[Federal Register Volume 80, Number 134 (Tuesday, July 14, 2015)]
[Proposed Rules]
[Pages 41144-41196]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-16613]
[[Page 41143]]
Vol. 80
Tuesday,
No. 134
July 14, 2015
Part II
Securities and Exchange Commission
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17 CFR Parts 229, 240, 249, et al.
Listing Standards for Recovery of Erroneously Awarded Compensation;
Proposed Rule
Federal Register / Vol. 80 , No. 134 / Tuesday, July 14, 2015 /
Proposed Rules
[[Page 41144]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 229, 240, 249, and 274
[RELEASE NOS. 33-9861; 34-75342; IC-31702; File No. S7-12-15]
RIN 3235-AK99
Listing Standards for Recovery of Erroneously Awarded
Compensation
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: We are proposing a new rule and rule and form amendments to
implement the provisions of Section 954 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010, which added Section 10D to
the Securities Exchange Act of 1934. Section 10D requires the
Commission to adopt rules directing the national securities exchanges
and national securities associations to prohibit the listing of any
security of an issuer that is not in compliance with Section 10D's
requirements for disclosure of the issuer's policy on incentive-based
compensation and recovery of incentive-based compensation that is
received in excess of what would have been received under an accounting
restatement. The proposed rule and rule amendments would direct the
national securities exchanges and national securities associations to
establish listing standards that would require each issuer to develop
and implement a policy providing for the recovery, under certain
circumstances, of incentive-based compensation based on financial
information required to be reported under the securities laws that is
received by current or former executive officers, and require the
disclosure of the policy. A listed issuer would be required to file the
policy as an exhibit to its annual report.
DATES: Comments should be received on or before September 14, 2015.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
Send an email to [email protected]; or
Use the Federal Rulemaking ePortal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments to Brent J. Fields, Secretary, U.S.
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-1090.
All submissions should refer to File Number S7-12-15. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street NE., Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. All comments received will be posted without change; we do
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the SEC's Web site. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Anne Krauskopf, Senior Special
Counsel, or Carolyn Sherman, Special Counsel at (202) 551-3500, in the
Office of Chief Counsel, Division of Corporation Finance, or Joel K.
Levine, Associate Chief Accountant at (202) 551-3400, in the Office of
Chief Accountant, Division of Corporation Finance, U.S. Securities and
Exchange Commission, 100 F Street NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are proposing to add new Rule 10D-1 \1\
under the Securities Exchange Act of 1934.\2\ We also are proposing
amendments to Items 402,\3\ 404 \4\ and 601 \5\ of Regulation S-K,\6\
Item 22 of Schedule 14A,\7\ Exchange Act Forms 20-F \8\ and 40-F,\9\
and Form N-CSR \10\ under the Exchange Act and the Investment Company
Act of 1940.\11\
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\1\ 17 CFR 240.10D-1.
\2\ 15 U.S.C. 78a et seq.
\3\ 17 CFR 229.402.
\4\ 17 CFR 229.404.
\5\ 17 CFR 229.601.
\6\ 17 CFR 229.10 et seq.
\7\ 17 CFR 240.14a-101.
\8\ 17 CFR 249.220f.
\9\ 17 CFR 249.240f.
\10\ 17 CFR 249.331 and 274.128.
\11\ 15 U.S.C. 80a-1 et seq.
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Table of Contents
I. Background and Summary.................................. 7
II. Discussion of the Proposals............................ 10
A. Issuers and Securities Subject to Proposed Exchange 11
Act Rule 10D-1........................................
1. General......................................... 11
2. Securities Futures Products and Standardized 17
Options...........................................
3. Registered Investment Companies................. 20
B. Restatements........................................ 23
1. Restatements Triggering Application of Recovery 23
Policy............................................
2. Date the Issuer Is Required to Prepare an 28
Accounting Restatement............................
C. Application of Recovery Policy...................... 33
1. Executive Officers Subject to Recovery Policy... 33
2. Incentive-Based Compensation.................... 39
a. Incentive-Based Compensation Subject to 39
Recovery Policy...............................
b. Time Period Covered by Recovery Policy...... 51
c. When Incentive-Based Compensation Is 54
``Received''..................................
3. Recovery Process................................ 58
a. Determination of Excess Compensation........ 58
b. Board Discretion Regarding Whether to Seek 67
Recovery......................................
c. Board Discretion Regarding Manner of 73
Recovery......................................
i. Amount to Be Recovered...................... 74
ii. Means of Recovery.......................... 75
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4. Compliance with Recovery Policy................. 79
D. Disclosure of Issuer Policy on Incentive-Based 80
Compensation..........................................
1. Listed U.S. Issuers............................. 83
2. Listed Foreign Issuers.......................... 88
E. Indemnification and Insurance....................... 95
F. Transition and Timing............................... 99
III. Economic Analysis..................................... 103
A. Baseline............................................ 105
B. Analysis of Potential Economic Effects.............. 114
1. Potential Effects on Financial Reporting........ 115
2. Potential Effects on Executive Compensation..... 122
3. Additional Potential Effects on Listed Issuers.. 133
4. Potential Effects on U.S. Exchanges............. 140
5. Indemnification and Insurance................... 142
C. Alternatives........................................ 144
1. Exemptions for Certain Categories of Issuers.... 144
2. Excluding Incentive-Based Compensation Tied to 145
Stock Price.......................................
3. Other Alternatives Considered................... 147
D. Request for Comment................................. 149
IV. Paperwork Reduction Act................................ 151
A. Background.......................................... 151
B. Summary of Proposed Rule and Rule Amendments........ 153
C. Paperwork Reduction Act Burden Estimates............ 156
D. Solicitation of Comments............................ 161
V. Small Business Regulatory Enforcement Fairness Act...... 162
VI. Initial Regulatory Flexibility Act Analysis............ 163
A. Reasons for, and Objectives of, the Proposed Action. 163
B. Legal Basis......................................... 164
C. Small Entities Subject to the Proposed Action....... 164
D. Reporting, Recordkeeping, and other Compliance 166
Requirements..........................................
E. Duplicative, Overlapping or Conflicting Federal 169
Rules.................................................
F. Significant Alternatives............................ 169
G. Solicitation of Comments............................ 171
VII. Statutory Authority and Text of the Proposed 172
Amendments................................................
I. Background and Summary
We are proposing a new rule, and rule and form amendments to
implement the provisions of Section 954 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 (the ``Act''),\12\ which
added Section 10D to the Securities Exchange Act of 1934 (the
``Exchange Act''). Specifically, Section 10D(a) of the Exchange Act
requires the Commission to adopt rules directing the national
securities exchanges \13\ (the ``exchanges'') and the national
securities associations \14\ (the ``associations'') to prohibit the
listing of any security of an issuer that is not in compliance with the
requirements of Section 10D(b). Section 10D(b) requires the Commission
to adopt rules directing the exchanges to establish listing standards
to require each issuer to develop and implement a policy providing:
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\12\ Public Law 111-203, 124 Stat. 1900 (2010).
\13\ A ``national securities exchange'' is an exchange
registered as such under Section 6 of the Exchange Act [15 U.S.C.
78f]. There are currently eighteen exchanges registered under
Section 6(a) of the Exchange Act: BATS Exchange, BATS Y-Exchange,
BOX Options Exchange, C2 Options Exchange, Chicago Board Options
Exchange, Chicago Stock Exchange, EDGA Exchange, EDGX Exchange,
International Securities Exchange (``ISE''), ISE Gemini, Miami
International Securities Exchange, NASDAQ OMX BX, NASDAQ OMX PHLX,
The NASDAQ Stock Market, National Stock Exchange, New York Stock
Exchange (``NYSE''), NYSE Arca and NYSE MKT. Certain exchanges are
registered with the Commission through a notice filing under Section
6(g) of the Exchange Act for the purpose of trading security
futures. As discussed in Section II.A.2, below, we propose to exempt
security futures products and standardized options from the scope of
the proposed rule. To the extent that our final rule exempts the
listing of security futures products and standardized options from
its scope, any registered national securities exchange that lists
and trades only security futures products or standardized options
would not be required to file a rule change in order to comply.
\14\ A ``national securities association'' is an association of
brokers and dealers registered as such under Section 15A of the
Exchange Act [15 U.S.C. 78o-3]. The Financial Industry Regulatory
Authority (``FINRA'') is the only association registered with the
Commission under section 15A(a) of the Exchange Act. Because FINRA
does not list securities, generally we refer only to the exchanges
in this release. However, if any associations were to list
securities, the rule proposals would apply to them also.
In addition, Section 15A(k) of the Exchange Act (15 U.S.C. 78o-
3(k) provides that a futures association registered under Section 17
of the Commodity Exchange Act (7 U.S.C. 21) shall be registered as
an association for the limited purpose of regulating the activities
of members who are registered as broker-dealers in security futures
products pursuant to Section 15(b)(11) of the Exchange Act (15
U.S.C. 78o(b)(11)).
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(1) For the disclosure of the issuer's policy on incentive-based
compensation that is based on financial information required to be
reported under the securities laws; and
(2) that, in the event that the issuer is required to prepare an
accounting restatement due to the issuer's material noncompliance with
any financial reporting requirement under the securities laws, the
issuer will recover from any of the issuer's current or former
executive officers who received incentive-based compensation (including
stock options awarded as compensation) during the three-year period
preceding the date the issuer is required to prepare the accounting
restatement, based on the erroneous data, in excess of what would have
been paid to the executive officer under the accounting restatement.
Other statutes and rules currently administered by the Commission
also address the recovery of executive compensation:
Section 304 of the Sarbanes-Oxley Act of 2002 (``SOX'')
\15\ provides that if an issuer is required to prepare an accounting
restatement due to the material noncompliance of the issuer, as a
result of misconduct,\16\ with any financial reporting requirements
under the securities laws, the chief executive officer and chief
financial officer of the issuer shall reimburse the issuer for any
bonus or other incentive-based or equity-based compensation received by
[[Page 41146]]
that person from the issuer during the 12-month period following the
first public issuance or filing with the Commission (whichever first
occurs) of the financial document embodying such financial reporting
requirement; and any profits realized from the sale of securities of
the issuer during that 12-month period; and
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\15\ 15 U.S.C. 7243.
\16\ The CEO or CFO need not personally engage in misconduct for
recovery to be required under Section 304. See SEC v. Jenkins, 718
F.Supp. 2d 1070, 1074-75 (D. Ariz. 2010) (``[T]he misconduct of the
issuer is the misconduct that triggers the reimbursement obligation
of the CEO and the CFO.''); SEC v. Baker, 2012 U.S. Dist. LEXIS
161784 (W.D. Tex 2012).
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Item 402(b) of Regulation S-K includes, as an example of
the kind of information that should be addressed, if material, in the
company's Compensation Discussion and Analysis (``CD&A''), company
policies and decisions regarding the adjustment or recovery of awards
or payments to named executive officers \17\ if the relevant company
performance measures upon which they are based are restated or
otherwise adjusted in a manner that would reduce the size of an award
or payment.\18\
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\17\ As defined in Item 402(a)(3) of Regulation S-K, ``named
executive officers'' are all individuals serving as the company's
principal executive officer during the last completed fiscal year,
all individuals serving as the company's principal financial officer
during that fiscal year, the company's three other most highly
compensated executive officers who were serving as executive
officers at the end of that year, and up to two additional
individuals who would have been among the three most highly
compensated but for not serving as executive officers at the end of
that year.
\18\ Item 402(b)(2)(viii). Item 402(b) contains the requirements
for CD&A, which is intended to be a narrative overview that puts
into context the executive compensation disclosure provided in
response to the other requirements of Item 402. The CD&A disclosure
requirement is principles-based, in that it identifies the
disclosure concept and provides several non-exclusive examples.
Under Item 402(b)(1), companies must explain all material elements
of their named executive officers' compensation by addressing
mandatory principles-based topics in CD&A. Item 402(b)(2) sets forth
nonexclusive examples of the kind of information that should be
addressed in CD&A, if material.
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The proposed rule and rule amendments would supplement these
existing provisions by directing the exchanges to establish listing
standards that require listed issuers to:
Adopt and comply with written policies for recovery of
incentive-based compensation based on financial information required to
be reported under the securities laws, applicable to the listed
issuers' executive officers, over a period of three years; and
disclose those recovery policies in accordance with
Commission rules.
To assure that issuers listed on different exchanges are subject to
the same disclosure requirements regarding compensation recovery
policies, we are proposing amendments to the disclosure rules that
would require all issuers listed on any exchange to file their written
recovery policy as an exhibit to their annual reports and, if they have
taken actions pursuant to that policy, to disclose those actions.
Under the proposed rule and rule amendments, an issuer would be
subject to delisting if it does not:
Adopt a compensation recovery policy that complies with
the applicable listing standard;
disclose the policy in accordance with Commission rules,
including providing the information in tagged data format; or
comply with the policy's recovery provisions.
Listed issuers could, of course, adopt policies more extensive than
those called for by the listing standards, so long as those policies at
a minimum satisfied the listing standards, and exchanges and
associations could adopt listing standards with requirements that are
more extensive than those of proposed Rule 10D-1.
II. Discussion of the Proposals
We are proposing new Exchange Act Rule 10D-1 to set forth the
listing requirements that exchanges would be directed to establish
pursuant to Section 10D of the Exchange Act. We also are proposing rule
amendments to Regulation S-K, to the forms by which foreign private
issuers file their Exchange Act annual reports, and for certain
investment companies, to Form N-CSR and Schedule 14A. These amendments
would require disclosure of the listed issuer's policy on recovery of
incentive-based compensation and information about actions taken
pursuant to such recovery policy. In developing these proposals, we
considered the comment letters we received on Section 10D pursuant to
our initiative to receive advance public comment in implementing the
Act.\19\
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\19\ In connection with all of the Dodd-Frank Act rulemakings,
we sought comment from the public prior to the issuance of a
proposing release. Comments related to the executive compensation
provisions of the Dodd-Frank Act are available at http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml. Regarding Section 10D, we received pre-proposal
letters from AFL-CIO, Americans for Financial Reform, As You Sow,
Center for Effective Government, Demos, Institute for Policy
Studies/Global Economy Project, International Brotherhood of
Teamsters, Other98.org, Public Citizen and Service Employees
International Union (``AFL-CIO Joint Letter''); American Benefits
Council; Baker, Donelson, Bearman, Caldwell & Berkowitz, PC; Brian
Foley & Company, Inc.; Center on Executive Compensation; Clark
Consulting, LLC; Committee on Federal Regulation of Securities of
the Section of Business Law of the American Bar Association (``ABA
Business Law Section''); Compensia, Inc.; Davis Polk & Wardwell LLP;
Frederic W. Cook & Co., Inc.; Mai Datta, Ph.D., Professor of
Finance, Wayne State University; Stuart R. Lombardi; Meridian
Compensation Partners, LLC; PGGM Investments; Pay Governance LLC;
Protective Life Corporation; Robert E. Scully Jr., Member, Stites
Harbison, PLLC; Society of Corporate Secretaries and Governance
Professionals; Towers Watson; and Sheila Waddell.
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A. Issuers and Securities Subject to Proposed Exchange Act Rule 10D-1
1. General
Section 10D of the Exchange Act provides that the Commission shall,
by rule, direct the exchanges ``to prohibit the listing of any security
of an issuer that does not comply with the requirements of [Section
10D].'' Commenters raised questions as to whether the rule should apply
to all issuers with listed securities, such as foreign private issuers
\20\ and issuers of listed debt whose stock is not also listed.\21\
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\20\ See letters from ABA Business Law Section (noting that
foreign private issuers are not required to comply with the proxy
rules or Item 402 executive compensation disclosure, and that home
countries may have a greater interest in determining whether
companies should have recourse against their executives) and Brian
Foley & Company, Inc. (seeking clarification whether Section 954
applies to foreign private issuers).
\21\ See letter from Brian Foley & Company, Inc.
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For the reasons discussed below, the rule and rule amendments we
propose would require exchanges to apply the disclosure and recovery
policy requirements to all listed issuers, with only limited
exceptions. As a preliminary matter, we read the language of Section
10D as generally calling for a broad application of the mandated
listing standards. Section 10D does not distinguish among issuers or
types of securities, and does not specifically instruct the Commission
to exempt any particular types of issuers or securities or direct the
Commission to permit the exchanges to provide such exemptions in
listing them.\22\ We recognize, however, that we could use our general
exemptive authority under the Exchange Act \23\ to exempt specific
categories of issuers or securities to the extent that doing so would
be necessary or appropriate in the public interest and consistent with
the protection of investors. In evaluating whether to exempt specific
categories of issuers and securities, though, we have considered
whether providing exemptions from the requirements of Section 10D would
be
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consistent with what we understand to be the purpose of this statutory
provision. In this regard, we note that a report by the Senate
Committee on Banking, Housing and Urban Affairs stated that ``[t]his
proposal will clarify that all issuers must have a policy in place to
recover compensation based on inaccurate accounting so that
shareholders do not have to embark on costly legal expenses to recoup
their losses or so that executives must return monies that should
belong to the shareholders.'' \24\ As discussed below, we propose to
exempt security futures products, standardized options, and the
securities of certain registered investment companies from the proposed
listing standards because we believe the compensation structures of
issuers of these securities render application of the rule and rule
amendments unnecessary.\25\ We are not proposing otherwise to exempt
categories of listed issuers, such as emerging growth companies,\26\
smaller reporting companies,\27\ foreign private issuers,\28\ and
controlled companies,\29\ because we believe the objective of
recovering excess incentive-based compensation is as relevant for these
categories of listed issuers as for any other listed issuer. In
reaching this conclusion, we also considered the relative burdens of
compliance on these categories of issuers. As discussed more fully in
the Economic Analysis, while we recognize that the proposed listing
standards could, in certain respects, impose a disproportionate burden
on these categories of issuers, there is also reason to believe that
these issuers, as well as investors and the markets in general, may
derive benefits from being subject to the proposed listing
standards.\30\
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\22\ In this regard, Section 10D differs from the Act's other
governance-related provisions, such as Section 951 Shareholder Vote
on Executive Compensation Disclosure (amending the Exchange Act to
add Section 14A) and Section 952 Compensation Committee Independence
(amending the Exchange Act to add Section 10C), which include
specific direction for either the Commission or the exchanges to
consider exemptions for classes of issuers, or to provide
exemptions. Additionally, Section 951 instructs the Commission to
take into account whether Section 951's requirements
disproportionately burden small issuers.
\23\ Section 36(a) of the Exchange Act (15 U.S.C. 78mm(a)).
\24\ See Report of the Senate Committee on Banking, Housing, and
Urban Affairs, S.3217, Report No. 111-176 at 135-36 (April 30, 2010)
(``Senate Report'').
\25\ See Sections II.A.2 and 3, below.
\26\ Section 2(a)(19) of the Securities Act of 1933 (the
``Securities Act'') and Exchange Act Section 3(a)(80) define
``emerging growth company'' as ``an issuer that had total annual
gross revenues of less than $1,000,000,000 . . . during its most
recently completed fiscal year.'' An issuer shall continue to be
deemed an emerging growth company until the earliest of (1) the last
day of the fiscal year during which it had total annual gross
revenues of $1 billion; (2) the last day of the fiscal year
following the fifth anniversary of the first sale of its common
equity securities; (3) the date on which it has issued more than $1
billion in non-convertible date during the previous three years; or
(4) the date on which it is deemed a large accelerated filer.
\27\ Exchange Act Rule 12b-2 defines ``smaller reporting
company'' as ``an issuer that is not an investment company, an
asset-backed issuer . . ., or a majority-owned subsidiary of a
parent that is not a smaller reporting company and that: (1) Had a
public float of less than $75 million as of the last business day of
its most recently completed second fiscal quarter, computed by
multiplying the aggregate worldwide number of shares of its voting
and non-voting common equity held by non-affiliates by the price at
which the common equity was last sold, or the average of the bid and
asked prices of common equity, in the principal market for the
common equity; or (2) in the case of an initial registration
statement under the Securities Act or Exchange Act for shares of its
common equity, had a public float of less than $75 million as of a
date within 30 days of the date of the filing of the registration
statement, computed by multiplying the aggregate worldwide number of
such shares held by non-affiliates before the registration plus, in
the case of a Securities Act registration statement, the number of
such shares included in the registration statement by the estimated
public offering price of the shares; or (3) in the case of an issuer
whose public float as calculated under paragraph (1) or (2) of this
definition was zero, had annual revenues of less than $50 million
during the most recently completed fiscal year for which audited
financial statements are available.'' Whether or not an issuer is a
smaller reporting company is determined on an annual basis.
