of principal business units or divisions, or any others who perform similar functions.

The proposed rule does not require misconduct by those executives in order to recoup the money. If companies do not comply, they can lose their listing on stock exchanges.

Thomas Quaadman, an executive vice president with the U.S. Chamber, wrote in a comment letter that the proposal is unnecessarily complex and too prescriptive. He added the number of public companies that have adopted a clawback policy has increased by almost 106 percent since the SEC first issued the proposal six and a half years ago.

According to a letter by the Society for Corporate Governance, 81 percent of Fortune 100 companies, more than 90 percent of companies in the S&P 500, and over 65 percent of companies in the Russell 3000 index already disclose clawback policies.

“Companies have, as a matter of good governance, developed rigorous policies that have enabled effective clawbacks in the intervening period since 2015 without formal action from the Commission,” U.S. Chamber’s Quaadman wrote. “Moreover, policies have been fine-tuned to meet company practices and circumstances. Considering these developments, we encourage the SEC to take an approach to its responsibilities under Section 954 that maintains flexibility for companies that have developed effective policies; the SEC should not needlessly override effective clawback compensation processes.”

As for the Business Roundtable, an association of CEOs of America’s leading companies, it wants the commission to put out another round of proposal, which would delay the already slow-moving rulemaking process.

While it is unclear what the rules’ exact parameters will be, there is no escaping it.

“The reopening of the comment letter, from a political standpoint is a signal to the investment community that the SEC under the Biden administration is seriously considering the measure and it’s providing the opportunity for individual institutions and different entities to provide their comments and input before rendering a final decision,” Bannister said. “I think that’s really more of a procedural than it is looking for new ideas or new ways of thinking about a clawback.”

The Council of Institutional Investors (CII), which has been pressing for completion of the rule, would have preferred that the SEC move ahead without opening it up for another round of proposal.

In a comment letter, CII called it long overdue. Moreover, the group wants improvements to the proposal before the SEC adopts clawback rules.

Among other things, CII General Counsel Jeffrey Mahoney wrote that the SEC should interpret the term “‘an accounting restatement due to material noncompliance’ to include all required restatements made to correct an error in previously issued financial statements.”

CII members manage almost $4 trillion in combined assets. Its associate members manage more than $40 trillion in assets.

Sandra Peters, senior head for global financial reporting policy advocacy with the CFA Institute, wrote that investors need disclosure about the nature of error and its materiality.

“Because of the inherent estimates, judgements, and complexity involved, companies should disclose their evaluations, the process and assumptions used to determine whether the error(s) in question were material or immaterial, and why it decided the matter in this way,” she wrote. “Such disclosure should be thorough enough for investors to understand the material facts of the case, understand the reasoning behind such a decision, and make appropriate decisions about the board’s actions.”

Companies Should Start Reviewing Policies

In the meantime, since the majority of companies already have some type of clawback policies, Farient Advisors’s Bannister advised them to revisit their compensation programs.

Companies in 2022 should “do an internal review of their existing clawback arrangement policies and determine what they want to modify their policy based upon the direction that the SEC is moving,” he said. “So, the issues that they would look at are: what would trigger a clawback; what would be the potential kind of scale; and what would be the items that would be considered that the company would clawback. I think it’s really those three buckets is where companies would want to evaluate their existing programs to determine if any changes to their policies are necessary before looking at the finalized rules.”

For example, if a company has a clawback policy, then it should set aside a reserve to potentially cover the costs incurred of the clawback, he said.

“Initially, most companies probably had the definition rather narrow so they would focus on if an executive committed a felony or something of that matter that those would be items that would considered a clawback,” he added. “As companies have thought about clawbacks… that definition has gotten broader.”

For instance, a company could consider behavior that does not fit the values or the company’s code of conduct that would trigger clawback.

McDonald’s last year took back $105 million from its ex-CEO Steve Easterbrook. The company claimed that he committed fraud and lied during an internal probe about his relationship with an employee.

 

This article originally appeared in the January 11, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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