Tag Archive: Clawback

An Update From the SEC

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It is no secret that the Securities and Exchange Commission has been slow to fulfill the rules mandated by Dodd-Frank. As of July 1, the agency had missed over half of the deadlines—56 out of 95 required rulemakings—according to the Davis Polk Dodd-Frank Progress Report. Despite this general lack of news, in late June the SEC released final rules on matters related to the compensation committee to little fanfare.

The rules focus on independence for both compensation committees and their advisors. Companies will now be required to disclose the existence of compensation consultant conflicts of interest and how these conflicts are addressed. Additionally, each national listing exchange is now required to propose heightened standards for independence of compensation committee members and the evaluation of compensation advisor independence. While the style of these new listing standards will be similar to those already existing for the audit committee, the SEC has established that the standards must consider the following two factors:

  • The source of compensation of the director, including any consulting, advisory or other compensatory factors paid by the listed company to the director; and
  • Whether the director is affiliated with the listed company or any of its subsidiaries or their affiliates.

While these rules affect proxy statement disclosures, compensation committee composition and boardroom procedure, they have received little attention. There are many possible explanations for this, including the fact that both the New York Stock Exchange and NASDAQ already address compensation committee director independence to an extent. However, timing is also a factor. The required disclosures of compensation consultant conflicts of interest will be effective for the 2013 proxy season. With respect to the new standards on independence, NYSE and NASDAQ have until Sept. 25, 2012, to propose new guidelines, which the SEC does not have to approve until June 27, 2013.

At NACD’s Compensation Committee Chair Advisory Council meeting in June, SEC Chief Counsel and Associate Director of the Division of Corporate Finance Thomas Kim spoke to the delegation on the SEC’s current activity. In addition to the rules on compensation committee independence, the agency is currently in the process of drafting proposed rules on the required pay ratio disclosure, as well as the “clawback” of executive compensation provision. Similar to the recently released rules, the clawback rules must be proposed and finalized by the SEC, then adopted by the listing exchanges—therefore placing the rules on the horizon, but not in the near future.

At the Advisory Council meeting, a key theme of the discussion was the necessity for boards to create transparent and comprehensive compensation packages. To this end, it was announced that NACD will produce a guide that will help boards develop pay plans to effectively compensate executives and communication strategies that articulate how these plans create long-term shareholder value.

For more information about the guide and the Advisory Council meeting, click here.


NACD Insight and Analysis

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As noted in yesterday’s NACD Director’s Daily, the Boston Globe reported that the Federal Deposit Insurance Corporation (FDIC) issued final rules on recovering cash compensation from executives and directors of financial institutions that have been liquidated by the federal government. The Dodd-Frank Act empowered the FDIC to recover compensation when a current or former senior executive or director is “substantially responsible” for the failed condition of a covered financial company. The FDIC’s final rule clarifies that an executive or director would be considered “substantially responsible” if that person failed to act “with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances.” In other words, executives and directors stand to lose their compensation from the previous two years if they are shown to be negligent in the performance of their duties.

While this new FDIC rule only applies to banking institutions, other clawback provisions in the Dodd-Frank Act will affect all public companies. The Act directs the Securities and Exchange Commission (SEC) and national listing exchanges to require companies to recover incentive-based compensation from any current or former executive if the company is required to prepare an accounting restatement due to the material noncompliance with any financial reporting requirement under the securities laws. The specifics of the rule are yet to be developed; the SEC is scheduled to release a proposed rule near the end of 2011 with final adoption in early 2012.

Both clawback provisions set a fairly low bar to recoup compensation. The FDIC will recover compensation in cases of negligence. In banking institutions on the verge of collapse, it may be a heavy burden for an executive or director to prove lack of a breach of a fiduciary obligation and exercised “prudent” business judgment. The SEC and national listing exchanges will recover compensation in the event of noncompliance with “any financial reporting requirement.” This seemingly provides many opportunities to clawback incentive compensation from an executive. Final rules from the SEC will shed more light on the practical implications of the law.

Clawbacks may have more lasting effects than simply revoking an executive’s pay. Therefore, boards must monitor the corporation’s well being and closely align executive pay with performance.