\28\ Exchange Act Rule 3b-4(c) defines ``foreign private
issuer'' as ``any foreign issuer other than a foreign government
except for an issuer meeting the following conditions as of the last
business day of its most recently completed second fiscal quarter:
(1) More than 50 percent of the issuer's outstanding voting
securities are directly or indirectly held of record by residents of
the United States; and (2) (i) the majority of the executive
officers or directors are United States citizens or residents, (ii)
more than 50 percent of the assets of the issuer are located in the
United States, or (iii) the business of the issuer is administered
principally in the United States.'' Exchange Act Rule 3b-4(b)
defines ``foreign issuer'' as ``any issuer which is a foreign
government, a national of any foreign country or a corporation or
other organization incorporated or organized under the laws of any
foreign country.''
\29\ Under New York Stock Exchange Rule 303A.00 and NASDAQ Stock
Market LLC Rule 5615(c) a ``controlled compan[y]'' is defined as a
company of which more than 50% of the voting power for the election
of directors is held by an individual, group or another company.
\30\ See Section III, below.
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In our determination of whether to propose exemptions for foreign
private issuers we considered the views of commenters that submitted
comments before this proposal \31\ as well as the incidence of
restatements among this category of listed issuers. We are aware of
studies that indicate that these issuers, from time to time, restate
their financial statements to correct accounting errors.\32\ For
example, during 2012 and 2013 foreign private issuers, which are
approximately 10 percent of all registrants, accounted for over 10
percent of all restatements.\33\
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\31\ See letters from Brian Foley & Company, Inc. (seeking
clarification of whether Section 954 would apply to foreign private
issuers and listed debt where the issuer's equity is not listed);
ABA Business Law Section(recommending the Commission exercise its
authority to exempt foreign private issuers from Section 954
rulemaking).
\32\ See 2013 Financial Restatements: A Thirteen Year
Comparison, Audit Analytics (2014) (``A Thirteen Year Comparison'')
(addressing accelerated foreign filers, non-accelerated foreign
filers, accelerated U.S. filers, and non-accelerated U.S. filers),
and Financial Restatement Trends in the United States: 2003-2012,
Professor Susan Scholz, University of Kansas, Study Commissioned by
the Center for Audit Quality (comparing U.S. and foreign issuers).
\33\ See A Thirteen Year Comparison.
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Although some exchange listing standards permit foreign private
issuers to follow home country practice in lieu of certain corporate
governance requirements,\34\ our proposed rule and rule amendments
would not permit the exchanges to exempt foreign private issuers from
compliance with Section 10D's disclosure and recovery requirements.
Consistent with a comment we received,\35\ our proposal would, however,
allow exchanges to permit foreign private issuers to forgo recovery as
impracticable if the recovery of erroneously awarded compensation
pursuant to Section 10D would violate the home country's laws so long
as certain other conditions are met.\36\
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\34\ See, e.g., New York Stock Exchange Rule 303A.00 and NASDAQ
Stock Market LLC Rule 5615(a)(3).
\35\ See letter from ABA Business Law Section.
\36\ See Section II.C.3.b, below, for a discussion of proposed
board discretion in these circumstances.
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We also considered the incidence of restatements for smaller
reporting companies, emerging growth companies and controlled companies
in determining not to exclude such companies from these requirements.
For example, during 2012 and 2013, U.S. issuers who are not accelerated
filers \37\ accounted for approximately 55 percent of total U.S. issuer
restatements.\38\
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\37\ As defined in Exchange Act Rule 12b-2 [17 CFR 240.12b-2].
\38\ See A Thirteen Year Comparison.
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We believe that smaller reporting companies constitute a
substantial majority of U.S. non-accelerated filers. We also believe
that at least some of these categories of issuers use incentive-based
compensation arrangements that are based on achievement of financial
reporting measures that may be affected by accounting restatements. As
a result, we believe that shareholders of these listed issuers would
benefit from a policy to recover excess incentive-based compensation
and that applying the proposed rule and rule amendments to these
issuers will further the statutory goal of assuring that executive
officers do not retain incentive-based compensation that they received
erroneously. For similar reasons, we are not proposing to grant the
exchanges discretion to decide whether additional categories of issuers
should be exempted from the proposed listing standards.
Further, Section 10D refers to ``any security'' of an issuer, which
would include not only common equity securities, but also debt and
preferred
[[Page 41148]]
securities. Accordingly, apart from the proposed exemptions discussed
below, we are proposing that the listing standards and other
requirements of the proposed rule and rule amendments apply without
regard to the type of securities issued, including to issuers of listed
debt or preferred securities that do not have listed equity. As
described in the Economic Analysis,\39\ the potential benefits of a
recovery policy would likely accrue to the holders of debt and
preferred securities as well as to equity holders. For the same
reasons, we do not propose to grant the exchanges discretion to decide
whether certain categories of securities should be exempted from the
proposed listing standards.
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\39\ See Section III, below.
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Request for Comment
1. Should the listing standards and other requirements of the
proposed rule and rule amendments apply generally to all listed
issuers, as proposed? If not, what types of issuers should be exempted,
and why? Please explain the rationale that justifies exempting any
particular category of issuer.
2. Should we distinguish among listed issuers based on the types of
securities listed? Please explain the rationale for any such exemption.
For example, do issuers with listed non-convertible debt or preferred
stock that do not have listed common equity raise the same concerns as
issuers with listed common equity? For listed issuers that do not have
listed common equity, do the different residual claims against the cash
flows of the issuer warrant a different treatment?
3. Would the proposed listing standards conflict with any home
country laws, stock exchange requirements, or corporate governance
arrangements that apply to foreign private issuers? If so, please
explain the nature of those conflicts. Should the proposed rule and
rule amendments allow exchanges to permit foreign private issuers to
forego recovery of erroneously awarded compensation if recovery would
violate the home country's laws and certain conditions were met, as
proposed? Is such an exception necessary or appropriate? If no, why
not? If not, are there more appropriate or effective means to address
such conflicts?
4. In the event that a foreign private issuer's home country has a
law that like Section 10D requires the issuer to disclose its policies
on incentive-based compensation and recover erroneously awarded
incentive-based compensation from current or former executive
officers,\40\ should the foreign private issuer be permitted to comply
with its home country law instead of complying with the listing
standard of the U.S. exchange that lists the foreign private issuer's
securities? Please explain why or why not.
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\40\ See, e.g., the UK Corporate Governance Code, September
2014, available at https://frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-2014.pdf. Under
Section D. of the Corporate Governance Code, a company's
remuneration scheme for executive directors for performance-related
remuneration should ``include provisions that would enable the
company to recover sums paid or withhold the payment of any sum, and
specify the circumstances in which it would be appropriate to do
so.'' See also, e.g., Directive 2013/36/EU of the European
Parliament and of the Council of June 26, 2013, available at http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32013L0036. The EU
Capital Requirements Directive IV includes specific requirements on
compensation, including a bonus cap up to 100% of variable
remuneration or, with shareholder approval, 200% of total fixed pay,
which must be subject to ``malus or clawback'' arrangements.
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5. Should there be a mechanism to determine whether additional
categories of issuers and/or securities should be exempted from the
proposed listing standards? If so, what mechanism would be appropriate?
Should new financial products that may be developed in the future be
subject to the proposed requirements? Why or why not? What principles
or requirements, if any, should apply to any mechanism? In the absence
of a discretionary mechanism for future exemptions, would the proposed
rule potentially hinder competition? If so, how?
2. Securities Futures Products and Standardized Options
The Exchange Act's definition of ``equity security'' includes any
security future on any stock or similar security.\41\ Exchanges
registered under Section 6 of the Exchange Act and associations
registered under Section 15A(a) of the Exchange Act may trade futures
on individual securities and on narrow-based security indexes
(``securities futures products'') \42\ without such securities being
subject to the registration requirements of the Securities Act of 1933
(``Securities Act'') and the Exchange Act so long as they are cleared
by a clearing agency that is registered under Section 17A of the
Exchange Act or that is exempt from registration under Section
17A(b)(7) of the Exchange Act.\43\ In December 2002, we adopted rules
to provide comparable regulatory treatment for standardized
options.\44\
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\41\ Exchange Act Section 3(a)(11).
\42\ Exchange Act Section 3(a)(56) [15 U.S.C. 78c(a)(56)], and
Commodities Exchange Act Section 1a(32) [7 U.S.C. 1a(32)] define
``security futures product'' as any security future or any put,
call, straddle, option or privilege on any security future.
\43\ See Securities Act Section 3(a)(14) [15 U.S.C. 77c(a)(14)],
Exchange Act Section 12(a) [15 U.S.C. 78l(a)], and Exchange Act Rule
12h-1(e) [17 CFR 240.12h-1(e)].
\44\ See Release No. 33-8171 (Dec. 23, 2002) [68 FR 188]. In
that release, we exempted standardized options issued by registered
clearing agencies and traded on a registered exchange or on a
registered association from all provisions of the Securities Act,
other than the antifraud provision of Section 17, as well as the
Exchange Act registration provisions. Standardized options are
defined in Exchange Act Rule 9b-1(a)(4) [17 CFR 240.9b-1(a)(4)] as
option contracts trading on an exchange, an automated quotation
system of a registered association, or a foreign securities exchange
which relate to option classes the terms of which are limited to
specific expiration dates and exercise prices, or such other
securities as the Commission may, by order, designate.
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The role of a clearing agency as the issuer for security futures
products and standardized options is fundamentally different from that
of other listed issuers.\45\ The purchaser of security futures products
and standardized options does not, except in the most formal sense,
make an investment decision regarding the clearing agency. As a result,
information about the clearing agency's business, its officers and
directors and their compensation, and its financial statements is less
relevant to investors in these securities than information about the
issuer of the underlying security.\46\ Moreover, the investment risk in
security futures products and standardized options is largely
determined by the market performance of the underlying security rather
than the performance of the clearing agency, which is a self-regulatory
organization subject to regulatory oversight.
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\45\ See Fair Administration and Governance of Self-Regulatory
Organizations; Disclosure and Regulatory Reporting by Self-
Regulatory Organizations; Recordkeeping Requirements for Self-
Regulatory Organizations; Ownership and Voting Limitations for
Members of Self-Regulatory Organizations; Ownership Reporting
Requirements for Members of Self-Regulatory Organizations; Listing
and Trading of Affiliated Securities by a Self-Regulatory
Organization, Release No. 34-50699 (Nov. 18, 2004) [69 FR 71126], at
n. 260 (``Standardized options and security futures products are
issued and guaranteed by a clearing agency.'')
\46\ See Listing Standards for Compensation Committees, Release
No. 33-9199 (Mar. 30, 2011) at Section II.B.2.b.
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In recognition of such fundamental differences, the Commission
provided exemptions for security futures products and standardized
options when it adopted the audit committee listing requirements in
Exchange Act Rule10A-3 \47\ and the compensation committee listing
requirements in Exchange Act Rule 10C-1.\48\ Specifically, these rules
exempt the listing of a security futures
[[Page 41149]]
product cleared by a clearing agency that is registered pursuant to
Section 17A of the Exchange Act or that is exempt from registration
pursuant to Section 17A(b)(7)(A) and the listing of a standardized
option issued by a clearing agency that is registered pursuant to
Section 17A of the Exchange Act. For the reasons that we exempted these
securities from Rules 10A-3 and 10C-1, and because any relationship
between any incentive-based compensation that the clearing agency pays
its executive officers and its financial statements would not be
significant to investors in these futures and options, we propose to
exempt these securities from the requirements of proposed Rule 10D-
1.\49\
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\47\ See Exchange Act Rules 10A-3(c)(4) and (5).
\48\ See Exchange Act Rules 10C-1(b)(5)(iii) and (iv).
\49\ For these same reasons, we believe exempting such
securities from Rule 10D-1 would be in the public interest and
consistent with the protection of investors. See Exchange Act
Section 36(a).
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Request for Comment
6. Are our proposed exemptions for listing securities futures
products and standardized options appropriate? Why or why not?
7. Are there other types of securities that we should consider
exempting from Rule 10D-1? If so, please explain which securities we
should exempt and why.
3. Registered Investment Companies
In some cases, registered investment companies list their
securities on an exchange. These registered investment companies
generally include closed-end management investment companies and
certain open-end management investment companies and unit investment
trusts (``UITs'') that operate as exchange-traded funds (``ETFs'').\50\
Listed registered management investment companies, unlike most other
issuers, are generally externally managed and often have few, if any,
employees that are compensated by the registered management investment
companies, (i.e., the issuers). Instead, registered management
investment companies typically rely on employees of the investment
adviser to manage fund assets and carry out other related business
activities. Such employees are typically compensated by the investment
adviser of the registered management investment company as opposed to
the fund. There are a small number of listed registered management
investment companies that are internally managed. Such internally
managed registered management investment companies might pay executive
officers incentive-based compensation, as defined in proposed Rule 10D-
1.
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\50\ See Investment Company Act Sections 5(a)(1) (definition of
open-end management investment company) and 5(a)(2) (definition of
closed-end management investment company) [15 U.S.C. 80a-5(a)]. See
also Investment Company Act Section 4(2) (definition of UIT). ETFs
are open-end management investment companies or UITs that offer
redeemable securities that are listed and trade on an exchange.
Since the investment portfolio of a UIT is generally fixed, UITs are
not management investment companies. See text following note 48
below.
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We believe that a listed registered management investment company
\51\ should be subject to the requirements of proposed Rule 10D-1 only
to the extent that it pays executive officers incentive-based
compensation. Accordingly, we propose to exempt the listing of any
security issued by a registered management investment company if such
management company has not awarded incentive-based compensation to any
executive officer of the registered management investment company in
any of the last three fiscal years or, in the case of a company that
has been listed for less than three fiscal years, since the initial
listing.\52\ Management investment companies that have paid incentive-
based compensation in that time period, however, would be subject to
the rule and rule amendments and be required to have implemented a
compensation recovery policy like other listed issuers. The conditional
exemption would avoid causing management investment companies that do
not pay incentive-based compensation to develop recovery policies they
may never use.
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\51\ We note that, as proposed, business development companies,
which are a category of closed-end management investment company
that are not registered under the Investment Company Act, would be
subject to proposed Rule 10D-1. [15 U.S.C. 80a-2(a)(48) and 80a-53-
64]. The purpose of business development companies is to fund small
and developing businesses. In discussing the amendments to the
Investment Company Act that established business development
companies, the House Report noted such companies' special purpose
and specifically recognized the need for such companies to be able
to offer incentive-based compensation to their officers. See H.R.
Rep. No. 1341, 96th Cong., 2d Sess. 21 (1980). We therefore see no
reason to exempt business development companies that list their
securities for trading on an exchange from the general requirements
of the proposed rule.
\52\ Proposed Rule 10D-1(b)(2)(iv). We expect that each exchange
and association would adopt the necessary listing standards to
ensure that those registered management investment companies that
qualify for the exemption have complied with the proposed rule's
exemption requirements.
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We are also proposing to exempt the listing of any security issued
by a UIT from the requirements of proposed Rule 10D-1.\53\ Unlike
management investment companies, UITs are pooled investment entities
without a board of directors, corporate officers, or an investment
adviser to render investment advice during the life of the UIT. In
addition, because the investment portfolio of a UIT is generally fixed,
UITs are not actively managed. Also, unlike registered management
investment companies, UITs do not file a certified shareholder report.
Accordingly, we believe that due to their particular structure and
characteristics, the requirements of proposed Rule 10D-1 would be
inapplicable to UITs.\54\
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\53\ Proposed Rule 10D-1(b)(2)(iii).
\54\ For similar reasons, the Commission exempted UITs when it
adopted the audit committee listing requirements in Exchange Act
Rule 10A-3. See Exchange Act Rules 10A-3(c)(6).
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We are also proposing to amend Form N-CSR to redesignate Item 12 as
Item 13 \55\ and to add new paragraph (a)(3) to that Item. The new
paragraph would require any registered management investment company
that would be subject to the requirements of proposed Rule 10D-1 to
include as an exhibit to its annual report on Form N-CSR its policy on
recovery of incentive-based compensation.
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\55\ We are also proposing a conforming amendment to General
Instruction D to Form N-CSR to refer to redesignated Item 13(a)(1).
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We are also proposing to add new Item 12 to Form N-CSR as well as
to amend Item 22 of Schedule 14A of the Exchange Act. Both amendments
would require registered management investment companies that would be
subject to proposed Rule 10D-1 to provide information that would mirror
the disclosure requirements of Item 402(w) of Regulation S-K.\56\
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\56\ See Section II.D.1, below.
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Request for Comment
8. Are the exemptions for registered management investment
companies and UITs as described above appropriate? Why or why not?
9. Should we conditionally exempt business development companies
from the proposed listing standards, to the same extent as we propose
to do with registered management investment companies? If so, please
explain why.
10. Should we unconditionally exempt registered management
investment companies from the proposed listing standards, as we propose
to do with UITs? Should we unconditionally exempt registered open-end
management investment companies that list their securities on an
exchange, and only apply the conditional exemption to closed-end
management investment companies? Please explain why.
11. Should we require listed registered management investment
companies to disclose in annual reports on Form N-CSR or elsewhere
whether or not the registered management investment company has in fact
[[Page 41150]]
awarded incentive-based compensation to executive officers in the last
three fiscal years, or in the case of a registered management
investment company that has been listed for less than three fiscal
years, since the listing of the registered management investment
company? Should a similar disclosure requirement apply to UITs?
B. Restatements
1. Restatements Triggering Application of Recovery Policy
Sections 10D(a) and 10D(b)(2) require exchanges and associations to
adopt listing standards that require issuers to adopt and comply with
policies that require recovery ``in the event that the issuer is
required to prepare an accounting restatement due to the material
noncompliance of the issuer with any financial reporting requirement
under the securities laws.'' The Senate Report indicated that Section
10D was intended to result in ``public companies [adopting policies] to
recover money that they erroneously paid in incentive compensation to
executives as a result of material noncompliance with accounting rules.
This is money that the executive would not have received if the
accounting was done properly.'' \57\ Commenters equested guidance
regarding the definition of material noncompliance generally.\58\ One
commenter recommended that the Commission either identify the
circumstances that would constitute material noncompliance with
financial reporting requirements or, at a minimum, provide examples of
such circumstances as a guide for making such a determination, since
the determination of whether or not any noncompliance is material would
be based on the facts and circumstances of each situation.\59\ In
addressing who must make the material noncompliance determination, one
commenter noted that Section 10D was unclear as to who must make this
determination \60\ and others recommended that the determination be
left to the issuer.\61\
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\57\ Senate Report at 135.
\58\ See letters from Frederic W. Cook & Co., Inc., Towers
Watson, Baker, Donelson, Bearman, Caldwell & Berkowitz, PC and
Compensia, Inc.
\59\ See letter from Compensia, Inc.
\60\ See letter from Compensia, Inc.
\61\ See letters from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC and David Polk & Wardwell LLP.
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Two commenters noted that because a restatement would have to be
the result of material noncompliance with financial reporting
requirements, Congress recognized that not all accounting restatements
would require recovery.\62\ Several commenters recommended that the
Commission exclude restatements based on changes in generally accepted
accounting principles from the types of restatements that trigger
recovery.\63\ Another commenter observed that a change in accounting
standards would appear not to trigger recovery, but a change in how an
auditor interprets accounting standards may trigger recovery, even
absent issues regarding whether the issuer had adequate controls in
place over its financial reporting system.\64\
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\62\ See letters from Towers Watson and Baker, Donelson,
Bearman, Caldwell & Berkowitz, PC.
\63\ See letters from Center on Executive Compensation, Frederic
W. Cook & Co., Inc. and Protective Life Corporation.
\64\ See letter from Towers Watson.
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We believe that an error that is material to previously issued
financial statements constitutes ``material noncompliance'' by the
issuer with a financial reporting requirement under the securities
laws, as contemplated by Section 10D. Accordingly, proposed Rule 10D-1
would provide that issuers adopt and comply with a written policy
providing that in the event the issuer is required to prepare a
restatement \65\ to correct an error \66\ that is material to
previously issued financial statements,\67\ the obligation to prepare
the restatement would trigger application of the recovery policy.\68\
In connection with this, proposed Rule 10D-1 would define an accounting
restatement as the result of the process of revising previously issued
financial statements to reflect the correction of one or more errors
that are material to those financial statements.\69\ We do not propose
to describe any type or characteristic of an error that would be
considered material for purposes of the listing standards required by
proposed Rule 10D-1 because materiality is a determination that must be
analyzed in the context of particular facts and circumstances.
Moreover, materiality has received extensive and comprehensive judicial
and regulatory attention.\70\ We note that issuers should consider
whether a series of immaterial error corrections, whether or not they
resulted in filing amendments to previously filed financial statements,
could be considered a material error when viewed in the aggregate.
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\65\ Under U.S. Generally Accepted Accounting Principles
(``GAAP''), a restatement is ``the process of revising previously
issued financial statements to reflect the correction of an error in
those financial statements.'' See FASB ASC Topic 250, Accounting
Changes and Error Corrections (formerly SFAS No. 154, Accounting
Changes and Error Corrections) (``ASC Topic 250''). Under
International Financial Reporting Standards as issued by the
International Accounting Standards Board (``IFRS''), a retrospective
restatement is ``correcting the recognition, measurement and
disclosure of amounts of elements of financial statements as if a
prior period error had never occurred.'' See IAS 8, Accounting
Policies, Changes in Accounting Estimates and Errors, paragraph 5.
\66\ Under GAAP, an error in previously issued financial
statements is ``[a]n error in recognition, measurement,
presentation, or disclosure in financial statements resulting from
mathematical mistakes, mistakes in the application of generally
accepted accounting principles (GAAP), or oversight or misuse of
facts that existed at the time the financial statements were
prepared. A change from an accounting principle that is not
generally accepted to one that is generally accepted is a correction
of an error.'' See ASC Topic 250. Under IFRS, prior period errors
are ``omissions from, and misstatements in, the entity's financial
statements for one or more prior periods arising from a failure to
use, or misuse of, reliable information that: (a) Was available when
financial statements for those periods were authorised for issue;
and (b) could reasonably be expected to have been obtained and taken
into account in the preparation and presentation of those financial
statements. Such errors include the effects of mathematical
mistakes, mistakes in applying accounting policies, oversights or
misinterpretations of facts, and fraud.'' See IAS 8, Accounting
Policies, Changes in Accounting Estimates and Errors, paragraph 5.
\67\ When we refer to financial statements, we mean the
statement of financial position (balance sheet), income statement,
statement of comprehensive income, statement of cash flows,
statement of owners' equity, and accompanying footnotes, as required
by Commission regulations. When we refer to financial statements for
registered investment companies and business development companies,
we mean the statement of assets and liabilities (balance sheet) or
statement of net assets, statement of operations, statement of
changes in net assets, statement of cash flows, schedules required
by Rule 6-10 of Regulation S-X, financial highlights, and
accompanying footnotes, as required by Commission regulations.
\68\ Proposed Rule 10D-1(c)(5).
\69\ Proposed Rule 10D-1(c)(1)
\70\ See, e.g., TSC Industries, Inc. v. Northway, 426 U.S. 438
(1976); Basic v. Levinson, 485 U.S. 224 (1988).
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As indicated in the accounting standards, the following types of
changes to an issuer's financial statements do not represent error
corrections, and therefore would not trigger application of the
issuer's recovery policy under the proposed listing standards:
Retrospective application of a change in accounting
principle; \71\
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\71\ A change in accounting principle is ``[a] change from one
generally accepted accounting principle to another generally
accepted accounting principle when there are two or more generally
accepted accounting principles that apply or when the accounting
principle formerly used is no longer generally accepted. A change in
the method of applying an accounting principle also is considered a
change in accounting principle.'' See ASC Topic 250. IAS 8 has
similar guidance. A change from an accounting principle that is not
generally accepted to one that is generally accepted, however, would
be a correction of an error.
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Retrospective revision to reportable segment information
due to a change in
[[Page 41151]]
the structure of an issuer's internal organization; \72\
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\72\ If an issuer changes the structure of its internal
organization in a manner that causes the composition of its
reportable segments to change, the corresponding information for
earlier periods, including interim periods, should be revised unless
it is impracticable to do so. See ASC Topic 280-10-50-34. IFRS 8 has
similar guidance.
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Retrospective reclassification due to a discontinued
operation; \73\
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\73\ See ASC Topic 205-20. IFRS 5 has similar guidance.
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Retrospective application of a change in reporting entity,
such as from a reorganization of entities under common control; \74\
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\74\ See ASC Topic 250-10-45-21. IFRS does not have specific
guidance addressing this reporting matter.
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Retrospective adjustment to provisional amounts in
connection with a prior business combination; \75\ and
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\75\ See ASC Topic 805-10-25-13. IFRS 3 has similar guidance.
---------------------------------------------------------------------------
Retrospective revision for stock splits.
Request for Comment
12. For purposes of proposed Rule 10D-1, an accounting restatement
would be defined as the result of the process of revising previously
issued financial statements to correct errors that are material to
those financial statements. Rather than including this definition in
our proposed rule, should we refer to the definition of ``restatement''
in GAAP? \76\ If we do not refer to the definition in GAAP, is it
appropriate to include in the proposed definition the phrase ``errors
that are material'' or might it be confusing or redundant? Is our
proposed approach the appropriate means to implement Section 10D,
including its ``material noncompliance'' provision?
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\76\ See n.65, above.
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13. If an issuer evaluates whether certain errors are material, and
concludes that such errors are immaterial or are not the result of
material noncompliance, should the issuer disclose its evaluation? If
so, what should be disclosed and where should such disclosure be
required?
14. Should any revision to previously issued financial statements
that results in a reduction in incentive-based compensation received by
an executive officer always trigger application of an issuer's recovery
policy under the proposed listing standards? Why or why not?
15. As noted above, certain changes to the financial statements
would not trigger recovery because they do not represent error
corrections under the accounting standards. Are there any other types
of changes to an issuer's financial statements that should not be
deemed to trigger application of the issuer's recovery policy?
16. Should the proposed listing standards contain any anti-evasion
language regarding the circumstances in which recovery would be
triggered? If so, what should the language provide?
2. Date the Issuer Is Required To Prepare an Accounting Restatement
Section 10D(b)(2) requires exchanges and associations to adopt
listing standards that require issuers to adopt and comply with
policies that require the recovery of excess incentive-based
compensation ``during the 3-year period preceding the date on which the
issuer is required to prepare an accounting restatement.'' Section 10D
does not specify when a listed issuer is ``required to prepare an
accounting restatement'' for purposes of this recovery provision.
Several commenters requested clarification on how to determine the
date on which the issuer is ``required to prepare an accounting
restatement'' and provided suggestions in this regard.\77\ One
commenter asked whether a restatement would be ``required'' for
purposes of Section 10D as of the date the financial statements are
stated incorrectly.\78\ Another commenter expressed the view that the
date of the erroneous statement should be the date on which a new
statement must be prepared.\79\ Other commenters recommended that the
recovery trigger should be the date the issuer files an accounting
restatement due to the issuer's material noncompliance with a financial
reporting requirement under the securities laws.\80\ A different
commenter suggested using the date the decision to undertake the
restatement is made, providing as examples the date an issuer's board
of directors authorizes the preparation of an accounting restatement or
the date a court or regulatory authority orders or requires an issuer
to prepare an accounting restatement.\81\ Another commenter recommended
that the issuer be deemed ``required to prepare an accounting
restatement'' when a Current Report on Form 8-K is filed disclosing
non-reliance on the issuer's financial statements, or, if no Form 8-K
is required, the date that either the board of directors or management
determines that a restatement is required.\82\
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\77\ See letters from Center on Executive Compensation,
Compensia, Inc., Davis Polk & Wardwell LLP, Meridian Compensation
Partners, LLC, and Towers Watson.
\78\ See letter from Towers Watson.
\79\ See AFL-CIO Joint Letter.
\80\ See letters from Center on Executive Compensation and
Protective Life Corporation.
\81\ See letter from Compensia, Inc.
\82\ See letter from Davis Polk & Wardwell LLP.
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We considered the alternatives identified by commenters for when an
issuer is ``required to prepare an accounting restatement'' for
purposes of the proposed listing standards, and are concerned that some
of these alternatives would not operate effectively with the three-year
look-back period for recovery prescribed by Section 10D. While the
issuer has an obligation to file materially complete and accurate
financial statements, which could support using the date the erroneous
financial statements were filed as the triggering date for Section 10D,
we believe this approach would not fully effectuate Section 10D's
purpose. If the date of filing of the erroneous financial statements
were used as the starting point for the look-back period, recovery
would not apply to any incentive-based compensation received after that
date, even when the amount was affected by the erroneous financial
statements. For example, if 2014 net income was materially misstated,
and a 2014-2016 long-term incentive plan had a performance measure of
three-year cumulative net income, a look-back period that covered only
the three years before the erroneous filing would not capture the
compensation earned under that plan. While the date of the erroneous
filing is easily discernible, using this date may result in listed
issuers recovering only incentive-based compensation that was received
during the fiscal year preceding the filing date of the financial
statements that included the subsequently restated financial reporting
measure. We believe this result would be inconsistent with the three-
year look-back period that the statute specifies.
We also considered using the date the issuer files the accounting
restatement for triggering the three-year look-back period. However, we
believe this approach also would not appropriately implement Section
10D because the issuer necessarily would have been required to prepare
an accounting restatement at some point before it actually filed the
restatement.\83\ Moreover, an issuer might improperly delay filing a
restatement after determining that restatement was necessary, and by
doing so could affect
[[Page 41152]]
the amounts of compensation subject to recovery.
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\83\ As noted in Section II.C.2.b, below, the three-year look-
back period is not meant to limit or designate the reporting periods
for which an accounting restatement is required, or to limit which
restated financial statements may be filed with the Commission.
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In considering how best to craft a trigger for recovery under the
proposed listing standards, we have sought to define the date on which
an accounting restatement is required in a way that provides reasonable
certainty for issuers, shareholders and exchanges while not permitting
issuers to avoid recovery when a material error has occurred. To that
end, we are proposing a definition that would be triggered by the
occurrence of certain issuer or third-party determinations about the
need for a restatement. Specifically, under the proposed listing
standards, the proposed rule would state that the date on which an
issuer is required to prepare an accounting restatement is the earlier
to occur of:
The date the issuer's board of directors, a committee of
the board of directors, or the officer or officers of the issuer
authorized to take such action if board action is not required,
concludes, or reasonably should have concluded, that the issuer's
previously issued financial statements contain a material error; or
The date a court, regulator or other legally authorized
body directs the issuer to restate its previously issued financial
statements to correct a material error.\84\
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\84\ Proposed Rule 10D-1(c)(2).
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A note to the proposed rule would indicate that the first proposed
date generally is expected to coincide with the occurrence of the event
described in Item 4.02(a) of Exchange Act Form 8-K, although neither
proposed date is predicated on a Form 8-K having been filed.\85\ For
the first proposed date to occur, the issuer merely needs to have
concluded that previously issued financial statements contain a
material error, which we expect may occur before the precise amount of
the error has been determined. While we recognize that listed issuers
must apply judgment before concluding that previously issued financial
statements contain a material error, we believe this judgment should be
applied on an objective basis, which is when a reasonable issuer, based
on the facts available, would have concluded that the previously issued
financial statements contain a material error. In this regard, while
not dispositive, we believe that an issuer would have to consider
carefully any notice received from its independent auditor that
previously issued financial statements contain a material error.
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\85\ Note to proposed Rule 10D-1(c)(2). For example, if a listed
issuer files an Item 4.02(b) Form 8-K because it is advised by, or
receives notice from, its independent accountant that disclosure
should be made or action should be taken to prevent future reliance
on a previously issued audit report or completed interim review
related to previously issued financial statements that contain a
material error, the triggering event for the recovery policy occurs
when the listed issuer decides to restate its financial statements
even if it subsequently neglects to file an Item 4.02(a) Form 8-K to
report that decision.
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We recognize that the second proposed date on which an issuer would
be required to prepare a restatement for purposes of Section 10D may
occur earlier than the board's determination if a court or other
legally authorized body, such as a regulator, directs the issuer to
restate.
We believe a definition that incorporates the proposed triggering
events rather than leaving the determination solely to the discretion
of the issuer would better realize the objectives of Section 10D while
providing clarity about when a recovery policy, and specifically the
determination of the three-year look-back period, will be triggered for
purposes of the proposed listing standards. In this regard, we note
that the proposed rule also states that an issuer's obligation to
recover excess incentive-based compensation is not dependent on if or
when the restated financial statements are filed. Further, we note that
issuers that knowingly, recklessly or negligently misreport materially
false or misleading financial information would be subject to liability
under existing antifraud provisions.\86\
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\86\ See Securities Act Section 17(a) [15 U.S.C. 77q(a)],
Exchange Act Section 10(b) [15 U.S.C. 78j(b)] and Exchange Act Rule
10b-5 [17 CFR 240.10b-5].
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Request for Comment
17. Is it appropriate to treat the earlier of the two proposed
dates as ``the date on which an issuer is required to prepare an
accounting restatement'' for purposes of triggering the Section 10D
recovery obligation? If not, why not? Would using these dates provide
sufficient certainty and transparency for issuers, investors and
exchanges to determine when recovery would be triggered for purposes of
compliance with the proposed listing standards? Are there additional
triggers we should consider including?
18. Should receipt of a notice from a company's independent auditor
that previously issued financial statements contain a material error
constitute a date when the issuer ``reasonably should have concluded''
that such statements contain a material error? Why or why not? What if
the issuer disagrees with the auditor's conclusion?
19. Are there other means of defining the date on which an issuer
is required to prepare an accounting restatement that would provide
clear benchmarks that do not inject subjectivity into when recovery
would be triggered? If so, how should the date on which the issuer is
required to prepare a restatement be defined?
C. Application of Recovery Policy
1. Executive Officers Subject to Recovery Policy
Section 10D(b)(2) requires exchanges and associations to adopt
listing standards that require issuers to adopt and comply with
policies that provide for recovery of excess incentive-based
compensation from ``any current or former executive officer of the
issuer who received incentive-based compensation.'' Section 10D does
not define ``executive officer'' for purposes of the recovery
policy.\87\
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\87\ The Senate Committee on Banking, Housing, and Urban Affairs
noted that ``[t]his policy is required to apply to executive
officers, a very limited number of employees, and is not required to
apply to other employees.'' Senate Report at 136.
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Several commenters requested guidance on the definition of
executive officer.\88\ One commenter \89\ indicated that the Section
10D's reference to executive officer appears to use the executive
officer definition in Exchange Act Rule 3b-7.\90\ Another commenter
\91\ questioned whether the recovery policy would cover officers
subject to Exchange Act Section 16 \92\ or only the
[[Page 41153]]
named executive officers.\93\ Another specifically recommended using
the Section 16 definition of ``officer,'' and stated that executive
officers of subsidiaries should be included in the definition.\94\ A
different commenter requested guidance regarding how the recovery
policy should apply to persons who are executive officers during only a
portion of the recovery period.\95\
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\88\ See letters from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC, Towers Watson and Robert E. Scully Jr.
\89\ See letter from Towers Watson.
\90\ Exchange Act Rule 3b-7 provides that ``[t]he term executive
officer, when used with reference to a registrant, means its
president, any vice president of the registrant in charge of a
principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a policy
making function or any other person who performs similar policy
making functions for the registrant.'' Executive officers of
subsidiaries may be deemed executive officers of the registrant if
they perform such policy making functions for the registrant.'' 17
CFR 240.3b-7.
\91\ See letter from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC.
\92\ 15 U.S.C. 78p. As defined in Exchange Act Rule 16a-1(f) [17
CFR 240.16a-1(f)], the term ``officer'' means ``an issuer's
president, principal financial officer, principal accounting officer
(or, if there is no such accounting officer, the controller), any
vice-president of the issuer in charge of a principal business unit,
division or function (such as sales, administration or finance), any
other officer who performs a policy-making function, or any other
person who performs similar policy-making functions for the issuer.
Officers of the issuer's parent(s) or subsidiaries shall be deemed
officers of the issuer if they perform such policy-making functions
for the issuer.'' The rule also contains specific provisions with
respect to limited partnerships and trusts, and a note providing
that ``policy-making function'' is not intended to include policy
making functions that are not significant and that persons
identified as ``executive officers'' pursuant to Item 401(b) of
Regulation S-K [17 CFR 229.401(b)] are presumed to be officers for
purposes of Section 16, as are other persons enumerated in Rule 16a-
1(f) but not in Item 401(b). 15 U.S.C. 78p.
\93\ See Item 402(a)(3) of Regulation S-K. For smaller reporting
companies and emerging growth companies, named executive officers
include the following: all individuals serving as the issuer's
principal executive officer or acting in similar capacities during
the last completed fiscal year, regardless of compensation level;
the issuer's two most highly compensated executive officers other
than the principal executive officer who were serving as executive
officers at the end of the last completed fiscal year; and up to two
additional individuals for whom disclosure would have been provided
based on highest compensation but for the fact that the individual
was not serving as an executive officer of the issuer at the end of
the last completed fiscal year. See Item 402(m)(2) of Regulation S-K
and Section 102(c) of the Jumpstart Our Business Startups Act
(``JOBS Act'').
\94\ See AFL-CIO Joint Letter.
\95\ See letter from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC.
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We believe that Section 10D's mandatory recovery policy was
intended to apply, at a minimum, to all executive officers of the
issuer, rather than a more limited category such as the named executive
officers for whom executive compensation disclosure is required under
Item 402 of Regulation S-K. The Senate Report accompanying the statute
indicates that ``[t]his policy is required to apply to executive
officers[.]'' \96\ Moreover, we believe applying the recovery policy to
all executive officers would more effectively realize the statutory
goal of Section 10D because officers with policy making functions and
important roles in the preparation of financial statements set the tone
for and manage the issuer. In this regard, we do not believe that a
listed issuer should be unable to recover unearned compensation from an
executive officer simply because he or she was not one of the
individuals identified for purposes of Item 402's disclosure
requirements.
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\96\ See Senate Report.
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The proposed listing standards would include a definition of
``executive officer'' in Rule 10D-1 that is modeled on the definition
of ``officer'' in Rule 16a-1(f). For purposes of Section 10D, an
``executive officer'' would be the issuer's president, principal
financial officer, principal accounting officer (or if there is no such
accounting officer, the controller), any vice-president of the issuer
in charge of a principal business unit, division or function (such as
sales administration or finance), any other officer who performs a
policy-making function, or any other person who performs similar
policy-making functions for the issuer. Executive officers of the
issuer's parents or subsidiaries would be deemed executive officers of
the issuer if they perform such policy making functions for the
issuer.\97\
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\97\ Proposed Rule 10D-1(c)(3), which also would specify who
would be executive officers if the issuer is a limited partnership
or trust.
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In particular, the proposed definition would expressly include the
principal financial officer and the principal accounting officer (or if
there is no such accounting officer, the controller) among the officers
specified. We believe that their responsibility for financial
information justifies their inclusion in the definition of ``executive
officer'' for this purpose, just as these officers were specifically
included in the Rule 16a-1(f) definition of ``officer.\98\ Although the
compensation recovery provisions of Section 10D apply without regard to
an executive officer's responsibility for preparing the issuer's
financial statements, we believe that it is clearly appropriate for
officers with an important role in financial reporting to be subject to
the recovery policy. The proposed definition, like Rule 16a-1(f),
provides that executive officers of the issuer's parents or
subsidiaries may be deemed executive officers of the issuer if they
perform policy making functions for the issuer. As is the case for
Section 16 officer determination, if pursuant to Item 401(b) of
Regulation S-K the issuer identifies a person as an ``executive
officer,'' it would be presumed that the board of directors has made
that judgment and the persons so identified are executive officers for
purposes of proposed Rule 10D-1.\99\
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\98\ 17 CFR 240.16a-1(f). In proposing their inclusion in the
Rule 16a-1(f) definition of ``officer,'' the Commission noted that
principal financial officers and principal accounting officers are
required to sign an issuer's Securities Act registration statements
and Exchange Act annual reports on Form 10-K. Release No. 34-27148
(Aug. 18, 1989) [54 FR 35667] at n. 31. Subsequently, Section 302 of
SOX required the principal financial officer, as well as the
principal executive officer, to certify the information contained in
each annual or quarterly report filed under Section 13(a) or 15(d)
of the Exchange, and the effectiveness of the issuer's internal
controls. Listed companies could, of course, adopt policies that
applied to a larger group of employees so long as the policy at a
minimum applied to executive officers.
\99\ See proposed Note to Rule10D-1(c)(3), modeled on the Note
to Rule 16a-1(f).
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Section 10D(b)(2) calls for the recovery policy to apply to ``any
current or former executive officer of the issuer who received
incentive-based compensation [during the three-year look-back
period].'' We believe that the statute was designed to require recovery
of excess incentive-based compensation provided for service as an
executive officer. Accordingly, the rule and rule amendments we propose
would require recovery of excess incentive-based compensation received
by an individual who served as an executive officer of the listed
issuer at any time during the performance period for that incentive-
based compensation.\100\ This would include incentive-based
compensation derived from an award authorized before the individual
becomes an executive officer, and inducement awards granted in new hire
situations, as long as the individual served as an executive officer of
the listed issuer at any time during the award's performance period. As
proposed, recovery would not apply to an individual who is an executive
officer at the time recovery is required if that individual had not
been an executive officer at any time during the performance period for
the incentive-based compensation subject to recovery.
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\100\ Proposed Rule 10D-1(b)(1)(i)(B).
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Request for Comment
20. Consistent with the Rule 16a-1(f) definition of ``officer'',
should we define ``executive officers'' to expressly include the
principal financial officer and the principal accounting officer (or if
there is no such accounting officer, the controller), as proposed?
21. Are there any other officers, such as the chief legal officer,
chief information officer, or such other officer, who by virtue of
their position should be specifically named as executive officers
subject to the issuer's recovery policy? If so, which additional
officers should be subject to the issuer's recovery policy and why?
22. Are there any other officers who should be included in the
group of executive officers subject to the issuer's recovery policy,
but who may not fall within the proposed definition? Is the definition
of executive officer appropriate? If not, how else should executive
officer be defined?
23. Alternatively, is the proposed definition of ``executive
officer'' too broad? Should we instead limit the recovery policy to
``named executive officers,'' as defined in Items 402(a)(3) and
402(m)(2) of Regulation S-K or otherwise define a more narrow set of
officers subject to recovery?
24. Will the scope of the term ``executive officer'' for purposes
of Section 10D affect issuers' practices in
[[Page 41154]]
identifying executive officers for other purposes? If so, how, and what
if anything should we do to address that? Are there other means of
simplifying the identification of ``executive officers'' for purposes
of Rule 10D-1 that would promote consistency with identifying executive
officers for other purposes, such as Item 401(b) of Regulation S-K? Is
there another, more appropriate definition?
25. Is it consistent with the purposes of Section 10D to apply
recovery to any incentive-based compensation earned during the three
completed fiscal years immediately preceding the date that the issuer
is required to prepare a restatement if that person served as an
executive officer at any time during the performance period?
Alternatively, should an individual be subject to recovery only for
incentive-based compensation earned during the portion of the
performance period during which the individual was serving as an
executive officer? Should an individual who is an executive officer at
the time recovery is required be subject to recovery even if that
individual did not serve as an executive officer of the issuer at any
time during the performance period for the affected incentive-based
compensation? If a different standard should govern the circumstances
when an executive officer or former executive officer is subject to
recovery, what should that standard be, and why should it apply?
2. Incentive-Based Compensation
a. Incentive-Based Compensation Subject to Recovery Policy
Section 10D(b)(2) requires exchanges and associations to adopt
listing standards that require issuers to adopt and comply with
recovery policies that apply to ``incentive-based compensation
(including stock options awarded as compensation)'' that is received,
based on the erroneous data, in ``excess of what would have been paid
to the executive officer under the accounting restatement.'' Implicit
in these statutory requirements is that the amount of such compensation
received in the three-year look-back period would have been less if the
financial statements originally had been prepared as later restated.
Several commenters recommended that the Commission clarify the
types of compensation to which the listing standards' recovery policy
would apply.\101\ To that end, some commenters suggested potential
standards that focused on the compensation being based on or related to
publicly reported financial statements.\102\ For example, one commenter
stated that any form of compensation that is contingent upon the
achievement of one or more pre-determined and objective performance
goals ``that expressly relate to and are derived from one or more
financial or stock price metric set forth in an issuer's financial
statements filed with the Commission'' should be incentive-based
compensation for purposes of Section 10D.\103\ In some cases,
commenters suggested we look to the existing definitions of ``incentive
plan,'' ``equity incentive plan award'' and ``non-equity incentive plan
award'' in Item 402(a)(6)(iii) of Regulation S-K in defining incentive-
based compensation subject to recovery.\104\
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\101\ See, e.g., letters from ABA Business Law Section, American
Benefits Council, Center on Executive Compensation, Meridian
Compensation Partners, LLC, Protective Life Corporation, Robert E.
Scully Jr, and Society of Corporate Secretaries and Governance
Professionals.
\102\ See, e.g., letters from ABA Business Law Section, American
Benefits Council, Center on Executive Compensation, David Polk, and
Meridian Compensation Partners, LLC.
\103\ See letter from Meridian Compensation Partners, LLC.
\104\ See letters from ABA Business Law Section and David Polk.
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To identify compensation that is awarded or vests based on
financial performance measures, some commenters \105\ provided various
examples of financial information required to be reported under the
securities laws, such as revenue, net income and earnings per share,
and examples of related non-GAAP measures, such as EBITDA.\106\
Commenters also recommended that awards based solely on satisfaction of
non-financial measures--for example, operational measures such as
market share and customer satisfaction, subjective measures such as
leadership, and strategic measures such as consummation of a merger--
should not be subject to an issuer's recovery policy.\107\ Generally,
commenters who specifically addressed stock price and total shareholder
return \108\ measures recommended excluding them from recovery
policies,\109\ or expressed the view that any connection between the
erroneous data relating to an accounting restatement and the
fluctuating value of the issuer's stock would be tangential and
speculative.\110\
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\105\ See, e.g., letters from Center on Executive Compensation,
Meridian Compensation Partners, LLC and Protective Life Corporation.
\106\ Earnings before interest, taxes, depreciation and
amortization.
\107\ See, e.g., letters from Center on Executive Compensation,
Meridian Compensation Partners, LLC, Protective Life Corporation,
and Society of Corporate Secretaries and Governance Professionals.
\108\ ``Total shareholder return'' or ``TSR'' is a measure based
on the change in stock price plus dividends over a period of time.
\109\ See letters from Center on Executive Compensation and
Protective Life Corporation.
\110\ See letter from American Benefits Council.
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One commenter who addressed the statute's inclusion of ``stock
options awarded as compensation'' questioned whether recovery should
apply to the extent the enhancement in an award's value is solely
attributable to increases in the fair market value of the underlying
shares.\111\ Other commenters recommended excluding from recovery
equity awards that are not granted upon achievement of one or more pre-
determined and objective financial metrics, and that vest solely upon
the passage of time, continued service or satisfaction of non-financial
metrics.\112\
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\111\ See letter from American Benefits Council.
\112\ See letters from Center on Executive Compensation,
Compensia, Meridian Compensation Partners, LLC and Protective Life
Corporation.
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Commenters also raised questions whether other forms of
compensation, such as discretionary bonuses, future benefits under
supplemental retirement benefit plans calculated based on incentive
compensation awards and investment returns on incentive-based
compensation deferred pursuant to deferred compensation plans, would be
incentive-based compensation subject to recovery.\113\ In particular,
some commenters requested guidance concerning bonuses paid pursuant to
``pool plans,'' where achievement of financial performance measures
establishes the overall size of the bonus pool, but discretion is
exercised in determining the amount of individual bonuses.\114\
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\113\ See, e.g., letter from Robert E. Scully, Jr.
\114\ See letters from Center on Executive Compensation and
Protective Life Corporation.
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In considering how best to define incentive-based compensation for
purposes of the proposed rule,\115\ we have considered the statutory
language of Section 10D, the views of commenters, and the
administrability of any mandatory recovery policy that encompasses such
compensation. Rather than identifying each type or form of compensation
to which a recovery policy required under the listing standards would
apply, for purposes of proposed Rule 10D-1 we propose to define
``incentive-based compensation'' in a principles-based manner, which we
believe would enable the rule and rule amendments to operate
effectively as new forms of compensation and new measures of
[[Page 41155]]
performance upon which compensation is based are developed. As
proposed, ``incentive-based compensation'' would be defined as ``any
compensation that is granted, earned or vested based wholly or in part
upon the attainment of any financial reporting measure.'' \116\
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\115\ The proposed definition would be applicable only to
recovery of incentive-based compensation under proposed Rule 10D-1,
and would not apply to the recovery of incentive-based compensation
pursuant to SOX Section 304.
\116\ See proposed Rule 10D-1(c)(4). ``In part,'' is included in
the definition to clarify that incentive-based compensation need not
be based solely upon attainment of a financial reporting measure. An
example of compensation that is based in part upon the attainment of
a financial reporting measure would include an award in which 60
percent of the target amount is earned if a certain revenue level is
achieved, and 40 percent of the target amount is earned if a certain
number of new stores are opened. Similarly, an award for which the
amount earned is based on attainment of a financial reporting
measure but is subject to subsequent discretion by the compensation
committee to either increase or decrease the amount would be based
in part upon attainment of the financial reporting measure.
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The proposed definition would further provide that ``financial
reporting measures'' are measures that are determined and presented in
accordance with the accounting principles used in preparing the
issuer's financial statements,\117\ any measures derived wholly or in
part from such financial information,\118\ and stock price and total
shareholder return. Such measures would be encompassed by the
definition of financial reporting measures whether or not included in a
filing with the Commission,\119\ and may be presented outside the
financial statements, such as in Management's Discussion and Analysis
of Financial Conditions and Results of Operations (``MD&A'') \120\ or
the performance graph.\121\ Accordingly, examples of financial
reporting measures would include, but would not be limited to, the
following accounting-based measures (including measures derived
therefrom):
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\117\ For foreign private issuers whose financial statements are
based upon a comprehensive body of accounting principles other than
GAAP or IFRS, the restatement would relate to amounts reported using
such other accounting principles but not the reconciliation to GAAP.
We would not consider the reconciliation to GAAP to be within the
meaning of financial reporting measures for purposes of this
proposed rule.
\118\ The proposed definition is broader than a ``non-GAAP
financial measure'' for purposes of Exchange Act Regulation G [17
CFR 244.100 et seq.] and Item 10 of Regulation S-K [17 CFR 229.10].
\119\ For example, same store sales or regional sales volume may
not be disclosed in a filing with the Commission, but nevertheless
could be affected by an accounting restatement for revenue
recognition.
\120\ 17 CFR 229.303. See also Item 5, Form 20-F. Examples of
this could be accounts receivable turnover, EBITDA, or sales per
square foot.
\121\ 17 CFR 229.201(e).
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Revenues;
Net income;
Operating income;
Profitability of one or more reportable segments; \122\
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\122\ As disclosed in a financial statement footnote. See ASC
Topic 280.
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Financial ratios (e.g., accounts receivable turnover and
inventory turnover rates);
Net assets or net asset value per share (for registered
investment companies and business development companies that are
subject to the rule);
EBITDA; \123\
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\123\ Earnings before interest, taxes, depreciation and
amortization.
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Funds from operations (``FFO'') \124\ and adjusted funds
from operations (``AFFO'');
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\124\ FFO is a non-GAAP financial measure commonly used in the
real estate industry.
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Liquidity measures (e.g., working capital, operating cash
flow);
Return measures (e.g., return on invested capital, return
on assets);
Earnings measures (e.g., earnings per share);
Sales per square foot or same store sales, where sales is
subject to an accounting restatement;
Revenue per user, or average revenue per user, where
revenue is subject to an accounting restatement;
Cost per employee, where cost is subject to an accounting
restatement;
Any of such financial reporting measures relative to a
peer group, where the issuer's financial reporting measure is subject
to an accounting restatement; and
Tax basis income.
In addition to measures that are derived from the financial statements,
the proposed definition of financial reporting measures would include
performance measures based on stock price or total shareholder return.
Section 10D(b) requires disclosure of an issuer's policy with respect
to ``incentive-based compensation that is based on financial
information required to be reported under the securities laws'' and
recovery of compensation awarded ``based on the erroneous data.''
Although the phrase ``financial information required to be reported
under the securities laws'' might be interpreted as applying only to
accounting-based metrics, we believe that it also includes performance
measures such as stock price and total shareholder return that are
affected by accounting-related information and that are subject to our
disclosure requirements.\125\ Further, Congress' direction to include
compensation that is based on financial information and to recover
compensation based on the erroneous accounting data suggests that we
should include incentive compensation tied to measures such as stock
price and total shareholder return to the extent that improper
accounting affects such measures, and in turn results in excess
compensation. We also recognize that total shareholder return is a
frequently used performance metric for executive compensation,\126\ and
that excluding it might not promote the goals we believe Congress
intended. Moreover, we are concerned that not including TSR could
incentivize issuers to alter their executive compensation arrangements
in ways that would avoid application of the mandatory recovery policy
and result in less efficient incentive alignment.\127\
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\125\ In this regard, we note that Item 201 of Regulation S-K
requires issuers with common equity the principal market for which
is an exchange, to disclose the high and low sales prices ``for each
full quarterly period within the two most recent fiscal years and
any subsequent interim period for which financial statements are
included . . . .'' In addition, Item 201(e) of Regulation S-K
requires issuers that are not smaller reporting companies to
disclose stock price information and a performance graph comparing
the company's cumulative total shareholder return with a performance
indicator of the overall stock market and either a published
industry index or company-determined peer comparison.
\126\ See Section III, below.
\127\ See Section III, below.
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In proposing that the statutory language should be interpreted to
encompass incentive-based compensation tied to stock price and total
shareholder return, as well as accounting-based metrics, we have
considered potential administrative burdens that could be imposed on
issuers in determining the amount of compensation to be recovered. In
some cases, issuers may need to engage in complex analyses that require
significant technical expertise and specialized knowledge, and may
involve substantial exercise of judgment in order to determine the
stock price impact of a material restatement. Due to the presence of
confounding factors, it sometimes may be difficult to establish the
relationship between an accounting error and the stock price. We
recognize these potential challenges and, as discussed more fully
below,\128\ are proposing that issuers be permitted to use reasonable
estimates when determining the impact of a restatement on stock price
and total shareholder return and to require them to disclose the
estimates.\129\ We believe that being able to use reasonable estimates
to assess the effect of the accounting restatement on these performance
measures in determining the amount of erroneously awarded compensation
should help to mitigate these potential difficulties.
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\128\ See Section II.C.3.a, below.
\129\ See Section II.D.1, below.
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While the definition we are proposing is intended to be applied
broadly and flexibly, it does not encompass all forms
[[Page 41156]]
of incentive compensation.\130\ An incentive plan award that is
granted, earned or vested based solely upon the occurrence of certain
non-financial events, such as opening a specified number of stores,
obtaining regulatory approval of a product, consummating a merger or
divestiture, completing a restructuring plan or financing transaction,
would not be ``incentive-based compensation'' because these measures of
performance are not financial reporting measures. Although these non-
financial metrics are not included in the proposed definition, we are
soliciting comment below on whether the definition of ``incentive-based
compensation'' should include additional performance measures.
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\130\ In this regard we note that the proposed definition of
``incentive-based compensation'' is narrower in scope than the
definition of ``incentive plan,'' in Item 402(a)(6)(iii) of
Regulation S-K, which is ``any plan providing compensation intended
to serve as an incentive for performance to occur over a specified
period, whether such performance is measured by reference to
financial performance of the registrant or an affiliate, the
registrant's stock price, or any other performance measure.'' Item
402(a)(6)(iii) of Regulation S-K [17 CFR 229.402(a)(6)(iii)]. The
proposed Rule 10D-1 definition would not include ``other performance
measures'' in light of Section 10D's reference to incentive-based
compensation based on financial information required to be reported
under the federal securities laws.
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The statute further specifies that incentive-based compensation to
which recovery should apply under the recovery policy required by the
listing standard ``includ[es] stock options awarded as compensation.''
Accordingly, as proposed, ``incentive-based compensation'' would
include options and other equity awards whose grant or vesting is based
wholly or in part upon the attainment of any measure based upon or
derived from financial reporting measures.\131\ Applying the proposed
Rule 10D-1 definition, compensation that would be subject to the
recovery policy required by the proposed listing standards would
include, but not be limited to:
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\131\ This would be the standard for purposes of proposed Rule
10D-1 even though time-vested stock options are generally considered
``performance-based'' for purposes of exclusion from the Internal
Revenue Code Section 162(m) $1 million cap on tax-deductible
executive compensation if the amount of compensation attributable to
the options is based solely on an increase in company stock price,
assuming the exercise price is no less than fair market value of the
underlying stock on the date of grant. See 26 CFR 1.162-
27(e)(2)(vi).
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Non-equity incentive plan awards that are earned based
wholly or in part on satisfying a financial reporting measure
performance goal;
Bonuses paid from a ``bonus pool,'' the size of which is
determined based wholly or in part on satisfying a financial reporting
measure performance goal;
Restricted stock, restricted stock units (``RSUs''),
performance share units (``PSUs''), stock options, and stock
appreciation rights (``SARs'') that are granted or become vested based
wholly or in part on satisfying a financial reporting measure
performance goal; and
Proceeds received upon the sale of shares acquired through
an incentive plan that were granted or vested based wholly or in part
on satisfying a financial reporting measure performance goal.
Examples of compensation that would not be ``incentive-based
compensation'' for this purpose would include, but not be limited to:
Salaries; \132\
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\132\ However, to the extent that an executive officer receives
a salary increase earned wholly or in part based on the attainment
of a financial reporting measure, such a salary increase would be
subject to recovery as a non-equity incentive plan award for
purposes of proposed Rule 10D-1.
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Bonuses paid solely at the discretion of the compensation
committee or board that are not paid from a ``bonus pool,'' the size of
which is determined based wholly or in part on satisfying a financial
reporting measure performance goal;
Bonuses paid solely upon satisfying one or more subjective
standards (e.g., demonstrated leadership) and/or completion of a
specified employment period;
Non-equity incentive plan awards earned solely upon
satisfying one or more strategic measures (e.g., consummating a merger
or divestiture), or operational measures (e.g., opening a specified
number of stores, completion of a project, increase in market share);
and
Equity awards for which the grant is not contingent upon
achieving any financial reporting measure performance goal and vesting
is contingent solely upon completion of a specified employment period
and/or attaining one or more non-financial reporting measures.
Request for Comment
26. Is the scope of incentive-based compensation subject to
recovery under Section 10D(b) properly defined by reference to
compensation that is granted, earned or vested based wholly or in part
upon attainment of any measure that is determined or presented in
accordance with applicable accounting principles? If not, please
explain what other forms of compensation should be covered and why.
27. Is the proposed definition of ``incentive-based compensation''
the best means to capture all forms of compensation that could be
subject to reduction if recalculated based on an accounting
restatement? If not, please explain what other forms of compensation,
which would not be covered by the proposed definition, should be
covered.
28. Are there circumstances in which compensation that is received
upon completion of a specified employment period or upon the attainment
of any other goal that is not covered by our proposed definition should
be considered incentive-based compensation subject to recovery? Why or
why not? If so, how would an issuer calculate the recoverable amounts
in the event of an accounting restatement? Are there any other measures
of compensation that should be included in the definition of incentive-
based compensation? If so, which ones and why?
29. Should compensation that is based upon stock price performance
or total shareholder return be considered incentive-based compensation
subject to recovery? If not, please explain why not. If compensation
that is based on stock price performance or total shareholder return is
included as incentive-based compensation subject to recovery, what
calculations would need to be made to determine the recoverable amount?
What are the costs and technical expertise required to prepare these
calculations? Who would make these calculations for issuers? Would the
costs be greater than for calculations tied to other financial
reporting measures, which would be subject to mathematical
recalculation directly from the information in an accounting
restatement? Would the exchanges be able to efficiently assess these
calculations for purposes of enforcing compliance with their listing
standards? Why or why not? Should we require an independent third party
to assess management's calculations?
30. Should incentive-based compensation be defined to include
compensation that is based on satisfying one or more subjective
standards (such as demonstrated leadership) to the extent that such
subjective standards are satisfied in whole or in part by meeting a
financial reporting measure performance goal (such as stock price
performance or revenue metrics)? If so, how could this approach be
implemented? Is it sufficient that the current proposal encompasses
``any compensation that is granted, earned or vested based wholly or in
part upon the
[[Page 41157]]
attainment of a financial reporting measure''? If not, why not?
31. Should the proposed rule or listing standards contain any anti-
evasion language that would treat as incentive-based compensation
amounts received purportedly based on one or more subjective standards
but that are in fact based on financial information metrics, total
shareholder return or stock price performance? If so, what should the
language provide?
32. Should the definition of ``incentive-based compensation''
included in Rule 10D-1 be principles-based, as proposed? Alternatively,
should the definition specify performance measures that may be affected
by an accounting restatement? If so, please explain which examples
should be included and why.
33. Regarding the statutory provision that incentive-based
compensation subject to recovery ``includ[es] stock options awarded as
compensation,'' does the proposed definition provide a basis by which
issuers can identify equity awards that would be covered? If not,
please explain why not. If all options should be subject to recovery,
how should the amount subject to recovery following an accounting
restatement be computed for time-vested options that are not granted
based on satisfaction of a financial reporting measure performance
goal?
34. Regarding bonuses granted from a ``bonus pool,'' the size of
which is based wholly or in part upon satisfying a financial reporting
measure performance goal, does the proposed definition properly subject
this form of compensation to recovery? If not, how should we treat such
compensation for purposes of Rule 10D-1?
35. Is further guidance needed as to how the proposed definition
would apply to forms of compensation that may be paid out on a deferred
basis, such as employee or employer contributions of incentive-based
compensation to nonqualified deferred compensation plans and earnings
thereon, and future retirement benefits payable under pension plans,
such as supplemental retirement benefit plans, that are calculated
based on incentive-based compensation? \133\ If so, what further
guidance should we provide?
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\133\ See Section II.C.3.a, below, addressing the computation of
excess incentive-based compensation for these forms of compensation.
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b. Time Period Covered by Recovery Policy
Section 10D(b)(2) requires exchanges and associations to adopt
listing standards that require issuers to adopt and comply with
recovery policies that apply to excess incentive-based compensation
received ``during the three-year period preceding the date on which the
issuer is required to prepare an accounting restatement'' but does not
otherwise specify how this three -year look-back period should be
measured. Commenters recommended that the listing standards address
this point.\134\ One commenter suggested that it be the three fiscal
years preceding the date that a Form 8-K is filed disclosing non-
reliance on the issuer's financial statements, or, if no Form 8-K is
required, preceding the date that either the board of directors or
management makes a determination that a restatement is required.\135\
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\134\ See letters from Frederic W. Cook & Co., Inc., ABA
Business Law Section and Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC.
\135\ See letter from Davis Polk & Wardwell LLP.
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Under proposed Rule 10D-1, the three-year look-back period for the
recovery policy required by the listing standards would be the three
completed fiscal years immediately preceding the date the issuer is
required to prepare an accounting restatement.\136\ We believe that
basing the look-back period on fiscal years, rather than a preceding
36-month period, is consistent with issuers' general practice of making
compensation decisions and awards on a fiscal year basis. Using the
proposed recovery period trigger, if a calendar year issuer concludes
in November 2018 that a restatement of previously issued financial
statements is required and files the restated financial statements in
January 2019, the recovery policy would apply to compensation received
in 2015, 2016 and 2017. The three-year look-back period is not meant to
alter the reporting periods for which an accounting restatement is
required or for which restated financial statements are to be filed
with the Commission.\137\ Moreover, an issuer would not be able to
delay or relieve itself from the obligation to recover erroneously
awarded incentive-based compensation by delaying or failing to file
restated financial statements.
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\136\ Proposed Rule 10D-1(b)(ii).
\137\ For example, assume the three-year look-back period is
2016, 2017 and 2018, and incentive compensation received (as
``received'' would be defined in proposed Rule 10D-1(c)(6),
discussed in Section II.C.2.c, below) in 2016 was earned by
achieving a certain level of cumulative operating income for the
two-year period from 2015 to 2016. In determining the amount of
excess compensation received in 2016, the issuer would be required
to prepare restated financial statements for 2015 and 2016 even if
the issuer does not file one or both of those restated financial
statements.
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In proposing Rule 10D-1, we considered other approaches, such as a
recovery policy that requires issuers to recover incentive-based
compensation received during any period of three consecutive years
preceding the date on which the issuer is required to prepare an
accounting restatement so long as the incentive-based compensation was
affected by the error. However, we do not believe that this approach is
the most appropriate means to implement Section 10D because it would
require additional judgments about which three years' compensation
should be subject to recovery, making it less objective and harder for
exchanges and listed issuers to apply uniformly.
In situations where an issuer has changed its fiscal year end
during the three-year look-back period, we are proposing that the
issuer must recover any excess incentive-based compensation received
during the transition period occurring during, or immediately
following, that three-year period in addition to any excess incentive-
based compensation received during the three-year look-back period
(i.e., a total of four periods).\138\ A transition period refers to the
period between the closing date of the issuer's previous fiscal year
end and the opening date of its new fiscal year.\139\ For example,
consider a situation in which, in late 2015, an issuer changes its
fiscal closing date from June 30 to December 31, and subsequently
reports on the transition period from July 1, 2015 to December 31,
2015. If the issuer's board of directors concludes in May 2017 that it
will restate previously issued financial statements due to a material
error, the look-back period would consist of the year ended June 30,
2014, the year ended June 30, 2015, the period from July 1, 2015 to
December 31, 2015, and the year ended December 31, 2016. However,
consistent with Rule 3-06(a) of Regulation S-X, a transition period of
nine to 12 months would be considered a full year in applying the
three-year look-back period requirement.
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\138\ Proposed Rule 10D-1(b)(1)(ii).
\139\ 17 CFR 240.13a-10 and 17 CFR 240.15d-10
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Request for Comment
36. Is the proposed approach to determine the three-year look-back
period for recovery an appropriate means to implement Section 10D? Does
it properly reflect the way in which issuers make their compensation
decisions (on a fiscal year by fiscal year basis)? Why or why not?
37. Should a different approach be used to determine the three-year
look-back period for recovery? If so, how should the look-back period
be determined, and why? For example, should an issuer be permitted to
apply
[[Page 41158]]
its recovery policy to any three-year period in which incentive-based
compensation received by executive officers was affected by the
accounting error?
38. Is the proposed approach regarding transition periods related
to a change in fiscal year appropriate? If not, what alternative
approach should we consider? Consistent with Rule 3-06(a) of Regulation
S-X, should a transition period of nine to 12 months be considered a
full year in satisfying the three-year look-back period requirement?
c. When Incentive-Based Compensation Is ``Received''
Section 10D does not specify when an executive officer should be
deemed to have received incentive-based compensation for the recovery
policy required under the applicable listing standards. One commenter
asked the Commission to clarify whether an option or SAR is received
when it is granted or when it is exercised or whether restricted stock,
RSUs, other stock-based compensation and long-term cash incentives are
received when granted, earned, vested or paid out.\140\ Another
commenter suggested that compensation be deemed received on the earlier
of the date the compensation is paid to or earned by the executive
officer, construing ``earned'' to mean when an executive officer
obtains a non-forfeitable interest in a compensatory award.\141\
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\140\ See letter from Brian Foley & Company, Inc.
\141\ See letter from Meridian Compensation Partners, LLC.
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As proposed, incentive-based compensation would be deemed received
for purposes of triggering the recovery policy under Section 10D in the
fiscal period \142\ during which the financial reporting measure
specified in the incentive-based compensation award is attained, even
if the payment or grant occurs after the end of that period.\143\ Under
this standard, the date of receipt would depend upon the terms of the
award. If the grant of an award is based, either wholly or in part, on
satisfaction of a financial reporting measure, the award would be
deemed received in the fiscal period when that measure was satisfied.
If an equity award vests upon satisfaction of a financial reporting
measure, the award would be deemed received in the fiscal period when
it vests. Similarly, a cash award earned upon satisfaction of a
financial reporting measure would be deemed received in the fiscal
period when that measure is satisfied.
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\142\ Including a transition period for a change in fiscal year,
if applicable.
\143\ Proposed Rule 10D-1(c)(6).
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A particular award may be subject to multiple conditions. We are
not proposing that an executive officer must have satisfied all
conditions to an award for the incentive-based compensation to be
deemed received for purposes of triggering the recovery policy. For
example, an issuer could grant an executive officer an RSU award in
which the number of RSUs earned is determined at the end of the three-
year incentive-based performance period (2015-2017), but the award is
subject to service-based vesting for two more years (2018-2019).
Although the executive officer does not have a non-forfeitable interest
in the RSUs before expiration of the subsequent two-year service-based
vesting period, the number of shares in which the RSUs ultimately will
be paid will be established at the end of the three-year performance
period. In light of Section 10D's purpose to require listed issuers to
recover compensation that ``the executive would not have received if
the accounting was done properly,'' \144\ we believe that in this
circumstance the executive officer ``receives'' the compensation for
purposes of triggering the recovery policy when the relevant financial
reporting measure performance goal is attained, even if the executive
officer has established only a contingent right to payment at that
time. If the issuer's board of directors concludes in 2018 that the
issuer will restate previously issued financial statements for 2015
through 2017 (the three-year performance period),\145\ the recovery
policy should apply to reduce the number of RSUs ultimately payable in
stock, even though the executive has not yet satisfied the two-year
service-based vesting condition to payment. In this example, if the
executive officer were deemed not to receive the RSUs before obtaining
a non-forfeitable interest in them, such a restatement of the financial
statements that would reduce the number of RSUs ultimately payable in
stock would not be subject to recovery because the incentive-based
compensation would not have been received during the three-year look-
back period. We do not believe such an outcome would appropriately
implement the policy underlying Section 10D, because it would mean that
the mere passage of time pursuant to a service-based vesting condition
or a subsequent performance condition unrelated to a financial
reporting measure \146\ would preclude the issuer from recovering
incentive-based compensation.
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\144\ See Senate Report at 135.
\145\ In this example, the three-year performance period
coincides with the three-year look-back period covered by the
recovery policy. See Section II.C.2.b. above regarding the three-
year look-back period.
\146\ For example, if the subsequent condition in the example
above was not service-based vesting but instead called for the
issuer to open 100 stores during 2018 and 2019, or required the
executive to comply with a non-compete or non-solicitation covenant
during those years.
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Ministerial acts or other conditions necessary to effect issuance
or payment, such as calculating the amount earned or obtaining the
board of directors' approval of payment, would not affect the
determination of the date received. For example, for an equity award
deemed received upon grant, receipt would occur in the fiscal year that
the relevant financial reporting measure performance goal was
satisfied, rather than a subsequent date on which the award was
issued.\147\ Similarly, a non-equity incentive plan award would be
deemed received in the fiscal year that the executive earns the award
based on satisfaction of the relevant financial reporting measure
performance goal, rather than a subsequent date on which the award was
paid.\148\
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\147\ The fiscal year in which an incentive-based equity award
is deemed received upon grant in some cases may be a fiscal year
preceding the fiscal year in which the ASC Topic 718 grant date
occurs and for which it is reported in the Summary Compensation
Table and Grants of Plan-Based Awards Table because our requirements
for reporting equity awards in the Summary Compensation Table do not
utilize a ``performance year'' standard. See Proxy Disclosure
Enhancements, Release No. 33-9089 (Dec. 16, 2009) [74 FR 68334] at
Section II.A.2.c.
\148\ This would be the same fiscal year for which the non-
equity incentive plan award earnings are reported in the Summary
Compensation Table, based on Instruction 1 to Item 402(c)(2)(vii),
which provides: ``If the relevant performance measure is satisfied
during the fiscal year (including for a single year in a plan with a
multi-year performance measure), the earnings are reportable for
that fiscal year, even if not payable until a later date, and are
not reportable again in the fiscal year when amounts are paid to the
named executive officer.''
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Under proposed Rule 10D-1, incentive-based compensation would be
subject to the issuer's recovery policy to the extent that it is
received while the issuer has a class of securities listed on an
exchange or an association.\149\ An award of incentive-based
compensation granted to an executive officer before the issuer lists a
class of securities would be subject to the recovery policy, so long as
the incentive-based compensation was received by the executive officer
while the issuer had a class of listed securities. Incentive-based
compensation received by an executive officer before the issuer's
securities become listed would not be subject to the recovery policy
under our proposed
[[Page 41159]]
rule. As proposed, an exchange would not be permitted to list an issuer
that it has delisted or that has been delisted from another exchange
for failing to comply with its recovery policy until the issuer comes
into compliance with that policy.\150\
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\149\ Proposed Rule 10D-1(b)(1)(i)(A).
\150\ Proposed Rule 10D-1(b)(1)(vi).
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Request for Comment
39. Should incentive-based compensation be deemed ``received'' for
purposes of triggering the recovery policy under Section 10D in the
fiscal year during which attainment of the financial reporting measure
specified in the incentive-based compensation award, by its terms,
causes the incentive-based compensation to be granted, to be earned or
to vest, as proposed? If not, when should incentive-based compensation
be deemed ``received'' for purposes of triggering the recovery policy?
40. Should an executive officer be required to obtain a non-
forfeitable entitlement to the incentive-based compensation to
``receive'' the compensation? Would such a requirement effectuate the
purpose of Section 10D? Should the rule specifically address the
treatment of awards subject to multiple vesting conditions, only some
of which may be linked to financial reporting measures? If so, what
would be the appropriate treatment of such rewards?
41. If following receipt, as proposed to be defined, an executive
officer contributes incentive-based compensation to a nonqualified
deferred compensation plan, how should deferral affect recovery? \151\
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\151\ See Section II.C.3.a, below, addressing the computation of
excess incentive-based compensation for this form of compensation.
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42. Should incentive-based compensation be subject to the issuer's
recovery policy only to the extent that it is received while the issuer
has a class of securities listed, as proposed? If not, please explain
in what circumstances a different standard should apply and why. For
example, if a company lists in 2017, and restates the three prior
fiscal years in 2018, should its policy require recovery of incentive-
based compensation received in 2015 or 2016?
3. Recovery Process
a. Determination of Excess Compensation
Section 10D(2)(b) requires exchanges and associations to adopt
listing standards that require issuers to adopt and comply with
recovery policies that apply to the amount of incentive-based
compensation received ``in excess of what would have been paid to the
executive officer under the accounting restatement.''
Commenters recommended that the Commission clarify how excess
compensation subject to recovery should be determined.\152\ One
commenter suggested that the Commission establish a clear set of
guidelines as to how issuers should calculate the recoverable amount
under a variety of common arrangements, or alternatively, a clear set
of principles to be used to make such calculations.\153\ In some cases,
commenters recommended specific ways to measure excess compensation for
particular forms of incentive-based compensation. For example, for cash
awards based upon the achievement of erroneous financial metrics, one
commenter recommended that the excess incentive-based compensation
should be the difference between the cash award that was granted and
the cash award that should have been granted using the restated
financial metric.\154\
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\152\ See, e.g., letters from Center on Executive Compensation,
Compensia, Inc., Meridian Compensation Partners, LLC, Pay Governance
LLC and Towers Watson.
\153\ See letter from Compensia, Inc.
\154\ See letter from Center on Executive Compensation.
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Several commenters sought clarity regarding performance-based
equity awards, with some recommending various methods to calculate the
recoverable amount for different forms of these awards, taking into
account such factors as whether an award is granted or vested based on
attaining a financial statement metric, whether or not an option has
been exercised, and whether the shares have been sold.\155\
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\155\ See, e.g., letters from Compensia, Inc., and Meridian
Compensation Partners, LLC.
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Regarding bonuses paid from ``pool plans,'' two commenters
questioned whether determination of the recoverable amount might depend
on whether the board or compensation committee had exercised any
discretion, either in determining whether to allocate the entire pool
to bonus awards or in determining individual bonus amounts.\156\ For
example, commenters noted that if a restatement reduces the size of the
bonus pool, but not below the aggregate amount that the board exercised
discretion to pay out as bonuses, there would not appear to be any
excess compensation to recover. Alternatively, if a restatement reduces
the size of the bonus pool below the aggregate amount paid out, the
commenters sought clarification whether each bonus paid would need to
be ratably reduced, or if discretion could be exercised in allocating
recovery of the excess amount among individual bonuses as long as the
aggregate excess amount is recovered. Another commenter questioned, in
general, whether the amount of compensation earned should be measured
by reference to the target achieved, or the compensation actually
provided after the compensation committee exercised discretion to
either increase or decrease the amount.\157\ A different commenter
suggested that where incentive-based compensation is not determined
based solely on formulaic measures, but also on qualitative measures,
the same percentage recoverable from the formulaic portion based on the
restatement also should be recovered from the portion based on
qualitative measures.\158\ Other commenters noted that executive
officers would already have paid personal income taxes on incentive-
based compensation they had received.\159\
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\156\ See letters from Center on Executive Compensation and
Protective Life Corporation.
\157\ See letter from Davis Polk & Wardwell LLP.
\158\ See AFL-CIO Joint Letter.
\159\ See letters from Clark Consulting, Davis Polk & Wardwell
LLP and Frederic W. Cook & Co, Inc.
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We propose to define the recoverable amount as ``the amount of
incentive-based compensation received by the executive officer or
former executive officer that exceeds the amount of incentive-based
compensation that otherwise would have been received had it been
determined based on the accounting restatement.'' \160\ Applying this
definition, after an accounting restatement, the issuer would first
recalculate the applicable financial reporting measure and the amount
of incentive-based compensation based thereon. The issuer would then
determine whether, based on that financial reporting measure as
calculated relying on the original financial statements and taking into
account any discretion that the compensation committee had applied to
reduce the amount originally received, the executive officer received a
greater amount of incentive-based compensation than would have been
received applying the recalculated financial reporting measure.\161\
Where
[[Page 41160]]
incentive-based compensation is based only in part on the achievement
of a financial reporting measure performance goal, the issuer first
would determine the portion of the original incentive-based
compensation based on or derived from the financial reporting measure
that was restated. The issuer would then need to recalculate the
affected portion based on the financial reporting measure as restated,
and recover the difference between the greater amount based on the
original financial statements and the lesser amount that would have
been received based on the restatement.\162\
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\160\ Proposed Rule 10D-1(b)(1)(iii).
\161\ For example, assume a situation in which, based on the
financial reporting measure as originally reported, the amount of
the award was $3,000. However, the issuer exercised negative
discretion to pay out only $2,000. Following the restatement, the
amount of the award based on the corrected financial reporting
measure is $1,800. Taking into account the issuer's exercise of
negative discretion, the recoverable amount would be $200 (i.e.,
$2,000--$1,800).
\162\ For example, assume a situation in which, based on the
financial reporting measure as originally reported, the amount of
the award was $3,000. The issuer exercised positive discretion to
increase the amount by $1,000, paying out a total of $4,000.
Following the restatement, the amount of the award based on the
corrected financial reporting measure is $1,800. Taking into account
the issuer's exercise of positive discretion, the recoverable amount
would be $1,200, provided that based on the revised measurement, the
exercise of positive discretion to increase the amount by $1,000 was
still permitted under the terms of the plan.
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For incentive-based compensation that is based on stock price or
total shareholder return, where the amount of erroneously awarded
compensation is not subject to mathematical recalculation directly from
the information in an accounting restatement, the recoverable amount
may be determined based on a reasonable estimate of the effect of the
accounting restatement on the applicable measure.\163\ To reasonably
estimate the effect on the stock price, there are a number of possible
methods with different levels of complexity of the estimations and
related costs.\164\ For these measures, the issuer would be required to
maintain documentation of the determination of that reasonable estimate
and provide such documentation to the relevant exchange or
association.\165\
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\163\ Proposed Rule 10D-1(b)(1)(iii)(A).
\164\ See Section III.B.2, below, discussing different
methodologies for determining a reasonable estimate of the effect of
the accounting restatement on the stock price or total shareholder
return.
\165\ Proposed Rule 10D-1(b)(1)(iii)(B).
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The recoverable amount would be calculated on a pre-tax basis \166\
to ensure that the company recovers the full amount of incentive-based
compensation that was erroneously awarded, consistent with the policy
underlying Section 10D. Recovery on a pre-tax basis also would permit
the company to avoid the burden and administrative costs associated
with calculating recoverable amounts based on the particular tax
circumstances of individual executive officers, which may vary
significantly based on factors independent of the incentive-based
compensation.
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\166\ Proposed Rule 10D-1(b)(1)(iii) provides that the
erroneously awarded compensation shall be computed without regard to
any taxes paid by the executive officer. The pre-tax amount refers
to the full amount of incentive-based compensation received by the
executive officer, rather than the amount remaining after he or she
satisfies his or her personal income tax obligation on it.
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While we intend for the definition to apply in a principles-based
manner, we recognize that applying the principles may not always be
simple. Cash awards that are received upon satisfaction of a financial
reporting measure should be relatively straightforward. The recoverable
amount would be the difference between the amount of the cash award
(whether payable as a lump sum or over time) that was received and the
amount that should have been received applying the restated financial
reporting measure.\167\
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\167\ Similarly, for nonqualified deferred compensation, the
executive officer's account balance or distributions would be
reduced by the excess incentive-based compensation contributed to
the nonqualified deferred compensation plan and the interest or
other earnings accrued thereon under the nonqualified deferred
compensation plan. In addition, for retirement benefits under
pension plans, the excess incentive-based compensation would be
deducted from the benefit formula, and any related distributions
would be recoverable.
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For cash awards paid from bonus pools, the size of the aggregate
bonus pool from which individual bonuses are paid would be reduced
based on applying the restated financial reporting measure. If the
reduced bonus pool is less than the aggregate amount of individual
bonuses received from it, the excess amount of an individual bonus
would be the pro rata portion of the deficiency. If the aggregate
reduced bonus pool would have been sufficient to cover the individual
bonuses received from it, then no recovery would be required.
Equity awards involve different considerations. For equity awards,
if the shares, options or SARs are still held at the time of recovery,
the recoverable amount would be the number received in excess of the
number that should have been received applying the restated financial
reporting measure. If the options or SARs have been exercised, but the
underlying shares have not been sold, the recoverable amount would be
the number of shares underlying the excess options or SARs applying the
restated financial measure. If the shares have been sold, the
recoverable amount would be the sale proceeds received by the executive
officer with respect to the excess number of shares.\168\ In any case
in which the shares have been obtained upon exercise and payment of an
exercise price, the recoverable amount would be reduced to reflect the
applicable exercise price paid.\169\
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\168\ Where excess shares have been gifted, such as gifts to
charities, the recoverable amount would be the gifted shares' fair
market value at the date of the gift.
\169\ Shares sold can be traced consistent with Treas. Reg.
1.1012-1(c) and Rule 144(d) [17 CFR 230.144(d)].
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We recognize that there may be circumstances in which both proposed
Rule 10D-1 and SOX Section 304 could provide for recovery of the same
incentive-based compensation. The proposed rule is not intended to
alter or otherwise affect the interpretation of Section 304 or the
determination by the Commission or the courts of when reimbursement is
required under Section 304. If, however, an executive officer
reimburses an issuer pursuant to Section 304, such amounts should be
credited to the extent that an issuer's Rule 10D-1 recovery policy
requires repayment of the same compensation by that executive officer.
Further, recovery under Rule 10D-1 would not preclude recovery under
Section 304 to the extent any applicable amounts have not been
reimbursed to the issuer.
Request for Comment
43. Do the proposed rule and rule amendments articulate an
appropriate standard for calculating the amount of excess incentive-
based compensation that listed issuers must recover? Why or why not?
44. For incentive-based compensation based on stock price or total
shareholder return, would permitting the recoverable amount to be
determined based on a reasonable estimate of the effect of the
accounting restatement, as proposed, facilitate administration of the
rule by issuers and exchanges? Why or why not? Should we provide
additional guidance regarding how such estimates should be calculated?
If so, what particular factors should that guidance address?
45. As proposed, should the issuer be required to maintain
documentation of the determination of that reasonable estimate and
provide such documentation to the relevant exchange? Why or why not? Is
the documentation required sufficient for compliance monitoring? If
not, what else should be required? Should the rule specify a period of
time that an issuer would need to maintain such documentation or what
types of documentation should be maintained? If so, what period of time
or
[[Page 41161]]
documentation is appropriate? Should we require that such determination
be disclosed, either to the exchange or in Commission filings? What
would be the effects of such disclosure?
46. Should the rule and rule amendments alternatively, or in
addition, include specific instructions for how to compute the excess
amount of specific forms of incentive-based compensation? If so, which
ones and why?
47. Is further guidance needed on the application of the proposed
standard? If yes, what additional guidance is necessary? Is further
guidance required regarding any particular form of compensation? For
example:
a. Should we provide guidance on how to determine the recoverable
amount of supplemental retirement plan benefits that are calculated
based on erroneously awarded incentive-based compensation? If so, what
should that guidance be?
b. For equity awards granted based on satisfaction of a financial
reporting measure, the guidance above directs listed issuers to recover
the excess number of shares or, if no longer held, the proceeds from
the sale of the excess shares so that executive officers cannot benefit
from future appreciation in shares that were not earned. Instead of
recovering the excess number of shares, should listed issuers have the
choice to recover the cash value of the excess shares? If so, should
the shares be valued at the vesting date, the date the recoverable
amount is determined, or some other date?
c. Where the number of excess shares is less than the entire award
and some of the shares received were sold and some are still held,
should recovery be made first against the remaining shares that are
held? Alternatively, should recovery apply first to shares that were
sold, so as not to erode company stock holding policies? Should this
decision be left to the listed issuer's discretion?
d. Where excess shares have been gifted, such as gifts to
charities, should the recoverable amount be the shares' fair market
value at the date of the gift? If not, at what other date should the
excess shares be valued?
e. Is the guidance above appropriate for determining the
recoverable amount where the listed issuer has exercised discretion to
reduce or increase the original amount of incentive-based compensation
received?
48. Where the issuer chose to increase the original amount of
incentive-based compensation, should an amount proportionate to the
effect of the restatement on the financial statement measure also be
recovered from the discretionary enhancement?
49. One commenter recommended that the Commission require recovery
of a proportionate amount of incentive compensation awarded under
qualitative standards.\170\ Should we require recovery of amounts
awarded under qualitative standards that may involve judgement by the
board? If so, how would the excess compensation be calculated in those
instances?
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\170\ See AFL-CIO Joint Letter.
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50. Is further guidance needed regarding circumstances in which
both proposed Rule 10D-1 and SOX Section 304 would apply?
b. Board Discretion Regarding Whether To Seek Recovery
Section 10D requires exchanges and associations to adopt listing
standards that require issuers to adopt and comply with recovery
policies. Specifically, the statute provides that ``the issuer will
recover'' incentive-based compensation, and does not address whether
there are circumstances in which an issuer's board of directors may
exercise discretion not to recover.
Commenters suggested that the Commission's implementing rules
should address the issue of board discretion whether to pursue recovery
and, if such discretion is permitted, address its scope. Many of these
commenters asserted that the Commission should allow for board
discretion to determine whether to pursue recovery.\171\ Commenters
raised concerns about situations where the potential costs of recovery
may exceed the excess incentive-based compensation to be recovered
\172\ and recommended that boards be permitted to evaluate the benefits
of recovery against the costs involved.\173\ Commenters noted the
following factors that may affect this decision: the likelihood of
recovery; \174\ de minimis recovery; \175\ the need to pursue
litigation to recover; \176\ and the possibility that recovery might
violate existing statutory or contractual provisions.\177\ One
commenter asserted that in the absence of discretion, companies will be
incentivized to implement compensation arrangements that are not
subject to Section 10D recovery provisions.\178\ Other commenters
recommended the Commission establish a standard similar to the Troubled
Asset Relief Program (``TARP'') standard where an issuer is not
required to enforce its recovery policy if it would be unreasonable to
do so.\179\
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\171\ See letters from Davis Polk & Wardwell LLP, Center on
Executive Compensation, Meridian Compensation Partners, LLC,
American Benefits Council, Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC, Compensia, Inc., Clark Consulting, LLC, Society of
Corporate Secretaries and Governance Professionals, Frederic W. Cook
& Co., Inc., Stuart R. Lombardi and Protective Life Corporation.
\172\ See letters from Clark Consulting, LLC and ABA Business
Law Section.
\173\ See letters from Davis Polk & Wardwell LLP, Meridian
Compensation Partners, LLC, American Benefits Council, Compensia,
Inc., Clark Consulting, LLC, Society of Corporate Secretaries and
Governance Professionals, Stuart R. Lombardi and Protective Life
Corporation.
\174\ See letter from Society of Corporate Secretaries and
Governance Professionals.
\175\ See letters from Center on Executive Compensation,
Meridian Compensation Partners, LLC, American Benefits Council,
Frederic W. Cook & Co., Inc., and Protective Life Corporation.
\176\ See letters from Society of Corporate Secretaries and
Governance Professionals and Center on Executive Compensation.
\177\ See letters from Society of Corporate Secretaries and
Governance Professionals and Center on Executive Compensation.
\178\ See letter from Stuart R. Lombardi. To guard against the
abuse of discretion, this commenter recommended that following a
restatement an issuer either should publicly announce its decision
whether to pursue or decline recovery, or should delegate all
clawback decision making authority to an independent party.
\179\ See letters from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC and Compensia, Inc.
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In considering this issue, we note that the Emergency Economic
Stabilization Act of 2008 (``EESA'') contained an executive
compensation recovery provision \180\ applicable to any financial
institution that sells troubled assets to the Secretary of the United
States Department of the Treasury under TARP. In its interim final rule
to provide guidance on the EESA's executive compensation and corporate
governance provisions applicable to entities receiving financial
assistance under TARP, the Department of the Treasury provided that
``[t]he TARP recipient must exercise its clawback rights except to the
extent it demonstrates that it is unreasonable to do so, such as, for
example, if the expense of enforcing the rights would exceed the amount
recovered.'' \181\
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\180\ Section 111(b)(3)(B) of EESA, Public Law 110-343, 12
U.S.C. 5221, as amended by Title VII of Division B of the American
Recovery and Reinvestment Act of 2009 (``ARRA''), Public Law 111-5
[123 STAT. 115] (Feb. 17, 2009).
\181\ TARP Standards for Compensation and Corporate Governance,
31 CFR 30.8.
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We are mindful that allowing discretion whether to recover excess
incentive-based compensation could undermine the purpose of Section 10D
by permitting an issuer's board of directors to determine that an
executive officer may retain incentive-based compensation to which he
or she is not entitled. At the same time, we acknowledge that there are
circumstances in which pursuing
[[Page 41162]]
recovery of excess incentive-based compensation may not be in the
interest of shareholders and that a standard similar to the TARP
standard would permit boards of directors to evaluate whether to pursue
recovery of excess incentive-based compensation in particular
circumstances.
To address these circumstances, proposed Rule 10D-1 would provide
that an issuer must recover erroneously awarded compensation in
compliance with its recovery policy except to the extent that pursuit
of recovery would be impracticable because it would impose undue costs
on the issuer or its shareholders or would violate home country law and
certain conditions are met. We believe the unqualified ``no-fault''
recovery mandate of Section 10D intends that the issuer should pursue
recovery in most instances. For example, we do not believe the extent
to which an individual executive officer may be responsible for the
financial statement errors requiring the restatement could be
considered in seeking the recovery. Further, we do not view
inconsistency between the proposed rule and rule amendments and
existing compensation contracts, in itself, as a basis for finding
recovery to be impracticable, because issuers can amend those contracts
to accommodate recovery.\182\
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\182\ We note that some have suggested that issuers may be able
to amend their by-laws to implement their recovery policies. See,
e.g., Robert E. Scully Jr, Executive Compensation, the Business
Judgment Rule, and the Dodd-Frank Act: Back to the Future for
Private Litigation?, The Federal Lawyer, January 2011, pp 39-41.
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In our view, the only criteria that should be considered are
whether the direct costs of enforcing recovery would exceed the
recoverable amounts or whether recovery would violate home country law.
Before concluding that it would be impracticable to recover any amount
of excess incentive-based compensation based on enforcement costs,\183\
the issuer would first need to make a reasonable attempt to recover
that incentive-based compensation.\184\ The issuer would be required to
document its attempts to recover, and provide that documentation to the
exchange.\185\ As described in Section II.D, below, the issuer also
would be required to disclose why it determined not to pursue recovery.
We believe that in this circumstance requiring an attempt to recover is
both consistent with the no-fault character of Section 10D, and
necessary for the issuer to justify concluding that recovery of the
amount at issue would be impracticable. Similarly, before concluding
that it would be impracticable to recover because doing so would
violate home country law, the issuer first would need to obtain an
opinion of home country counsel, not unacceptable to the applicable
national securities exchange or association, that recovery would result
in such a violation.\186\ In addition, to minimize any incentive
countries may have to change their laws in response to this provision,
the relevant home country law must have been adopted in such home
country prior to the date of publication in the Federal Register of
proposed Rule 10D-1.
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\183\ Only direct costs involving financial expenditures, such
as reasonable legal expenses, would be considered for this purpose.
Indirect costs relating to concerns such as reputation or the effect
on hiring new executive officers would not be taken into account.
\184\ Proposed Rule 10D-1(b)(1)(iv).
\185\ Id.
\186\ Id. The listed issuer would need to provide such opinion
to the exchange or association.
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In either case, to prevent potential conflicts of interest, any
determination that recovery would be impracticable would need to be
made by the issuer's committee of independent directors that is
responsible for executive compensation decisions.\187\ In the absence
of a compensation committee, the determination would need to be made by
a majority of the independent directors serving on the board. Such a
determination, as with all determinations under proposed Rule 10D-1,
would be subject to review by the listing exchange.\188\
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\187\ Exchange Act Rule 10C-1 mandated that the exchanges adopt
listing standards to require that directors responsible for
oversight of executive compensation (whether or not serving as part
of a formal compensation committee) be independent. Examples of such
listing standards are Section 303A.05 of the NYSE Listed Company
Manual and NASDAQ Rule 5605(d), both of which require listed
companies, with limited exceptions, to have a compensation committee
composed entirely of independent directors. Listed companies were
given until the earlier of their first annual meeting of
shareholders after January 15, 2014 or October 31, 2014 to comply
with the revised NYSE and Nasdaq independence requirements for
compensation committee members.
\188\ Proposed Rule 10D-1(b)(1)(iv).
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We believe that the proposed issuer discretion is necessary or
appropriate in the public interest and consistent with the protection
of investors because it would save issuers the expense of pursing
recovery in circumstances where the costs of recovery could exceed or
be disproportionate to the recoverable amounts, and for foreign private
issuers, would avoid such issuers having to choose between potential
de-listing or violating home country laws, either of which could be
detrimental to shareholders. Further, as discussed below,\189\ we
propose to require a listed issuer to disclose the reasons why it
decided not to pursue recovery in particular instances. We believe that
requiring this disclosure will mitigate potential abuse of this
discretion.
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\189\ See Section II.D.1, below.
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Request for Comment
51. Is the proposed issuer discretion not to pursue recovery of
incentive-based compensation consistent with the purpose of Section
10D? Is the scope of this discretion appropriate? Why or why not?
52. Should the standard for exercising discretion not to recover be
limited to the extent to which that recovery is impracticable? Should
direct costs of recovery be a basis for exercising discretion not to
recover? If so, what specific costs of recovery should be considered?
For example, should only direct expenditures to third-parties be
considered, as proposed? Should we further define what constitutes
``direct costs''? Should an issuer be permitted to consider indirect
costs, such as opportunity costs or reputational costs? Should the
issuer disclose the cost estimates in its Exchange Act annual reports?
If the cost estimates are not disclosed in the issuer's annual reports,
should those costs be independently verified?
53. Should the issuer first be required to make a reasonable
attempt to recover that compensation, as proposed? If so, should we
specify what steps to recover excess incentive-based compensation
should be required or what constitutes a ``reasonable attempt'' to
recover such compensation? Should this requirement depend on what
financial reporting metric triggers recovery? Should the issuer be
required to document its attempts to recover, and provide that
documentation to the exchange?
54. Should a listed issuer be permitted to forego recovering
incentive-based compensation if doing so would violate home country
law? In this circumstance, should the issuer first be required to
obtain a legal opinion from home country counsel, as proposed? If not,
why not? Are there any other conditions that should be met beyond a
legal opinion from home country counsel before an issuer should be
permitted to forego recovering incentive-based compensation in these
circumstances? Should the proposed accommodation apply only to the
extent that recovery would conflict with home country laws in effect
before the date of publication of proposed Rule 10D-1 in the Federal
Register, as proposed? If not, please explain why not. In addition, as
proposed, the listed issuer would need to provide such opinion to the
[[Page 41163]]
exchange upon request. Should a copy of this opinion be filed with the
Commission as an exhibit? Why or why not?
55. Should the determination that recovery would be impracticable
need to be made by the issuer's committee of independent directors
responsible for executive compensation decisions, or in the absence of
such a committee, by a majority of the independent directors serving on
the board? If not, why not, and who should be authorized to make the
determination?
56. Are there other circumstances in which a listed issuer should
be permitted to not pursue recovery from its former executive officers?
If so, please explain the circumstances and what, if any, conditions
should apply.
57. Could application of the Section 10D recovery policy to current
or former employees cause an issuer to violate any existing statutory
or contractual provisions? If so, please specify the applicable
provisions, how they might make affect recovery, and how an issuer
could address them to implement recovery.
58. Would issuers be able to implement their recovery policies with
respect to existing compensation agreements and arrangements through
amendments to their by-laws?
c. Board Discretion Regarding Manner of Recovery
Section 10D does not address whether an issuer's board of directors
may exercise discretion in the manner in which it recovers excess
compensation to comply with the listing standards. Commenters suggested
that the Commission's rule and rule amendments should address whether
boards may exercise discretion in effecting recovery in two primary
areas--the amount to be recovered when discretion was exercised in the
original grant, and the means of recovery.
i. Amount To Be Recovered
Commenters requested that boards be able to exercise discretion
with regard to the amount to be recovered when discretion was used in
determining the original award amount.\190\ For example, some issuers
use ``pool plans,'' in which the size of the available bonus pool is
determined based wholly or in part on satisfying a financial reporting
measure performance goal, but specific amounts granted from the pool to
individual executives are based on discretion. One commenter
recommended that the issuer's board of directors have the discretion to
decide how much to recover from each executive officer, as long as the
issuer recovers the aggregate erroneously awarded amount.\191\ A
different commenter stated that the issuer's board should be given the
same level of discretion to determine the amount to be recovered from
individual executive officers as was used in making the initial
compensation decision.\192\ This commenter also suggested that the
Commission consider situations in which the issuer's board would be
permitted to settle for less than the full amount when seeking recovery
under its recovery policy.\193\
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\190\ See letters from Davis Polk & Wardwell LLP, Center on
Executive Compensation and Society of Corporate Secretaries and
Governance Professionals. See Section II.C.3.a, above, regarding the
amount to be recovered when discretion was used to either increase
or decrease the original award amount.
\191\ See letter from Protective Life Corporation.
\192\ See letter from Center on Executive Compensation.
\193\ See letter from Center on Executive Compensation.
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As proposed, Rule 10D-1 would not limit the amount of compensation
the board could seek to recover on any other legal basis. However,
under the proposed rule, issuers' boards of directors would not be
permitted to pursue differential recovery among executive officers,
including in ``pool plans,'' where the board may have exercised
discretion as to individual grants in allocating the bonus pool. In
this instance, we believe that recovery should be pro rata based on the
size of the original award rather than discretionary. We believe that
permitting discretion in these instances would be inconsistent with
Section 10D's no-fault standard and its goal of preventing executive
officers from retaining compensation to which they are not entitled
under the restated financial reporting measure. Additionally,
permitting discretion in these instances could result in issuers
selectively applying recovery policies to former executive officers,
which we believe also would be inconsistent with Section 10D's purpose.
Moreover, consistent with Section 10D's emphasis on preventing
executive officers from retaining compensation that they received and
to which they were not entitled under the issuer's restated results,
and as described above, we are not proposing that issuers be permitted
to settle for less than the full recovery amount unless impracticable
from a cost standpoint. In that circumstance, the same conditions would
apply as for a determination to forgo recovery.\194\
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\194\ See Section II.C.3.b, above.
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ii. Means of Recovery
In addition, several commenters recommended that boards of
directors be able to exercise discretion on how to accomplish recovery
under the recovery policy required by the proposed listing
standards.\195\ One commenter suggested that boards may decide to
recover the excess compensation over time or from future pay,\196\
while another commenter recommended that issuers recover erroneously
paid compensation first from current compensation owing, and then from
executive officers' after-tax funds.\197\ One commenter recommended
that recovery of an incentive-based compensation award that has been
earned but not paid should be accomplished through forfeiture of the
award, while recovery in all other cases should be accomplished solely
by the executive officer's repayment.\198\ Several commenters suggested
cancellation of unvested equity and non-equity awards or offsetting
against amounts otherwise payable by the issuer to the executive
officer, such as deferred compensation, as possible recovery
methods.\199\
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\195\ See letters from Davis Polk & Wardwell LLP, Center on
Executive Compensation, Pay Governance LLC, Society of Corporate
Secretaries and Governance Professionals, Stuart R. Lombardi and
Protective Life Corporation.
\196\ See letter from Davis Polk & Wardwell LLP.
\197\ See letter from Frederic W. Cook & Co., Inc.
\198\ See letter from Meridian Compensation Partners, LLC.
\199\ See letters from Center on Executive Compensation, Society
of Corporate Secretaries and Governance Professionals and Protective
Life Corporation.
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We recognize that the appropriate means of recovery may vary by
issuer and by type of compensation arrangement. Consequently, we
believe issuers should be able to exercise discretion in how to
accomplish recovery. Nevertheless, in exercising this discretion, we
believe that issuers should act in a manner that effectuates the
purpose of the statute--to prevent executive officers from retaining
compensation that they received and to which they were not entitled
under the issuer's restated results. Regardless of the means of
recovery utilized, we believe that issuers should recover excess
incentive-based compensation reasonably promptly, as undue delay would
constitute non-compliance with an issuer's policy as required.
Request for Comment
59. How and under what circumstances, if any, should the board of
directors be able to exercise discretion regarding the amount to be
recovered? What steps should the board
[[Page 41164]]
of directors be required to take, if any, before exercising any
permitted discretion about the amount to be recovered from individual
executive officers?
60. Are there any material tax considerations relevant to whether
an issuer should be able to exercise discretion as to the amount of
recovery? If so, please explain.
61. Would the exercise of discretion by an issuer's board of
directors on the amount to be recovered where discretion was used in
determining the original award amount (e.g., in a pool plan) be
consistent with the purpose of Section 10D? If so, how?
a. If an issuer uses a pool plan in which achievement of a
financial reporting measure determines the aggregate amount of the
bonus pool and the bonus pool is insufficient after giving effect to
the restatement, how should the issuer determine the amount to be
recovered? Should this decision be left to the board of directors or
compensation committee? Should recovery be on a pro rata basis?
62. Should an issuer's board of directors be able to exercise
discretion regarding the means of recovery, as proposed? If so, how and
under what circumstances should the board be able to exercise
discretion regarding the means of recovery? Are there any steps the
board should be required to take before it exercises any permitted
discretion regarding the means of recovery?
63. Should any of the principles discussed in this section be
codified?
64. Should deferred payment arrangements be permitted when an
executive officer otherwise is unable to repay excess incentive-based
compensation? If so, should the time period over which repayment may be
deferred be limited?
65. If recovery does not occur reasonably promptly, this would
constitute non-compliance with an issuer's policy. Should there be an
explicit window of time within which an issuer must have recovered
excess incentive-based compensation from an executive beyond which the
failure to recover would not be considered ``reasonably prompt''? Why
or why not? If so, what should that time period be?
66. Should an issuer be permitted to recover excess incentive-based
compensation by netting incentive-based compensation overpayments with
incentive-based compensation underpayments that result from restating
financial statements for multiple periods during the three-year
recovery period? For example, suppose an issuer's restatement for a
material error in revenue recognition results in a shift in revenue
from the most recent year to an earlier year in the three-year period,
such that an incentive payment in the earlier year would have been
greater under the restatement. Should the issuer be permitted to
recover the excess incentive-based compensation in the later year by
crediting the earlier ``underpayment''? Why or why not? Should the
conclusion be different from the situation where the executive officer
received incentive-based compensation due to the achievement of a
cumulative performance goal for the three-year period based on the
financial reporting measure? Why or why not?
67. One commenter suggested that we specifically authorize or
approve of the use of a nonqualified deferred compensation plan (e.g.,
a ``holdback plan'' or ``bonus bank'') to aid in the recovery of
erroneously awarded incentive-based compensation.\200\ Would these or
other mechanisms aid in the recovery of such compensation? Why or why
not?
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\200\ See letter from Clark Consulting.
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4. Compliance With Recovery Policy
Under the proposed rule and rule amendments, an issuer would be
subject to delisting if it does not adopt and comply with its
compensation recovery policy.\201\ The proposed rule and rule
amendments do not specify the time by which the issuer must complete
the recovery of excess incentive-based compensation. Rather, under
proposed Rule 10D-1, an exchange would determine whether the steps an
issuer is taking constitute compliance with its recovery policy. In
making this assessment, an exchange would need to determine, among
other things, whether the issuer was making a good faith effort to
promptly pursue recovery.
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\201\ Under the proposed rule and rule amendments, it would also
be subject to delisting if it does not disclose its compensation
recovery policy in accordance with Commission rules.
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Request for Comment
68. Should Rule 10D-1 specify the time by which the issuer must
complete the recovery of excess incentive-based compensation required
by the listing standards?
69. Should Rule 10D-1 provide an objective standard to determine
whether an issuer is complying with its recovery policy? For example,
if the issuer has not recovered a certain percentage of excess
incentive-based compensation within a certain time period after a
restatement that triggers application of the policy, should it be
deemed non-compliant? If so, what percentages or time periods should be
used, and why?
70. Alternatively, should Rule 10D-1 provide a standard that
includes different subjective criteria, or both subjective and
objective criteria, to determine whether an issuer is complying with
its recovery policy? If so, what standard should be used and why?
71. Are there procedures that should be considered to assess
compliance with an issuer's policies and procedures concerning recovery
of excess incentive-based compensation? If so, what are they? Should an
issuer be required to disclose those policies and procedures? Should
there be an independent third-party assessment of an issuer's
compliance with those policies and procedures?
72. Could proposed Rule 10D-1 be revised to better ensure
compliance with the obligation to recover? If so, how?
D. Disclosure of Issuer Policy on Incentive-Based Compensation
Section 10D(b)(1) requires exchanges and associations to adopt
listing standards that call ``for disclosure of the policy of the
issuer on incentive-based compensation that is based on financial
information required to be reported under the securities laws.''
Sections 10D(a) and (b) require that the Commission adopt rules
requiring the exchanges to prohibit the listing of any security of an
issuer that does not develop and implement a policy providing for such
disclosure.
Commenters noted that Section 10D(b)(1) could be read either to
require disclosure about the issuer's policy on incentive-based
compensation generally, or, instead, to require disclosure only about
the issuer's recovery policy with regard to such compensation. One
commenter \202\ requested that the Commission address how the
disclosure required by Section 10D(b)(1) would relate to the recovery
policy disclosure already provided in an issuer's CD&A.\203\ Another
commenter recommended implementing Section 10D(b)(1)'s disclosure
requirement by mandating that CD&A include the type of disclosure
currently addressed but not mandated under Item 402(b)(2)(viii) of
Regulation S-K, to the extent that such policies relate to financial
[[Page 41165]]
information required to be reported under the securities laws.\204\
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\202\ See letter from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC.
\203\ Item 402(b)(2)(viii) provides as an example of information
that may be material information to be disclosed under CD&A
``[r]egistrant policies and decisions regarding the adjustment or
recovery of awards or payments if the relevant registrant
performance measures upon which they are based are restated or
otherwise adjusted in a manner that would reduce the size of an
award or payment.''
\204\ See letter from ABA Business Law Section.
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A different commenter recommended that the Commission not interpret
Section 10D(b)(1) as creating a new disclosure requirement for
incentive-based compensation or, if the Commission does adopt a
separate disclosure requirement, that it allow the requirement to be
satisfied by identifying any types of incentive-based compensation that
are based on financial information that is required to be reported
under the securities laws.\205\ This commenter further recommended that
the Commission allow an issuer to present any required disclosure on
its general corporate Web site in view of the information about
incentive-based compensation that is currently required in proxy
materials under Item 402 of Regulation S-K.
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\205\ See letter from Compensia, Inc.
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Other commenters sought disclosure of issuers' clawback decisions.
One commenter recommended public disclosure of an issuer's decision
whether or not to pursue recovery as a means to prevent abuse of any
permitted discretion.\206\ A different commenter stated that in
addition to disclosing the existence of a clawback policy, listed
issuers should be required to disclose whether or not recovery has been
initiated and completed, along with details of the sums recovered and
identity of executives from whom compensation was recovered, as a
prophylactic against firms that restate but do not meet their
obligation to recover funds.\207\
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\206\ See letter of Stuart R. Lombardi.
\207\ See AFL-CIO Joint Letter, suggesting that this disclosure
be in the Form 8-K.
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In part, because Section 10D(b)(1) comes under the Section 10D(b)
heading ``Recovery of Funds,'' we construe its disclosure requirement
to mean disclosure of the listed issuer's policy related to recovery of
erroneously awarded compensation. This approach would permit an
assessment of a listed issuer's compliance with the mandatory recovery
policy, while avoiding a potential duplication of the existing
disclosure requirements applicable to incentive-based compensation. The
proposed disclosure requirements are intended to inform shareholders
and the listing exchange as to both the substance of a listed issuer's
recovery policy and how the listed issuer implements that policy in
practice.
While the specific language of Sections 10D(a) and (b) may be
ambiguous, we believe that it is intended to require listed issuers to
adopt, comply with, and provide disclosure about their compensation
recovery policies. Accordingly, proposed Rule 10D-1 would call for the
listing standards to include among the new requirements that listed
issuers disclose their recovery policies.\208\ Implementing the
disclosure requirement as an element of the listing standards would
permit exchanges to commence de-listing proceedings for issuers that
fail to make the required disclosure, as well as those that fail to
adopt recovery policies or fail to comply with their terms.
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\208\ Proposed Rule 10D-1(b)(1).
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Further, to provide consistent disclosure across exchanges,
proposed Rule 10D-1 would provide that the required disclosure about
the issuer's recovery policy must be filed in accordance with the
disclosure requirements of the federal securities laws. These
requirements would be implemented by the proposed amendments to
Regulation S-K and relevant forms described below. Structuring the
provision in this manner would assure that, in addition to making the
disclosure a condition to listing, it would be subject to Commission
oversight to the same extent as other disclosure required in Commission
filings.
Finally, to facilitate verification of compliance by the exchanges,
the listing standards of each exchange would require that listed
issuers record their compensation recovery policies in writing, and
these recovery policies would be filed with the Commission, as
described immediately below.
1. Listed U.S. Issuers
The first of the proposed disclosure requirements would amend Item
601(b) of Regulation S-K to require that a listed issuer file its
recovery policy as an exhibit to its annual report on Form 10-K.\209\
For this purpose, an issuer would be ``a listed issuer'' if it had a
class of securities listed on an exchange registered pursuant to
Section 6 of the Exchange Act or an association registered pursuant to
Section 15A of the Exchange Act at any time during its last completed
fiscal year. Because the disclosure is keyed to the statutorily
mandated listing requirement, we would apply this disclosure
requirement to all listed issuers and do not propose to apply it to
issuers who do not have a listed class of securities.
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\209\ Proposed Item 601(b)(96) of Regulation S-K. The Form 20-F
Instructions as to Exhibits would be amended correspondingly to add
new Instruction 17. Similarly, Form 40-F would be amended to add new
paragraph (17(a)) to General Instruction B. Form N-CSR would be
amended to renumber Item 12 (Exhibits) as Item 13 and add new
paragraph (a)(3) to that item for those registered management
investment companies that would be subject to the requirements of
proposed Rule 10D-1.
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Although not specifically required by the Act, to further implement
Section 10D(b)(1), we are also using our discretionary authority to
propose to amend Item 402 of Regulation S-K to require listed issuers
to disclose how they have applied their recovery policies. Proposed
Item 402(w) of Regulation S-K would apply if at any time during its
last completed fiscal year either a restatement that required recovery
of excess incentive-based compensation pursuant to the listed issuer's
compensation recovery policy was completed or there was an outstanding
balance of excess incentive-based compensation from the application of
that policy to a prior restatement. In this circumstance, the listed
issuer would be required to provide the following information in its
Item 402 disclosure:
For each restatement, the date on which the listed issuer
was required to prepare an accounting restatement, the aggregate dollar
amount of excess incentive-based compensation attributable to such
accounting restatement and the aggregate dollar amount of excess
incentive-based compensation that remains outstanding at the end of its
last completed fiscal year; \210\
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\210\ Proposed Instruction 4 to Item 402(w) would provide that
if the aggregate dollar amount of excess incentive-based
compensation has not yet been determined, the listed issuer would
disclose this fact and explain the reasons.
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The estimates used to determine the excess incentive-based
compensation attributable to such accounting restatement, if the
financial reporting measure related to a stock price or total
shareholder return metric;
The name of each person subject to recovery of excess
incentive-based compensation attributable to an accounting restatement,
if any, from whom the listed issuer decided during the last completed
fiscal year not to pursue recovery, the amount forgone for each such
person, and a brief description of the reason the listed issuer decided
in each case not to pursue recovery; and
The name of, and amount due from, each person from whom,
at the end of its last completed fiscal year, excess incentive-based
compensation had been outstanding for 180 days or longer since the date
the issuer determined the amount the person owed.
As proposed, the disclosure would show a listed issuer's activity
to recover excess incentive-based compensation
[[Page 41166]]
during its last completed fiscal year. We believe this disclosure would
inform shareholders' voting and investment decisions and help exchanges
ensure compliance with their listing standards. All listed issuers
would be subject to Item 402(w) disclosure.\211\ The proposed
disclosure would be included along with the listed issuer's other Item
402 disclosure in annual reports on Form 10-K and any proxy and consent
solicitation materials that require executive compensation disclosure
pursuant to Item 402 of Regulation S-K.\212\ As proposed, a listed
issuer that complies with its Item 402(w) disclosure requirements would
not need to disclose any incentive-based compensation recovery pursuant
to Item 404(a).\213\ With respect to registered management investment
companies subject to proposed Rule 10D-1, information mirroring the
proposed Item 402(w) disclosure would be included in annual reports on
Form N-CSR and in proxy statements and information statements relating
to the election of directors.\214\
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\211\ See proposed Instruction 1 to Item 402(w), defining the
term ``listed registrant; and proposed Instruction 2 to Item 402(w)
defining the term ``compensation recovery policy.''
\212\ Proposed Instruction 5 to Item 402(w).
\213\ Proposed Instruction 5.a.iii to Item 404(a) of Regulation
S-K. Item 404(a) requires a description of any transaction, since
the beginning of the issuer's last fiscal year, or any currently
proposed transaction, in which the issuer was or is to be a
participant and the amount involved exceeds $120,000, and in which
any related person had or will have a direct or indirect material
interest. For registered management investment companies, see
proposed Instruction 1 to Item 22(b)(20) of Schedule 14A
(information provided pursuant to Item 22(b)(20) is deemed to
satisfy the requirements of paragraphs (b)(8) and (b)(11) of Item 22
with respect to the recovery of erroneously awarded compensation
pursuant to Rule 10D-1(b)(1)).
\214\ Proposed Item 12 of Form N-CSR; proposed Item 22(b)(20) of
Schedule 14A. We are also proposing to amend General Instruction D
to Form N-CSR to permit registered management investment companies
subject to proposed Rule 10D-1 to answer the information required by
proposed Item 12 by incorporating by reference from the company's
definitive proxy statement or definitive information statement.
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Since our proposal would apply to any current or former executive
officer to recovery, rather than only the ``named executive officers''
whose compensation is subject to discussion in CD&A, we propose this
disclosure requirement as a separate item rather than as an amendment
to CD&A. If the listed issuer is required to provide CD&A under Item
402 of Regulation S-K, however, the listed issuer could choose to
include the disclosure required by proposed Item 402(w) in its CD&A
discussion of its recovery policies and decisions pursuant to Item
402(b)(2)(viii) of Regulation S-K. Such a practice could benefit
investors by disclosing all compensation recovery information in a
single location in the filing.
We also considered implementing Section 10D(b)(1)'s disclosure
requirement by mandating that CD&A include the type of disclosure
currently addressed but not mandated under Item 402(b)(2)(viii) of
Regulation S-K, to the extent that such policies relate to financial
information required to be reported under the securities laws. This
approach, however, would always locate the disclosure in CD&A, a
section that requires discussion of the compensation awarded to, earned
by, or paid to the smaller group of ``named executive officers.''
Further, smaller reporting companies, emerging growth companies and
foreign private issuers are not required to provide CD&A in their
filings and proposed Item 402(w) disclosure would be required in some
filings that do not require CD&A disclosure.\215\ In addition, the
disclosure called for by CD&A is not limited to recovery triggered by
the restatement of a financial reporting measure, but instead
encompasses other adjustments that would reduce the size of an award or
payment, including with respect to an award based on a strategic or
operational measure.\216\
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\215\ Smaller reporting companies and emerging growth companies
are not required to provide CD&A in accordance with the scaled
disclosure requirements contained in Item 402 of Regulation S-K. See
Item 402(l) of Regulation S-K and Section 102(c) of the JOBS Act.
Foreign private issuers and filers under the multijurisdictional
disclosure system (``MJDS'') who file annual reports on Form 20-F or
Form 40-F, respectively, are not subject to Item 402 of Regulation
S-K and are not required to provide CD&A. See Form 20-F and Form 40-
F. Similarly, foreign private issuers electing to use U.S. issuer
registration and reporting forms are not required to provide CD&A
because they will be deemed to comply with Item 402 by providing the
information required by Items 6.B and 6.E of Form 20-F, with more
detailed information provided if otherwise made publicly available
or required to be disclosed by the issuer's home jurisdiction or a
market in which its securities are listed or traded. See Item
402(a)(1) of Regulation S-K.
In addition, Form N-CSR and Schedule 14A do not require
registered investment companies to provide CD&A disclosure.
Currently, registered investment companies are not subject to Item
402 disclosure. We are proposing that registered management
investment companies subject to proposed Rule 10D-1 would provide
information mirroring the proposed Item 402(w) disclosure in annual
reports on Form N-CSR pursuant to proposed Item 12 of that form, and
in proxy statements and information statements pursuant to proposed
Item 22(b)(20) of Schedule 14A.
\216\ Item 402(b)(2)(viii) of Regulation S-K: ``Registrant
policies and decisions regarding the adjustment or recovery of
awards or payments if the relevant registrant performance measures
upon which they are based are restated or otherwise adjusted in a
manner that would reduce the size of an award or payment.''
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We are also proposing amendments to the Summary Compensation Table
disclosure requirements. A new instruction to the Summary Compensation
Table would require that any amounts recovered pursuant to a listed
issuer's erroneously awarded compensation recovery policy reduce the
amount reported in the applicable column for the fiscal year in which
the amount recovered initially was reported, and be identified by
footnote.\217\ For example, if a listed issuer reported that in 2016
its Principal Executive Officer earned $1 million in non-equity
incentive plan award compensation, and in 2017 a restatement of 2016
financial statements resulted in recovery of $300,000 of that
incentive-based compensation, the 2017 Summary Compensation Table would
revise the 2016 reported amount to $700,000, with footnote disclosure
of the $300,000 recovered. The Summary Compensation Table ``total''
column would also be revised the same way. The new instruction would
apply in any filing requiring Summary Compensation Table disclosure
covering the affected fiscal year, including in Securities Act
registration statements.
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\217\ Proposed Instruction 5 to Item 402(c), and proposed
Instruction 5 to Item 402(n).
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We are proposing that the disclosure required by proposed Item
402(w) be provided in interactive data format using XBRL using block-
text tagging.\218\ The interactive data would have to be provided as an
exhibit to the definitive proxy or information statement filed with the
Commission and as an exhibit to the annual report on Form 10-K.\219\
Issuers would be required to prepare their interactive data using the
list of tags the Commission specifies and submit them with any
supporting files the EDGAR Filer Manual prescribes.\220\ This
requirement generally would apply to all listed issuers.\221\ We
believe requiring the data to be tagged would lower the cost to
investors of collecting this information, and would permit data to be
analyzed more quickly by shareholders, exchanges and other end-users
than if the data was provided in a non-machine readable format.
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\218\ Data becomes interactive when it is labeled or ``tagged''
using a computer markup language such as XBRL that software can
process for analysis.
\219\ Proposed Item 25 of Schedule 14A and proposed Item
601(b)(97) of Regulation S-K.
\220\ The EDGAR Filer Manual is available at: http://www.sec.gov/info/edgar/edmanuals.htm.
\221\ See n. 229, below.
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2. Listed Foreign Issuers
Foreign private issuers, including Canadian issuers using the MJDS,
would be required to provide the same information called for by Item
402(w) in, and to file their erroneously awarded
[[Page 41167]]
compensation policies as an exhibit to, the annual reports they file
with the Commission pursuant to Section 13(a) of the Exchange Act.\222\
We propose to require foreign private issuers, including MJDS filers,
to disclose the information in annual reports they file on Form 20-F,
Form 10-K \223\ and Form 40-F, as applicable. Because securities
registered by these listed issuers are exempt from Section 14(a) of the
Exchange Act,\224\ they would not be required to disclose the
information in any proxy or consent solicitation materials with respect
to their securities.
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\222\ A foreign private issuer required to file annual reports
with the Commission pursuant to Section 13(a) or Section 15(d) of
the Exchange Act may file on Form 20-F or, if it elects to use the
registration and reporting forms that U.S. issuers use, on Form 10-
K. MJDS filers are those eligible Canadian reporting issuers that
file registration statements and reports with the Commission in
accordance with the requirements of the MJDS. MJDS filers file
annual reports with the Commission pursuant to Section 13(a) or
Section 15(d) of the Exchange Act on Form 40-F.
\223\ If a foreign private issuer elects to use the registration
and reporting forms that U.S. issuers use and files its annual
report on Form 10-K, it is deemed to comply with Item 402 of
Regulation S-K, an express form requirement of Form 10-K, by
complying with Item 402(a)(1) of Regulation S-K. Therefore, we are
also proposing to amend Item 402(a)(1) of Regulation S-K to include
proposed Item 6.F of Form 20-F, which calls for the same disclosure
as proposed Item 402(w).
\224\ See Exchange Act Rule 3a12-3 (stating that securities
registered by a foreign private issuer, as defined in Rule 3b-4,
shall be exempt from sections 14(a), 14(b), 14(c), 14(f) and 16 of
the Exchange Act).
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Form 20-F is used as either the registration statement or annual
report for foreign private issuers under the Exchange Act.\225\ The
proposals would amend Item 402(a)(1) to add proposed Item 6.F of Form
20-F to the list of mandatorily required executive compensation
disclosures for foreign private issuers.\226\ As proposed, Item 6.F
would mirror the disclosure requirements of Item 402(w). In addition, a
listed foreign private issuer that provides the disclosure required by
Item 6.F of Form 20-F would not need to provide Item 7.B \227\
disclosure of any individual excess incentive-based compensation
recovery transaction otherwise subject to Item 7.B.\228\ We are
proposing a similar amendment to Form 40-F to add Paragraph (17) of
General Instruction B to mirror the disclosure requirements of Item
402(w). As discussed above, listed issuers would generally be required
to tag this disclosure in an interactive data format.\229\
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\225\ Form 20-F also sets forth disclosure requirements for
registration statements filed by foreign private issuers under the
Securities Act. Effective in 2000, the Commission incorporated in
Form 20-F the International Equity Disclosure Standards, which were
published by the International Organization of Securities
Commissions (IOSCO). Release No. 33-7745 (Sept. 28, 1999) [64 FR
53900]. The disclosure requirements for related party transactions
are set forth in Item 7.B of Form 20-F.
\226\ The amendment would require a foreign private issuer that
elects to provide domestic Item 402 disclosure to provide Item
402(w) disclosure in its annual report.
\227\ Item 7.B requires a description of related party
transactions for foreign private issuers.
\228\ Proposed Instruction 4 to Item 7.B of Form 20-F.
\229\ In general, foreign private issuers are required to submit
Interactive Data Files, as defined in Rule 11 of Regulation S-T, to
the Commission with their financial statements; however, those
foreign private issuers that prepare their financial statements in
accordance with International Financial Reporting Standards (IFRS)
as issued by the International Accounting Standards Board are not
required to submit Interactive Data Files until the Commission
specifies on its Web site a taxonomy for use by such foreign private
issuers in preparing their Interactive Data Files. See Interactive
Data to Improve Financial Reporting, Release No. 33-9002 (Jan. 30,
2009) at n. 94 http://www.sec.gov/rules/final/2009/33-9002.pdf. See
also Letter to the Center for Audit Quality (Apr. 8, 2011) at http://www.sec.gov/divisions/corpfin/cf-noaction/2011/caq040811.htm. We
anticipate that foreign private issuers that do not yet submit a
data file with their financial statements would have a similar
accommodation for submitting proposed Item 6.F disclosure in a
tagged format.
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Request for Comment
73. Is the proposed approach of having the listing standard require
an issuer to disclose its compensation recovery policy an appropriate
means to implement Sections 10D(a) and 10D(b)(1)?
74. Would it be preferable to implement the disclosure requirement
only through issuer disclosure requirements? Alternatively, would it be
preferable to make the disclosure requirement solely a listing standard
requirement? If so, please explain why.
75. Should a listed issuer be required, as proposed, to file as an
exhibit to its Exchange Act annual report its policy regarding the
recovery of incentive-based compensation that is based on or derived
from financial information required to be reported under the securities
laws? Are there better ways to disclose the policy? Should the policy
be included in the text of the Exchange Act annual report?
76. Would proposed Item 402(w) and the proposed amendment to Item
404 elicit the appropriate level of detail about how issuers have
applied their recovery policies? Should listed issuers be required to
disclose the names of executive officers from whom recovery has been
forgone, the amounts forgone and the reason the listed issuer decided
not to pursue recovery? Should listed issuers be required to disclose
the names of executive officers from whom, as of the end of the last
completed fiscal year, excess incentive-based compensation had been
outstanding for 180 days or longer since the date the issuer determined
the amount the person owed? If not, are there different disclosures
that should be required?
77. Should an issuer also be required to disclose the basis of the
determination of the amount of excess incentive-based compensation and
any critical estimates used in determining the amounts? Should a listed
issuer also be required to disclose the process or procedures by which
it will seek to recover excess incentive-based compensation for amounts
in which it is seeking recovery? Why or why not? If not, what should be
disclosed and why?
78. As proposed, Item 402(w) disclosure would be required if at any
time during the last completed fiscal year either a restatement was
completed that required recovery pursuant to the listed issuer's
compensation recovery policy, or there was an outstanding balance of
excess incentive-based compensation based on application of that policy
to a prior restatement. Should the disclosure proposed in Item 402(w)
be required in both these circumstances? If not, please explain why.
Will it be clear if a restatement was completed during a fiscal year,
such that disclosure would be required? If not, what guidance should we
provide? Alternatively, should listed issuers be required to disclose
every restatement in Item 402(w)--even if recovery of excess incentive-
based compensation is not required?
79. Should Item 402(w) disclosure be required even after an issuer
has been delisted if it has not recovered all compensation under the
policy?
80. Would the proposed Item 402(w) disclosure properly track any
amount of incentive-based compensation subject to recovery through the
duration of the recovery obligation until that amount either is
recovered or the listed issuer concludes that recovery would be
impracticable? If not, how should we revise the disclosure requirement
to better track such amounts?
81. Is there any additional information that would be important to
investors that should be disclosed?
82. Should the disclosure proposed by Item 402(w) of Regulation S-K
be required only in annual reports and proxy and consent solicitations,
as proposed? If not, please explain why. Should the disclosure of a
listed issuer's application of its recovery policy be implemented by
amending the executive compensation disclosure requirements of Item
402, as proposed? Alternatively, should it be implemented
[[Page 41168]]
by amending the Item 407 corporate governance disclosure requirements,
or by adopting a new Item of Regulation S-K? If so, please explain why.
83. Should a listed issuer only be required to provide the
disclosure proposed by Item 402(w) in a report to its listing exchange
or association, rather than in its annual reports and proxy and consent
solicitations? If detailed notification is provided to its exchange or
association, what type of disclosure, if any, should be made in a
listed issuer's Commission filings? Alternatively, should a listed
issuer be required to provide the proposed Item 402(w) disclosure and,
in addition, be required to make a separate notification to its
exchange or association?
84. How would the proposed Item 402(w) disclosure be used by
institutional and retail investors, investment advisers, and proxy
advisory firms in making voting decisions and recommendations on
matters such as director elections and executive compensation?
85. Should we require that the disclosure required by proposed Item
402(w) be tagged in XBRL format, as proposed? Should we require a
different format, such as, for example, eXtensible Markup Language
(XML)? Would tagging these disclosures enhance the ability of
shareholders and exchanges to assess issuers' compliance with their
recovery policies? Alternatively, instead of requiring that either of
these disclosures be tagged, should tagging this disclosure be
optional?
86. Is the burden to implement the proposed tagging requirements
comparatively greater for smaller reporting companies and emerging
growth companies than for other issuers, such that we should exempt
them or provide them a phase-in period for this requirement? If so,
please explain the differential burden and how long a phase-in period
it would justify.
87. We anticipate that foreign private issuers would not be
required to submit an electronic data file with proposed Item 6.F
disclosure until they submit financial statement information in an
electronic data file. Is there a reason to require this information to
be tagged before financial statement information is available in an
electronic data file? What would the relative costs and benefits be of
filing this information for the first time together or filing them
separately?
88. Is the proposed instruction to Item 404(a), which would exclude
a transaction involving recovery of excess incentive-based compensation
that is disclosed pursuant to Item 402(w) from disclosure as a related
party transaction, appropriate? Why or why not?
89. In the Summary Compensation Table, should any amount recovered
pursuant to a listed issuer's recovery policy reduce the amount
reported in the applicable column for the fiscal year in which the
amount recovered initially was reported, as proposed? For example, with
respect to equity awards, should the then-probable grant date fair
value reported be reduced by the portion of that grant date fair value
attributable to the number of shares or options recovered? Should this
disclosure be required in any filing containing Summary Compensation
Table disclosure? Should we require similar reductions in amounts
reported in compensation tables required for registered management
investment companies? Why or why not? Are there any special
considerations relating to registered management investment companies
that make disclosing this information more or less useful than similar
disclosure by operating companies? If so, please describe.
90. Our rules permit emerging growth companies and smaller
reporting companies to provide scaled disclosure of certain
requirements. Should the proposed disclosure rules for incentive-based
compensation recovery policies be scaled for these companies? If so,
please explain why and in what manner.
91. Is the disclosure proposed to be included in annual reports on
Form N-CSR and proxy statements and information statements that mirrors
the proposed disclosure in Item 402(w) appropriate for registered
management investment companies subject to the rule? Should it be
modified and, if so, how? Is it appropriate to include disclosure in
both Form N-CSR reports and proxy statements and information
statements? Should we, as proposed, amend General Instruction D to
permit registered management investment companies to answer proposed
Item 12 of Form N-CSR by incorporating by reference information from
definitive proxy statements and definitive information statements? Why
or why not? Should the proposed disclosure appear elsewhere in addition
to, or in lieu of, reports on Form N-CSR and proxy and information
statements, and, if so, where (e.g., the Statement of Additional
Information)? Should we require that registered management investment
companies tag these disclosures in XBRL format, as proposed? Why or why
not? Are there any special considerations relating to registered
management investment companies that make tagging this information more
or less useful than similar tagging by operating companies? If so,
please describe.
92. Should listed foreign private issuers, including MJDS filers,
be exempt from the requirement to provide disclosure about compensation
recovery policies? If so, please explain why.
E. Indemnification and Insurance
State indemnification statutes, indemnification provisions in an
issuer's charter, bylaws, or general corporate policy and coverage
under directors' and officers' liability insurance provisions may
protect executive officers from personal liability for costs incurred
in a successful defense against a claim or lawsuit resulting from the
executive officer's service to the issuer.\230\ Commenters requested
clarification about whether issuers may indemnify executive officers
whose compensation is recovered due to no fault of their own.\231\ If
the Commission does not prohibit such arrangements, these commenters
asserted that issuers should be required to disclose the existence of
these agreements in their proxy statements and other filings.
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\230\ In the context of Securities Act registration statements,
a registrant is required to ``state the general effect of any
statute, charter provisions, by-laws, contract or other arrangements
under which any controlling persons, director or officer of the
registrant is insured or indemnified in any manner against liability
which he may incur in his capacity as such.'' Item 702 of Regulation
S-K.
\231\ See letters from Towers Watson and Baker, Donelson,
Bearman, Caldwell & Berkowitz, PC.
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We believe that indemnification arrangements may not be used to
avoid or nullify the recovery required by Section 10(D). Section 10D's
listing standard requirement that ``the issuer will recover'' is
inconsistent with indemnification because a listed issuer does not
effectively ``recover'' the excess compensation from the executive
officer if it has an agreement, arrangement or understanding that it
will mitigate some or all of the consequences of the recovery.\232\
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\232\ See Cohen v. Viray, 622 F.3d 188, 195 (2d Cir. 2010)
(holding that an indemnification agreement cannot be used to release
chief executive officer and chief financial officer from liability
to repay compensation under Section 304 of SOX, in part because
``indemnification cannot be permitted where it would effectively
nullify a statute''); see, also Senate Report at 136 (``[I]t is
unfair to shareholders for corporations to allow executives to
retain compensation that they were awarded erroneously.''). To the
extent that an issuer indemnifies an executive officer, arranges for
or provides insurance protecting against the risk that incentive-
based compensation will be recovered pursuant to the issuer's
recovery policy, whether directly by purchasing this coverage or
indirectly by increasing the executive compensation to facilitate
the executive's purchase of this coverage, the executive officer
retains the excess compensation to which he or she was not entitled.
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[[Page 41169]]
Congress designed the recovery policy required by Section 10D to
apply on a no-fault basis, requiring listed issuers to develop and
implement a policy to recover ``any compensation in excess of what
would have been paid to the executive officer had correct accounting
procedures been followed.'' \233\ Indemnification arrangements that
permit executive officers to retain compensation that they were not
entitled to receive based on restated financial statements
fundamentally undermine the purpose of Section 10D.\234\
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\233\ See Senate Report at 136.
\234\ Cf. First Golden Bancorporation v. Weiszmann, 942 F.2d
726, 729 (10th Cir. 1991) (finding any attempt by a corporate
insider to seek indemnity against liability for short-swing profits
under Section 16(b) of the Exchange Act void as against public
policy where Congress had a clear intent to provide a ``catch-all,
prophylactic remedy, not requiring proof of actual misconduct.'').
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We further believe that Section 29(a) of the Exchange Act would
render any indemnification agreement unenforceable to the extent that
the agreement purported to relieve the issuer of its obligation under
Section 10(D), the proposed rule and rule amendments, and a resulting
listing standard to recover erroneously-paid incentive compensation.
Section 29(a) provides that ``[a]ny condition, stipulation, or
provision binding any person to waive compliance with any provision of
this title or of any rule or regulation thereunder, or of any rule of a
self-regulatory organization, shall be void.'' \235\ As courts have
noted, ``by its terms, Section 29(a) `prohibits waiver of the
substantive obligations imposed by the Exchange Act.' . . . . The
underlying concern of this section is `whether the [challenged]
agreement weakens [the] ability to recover under the Exchange Act.' ''
\236\ Thus, we believe that Section 29(a) would not permit an
indemnification agreement to undermine an issuer's right and obligation
to recover excess incentive-based compensation.\237\
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\235\ 15 U.S.C. 77cc. National securities exchanges and national
securities associations are self-regulatory organizations. 15 U.S.C.
78c(a)(26).
\236\ AES Corp. v. The Dow Chemical Company, 325 F.3d 174, 179
(3d Cir. 2003) (quoting Shearson/American Express, Inc. v. McMahon,
482 U.S. 220, 228, 230 (1987)).
\237\ See Cohen v. Viray, 622 F.3d at 195 (citing Section 29(a)
in rejecting indemnification against SOX Sec. 304 liability);
Allied Artists Pictures Corp. v. Giroux, 312 F. Supp. 450 (S.D.N.Y.
1970) (Section 29(a) rendered general release given by corporation
to former chairman ``unenforceable as a matter of law'' in action by
corporation to recover short-swing profits action under Section
16(b) of the Exchange Act).
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For these reasons, Rule 10D-1, as proposed, would prohibit a listed
issuer from indemnifying any executive officer or former executive
officer against the loss of erroneously awarded compensation.\238\
Further, while an executive officer may be able to purchase a third-
party insurance policy to fund potential recovery obligations, the
indemnification prohibition would prohibit an issuer from paying or
reimbursing the executive for premiums for such an insurance policy.
For the reasons stated above, we believe that indemnification and
insurance premium payment or reimbursement arrangements would frustrate
Section 10D's ultimate purpose of preventing an executive officer from
retaining compensation ``that the executive would not have received if
the accounting was done properly and was not entitled to.'' \239\
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\238\ Proposed Rule 10D-1(b)(1)(v).
\239\ See Senate Report at 135.
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Request for Comment
93. Should we require the exchanges to adopt listing standards that
would prohibit issuers from indemnifying executive officers and/or
funding the purchase of insurance to protect against the risk that an
executive officer will be subject to the issuer's recovery policy, as
proposed?
94. Should such listing standards also prohibit issuers from
indemnifying executive officers' litigation expenses in recovery
actions?
95. As noted above, the anti-indemnification provisions of Rule
10D-1 would prohibit agreements, arrangements or understandings that
directly or indirectly mitigate some or all of the consequences of
recovery. Will the exchanges and issuers be able to distinguish between
payments that are made to mitigate the effect of a recovery and those
that are paid as compensation in the ordinary course of business?
96. Should we define ``indemnification'' for purposes of the
recovery under Section 10D? If so, how should it be defined? Should it
require that there be an agreement on the part of the indemnitor in
advance of the event for which the indemnitee is being indemnified?
F. Transition and Timing
We received a number of comments regarding timing and transition
issues. Commenters generally advocated for prospective application of
the recovery policy required by the listing standard. Commenters who
addressed the application of Section 10D to former executive officers
expressed concern about retroactive application to persons who were
executive officers before Section 10D was enacted.\240\ Some commenters
recommended specific dates after which incentive-based compensation
should be subject to recovery, such as the enactment date of the
Act,\241\ the effective date of the final implementing rules,\242\ the
effective date of the listing standards approved by the
Commission,\243\ or the date the issuer implements the listing
standard.\244\
---------------------------------------------------------------------------
\240\ See letters from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC; Davis Polk & Wardwell; and Towers Watson.
\241\ See letter from Compensia, Inc.
\242\ See letter from Davis Polk & Wardwell LLP.
\243\ See letter from Center on Executive Compensation.
\244\ See letter from ABA Business Law Section.
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Commenters also expressed concerns regarding how the recovery
policy would affect existing compensation contracts and
agreements.\245\ Commenters asserted that issuers may be unable to
apply recovery policies retroactively to arrangements in which
compensation already has been granted or earned, or to compensation
provided pursuant to pre-existing employment agreements.\246\ One
commenter recommended that the Commission establish a grandfathering
rule that would exempt incentive-based compensation awards granted
before the effective date of the Commission's final rules implementing
Section 10D.\247\ Another commenter asked whether the recovery policy
would apply to compensation paid from the date the policy is effective,
regardless of contract terms, and when issuers would be required to
make their recovery policies first enforceable.\248\
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\245\ See letters from Baker, Donelson, Bearman, Caldwell &
Berkowitz, PC, American Benefits Council and Towers Watson.
\246\ See letters from ABA Business Law Section; American
Benefits Council; and Davis Polk & Wardwell.
\247\ See letter from American Benefits Council.
\248\ See letter from Towers Watson.
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Additionally, some commenters suggested that the Commission provide
for delayed compliance after the effective date of proposed Rule 10D-1
or approval of the listing standards, during which time issuers could
develop and implement a recovery policy and make necessary plan
amendments. These commenters recommended a 12-month period following
Commission approval of the listing standards,\249\ or a one-year period
after the issuance of final rules,\250\ for issuers to develop and
implement their recovery policies and make any necessary plan
amendments.
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\249\ See letter from Center on Executive Compensation.
\250\ See letter from American Benefits Council.
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We propose that each exchange file its proposed listing rules no
later than 90
[[Page 41170]]
days following publication of the final adopted version of Rule 10D-1
in the Federal Register, and that its rules be effective no later than
one year following that publication date,\251\ and that each listed
issuer shall adopt the recovery policy required by this section no
later than 60 days following the date on which the exchanges' rules
become effective.\252\ We also propose that each listed issuer be
required to recover all erroneously awarded incentive-based
compensation received by executive officers and former executive
officers as a result of attainment of a financial reporting measure
based on or derived from financial information for any fiscal period
ending on or after the effective date of Rule 10D-1 and that is
granted, earned or vested on or after the effective date of Rule 10D-1
pursuant to the issuer's recovery policy.\253\ Finally, we propose that
a listed issuer be required to file the required disclosures in the
applicable Commission filings required on or after the date on which
the exchanges rules become effective.\254\
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\251\ Proposed Rule 10D-1(a)(2)(i).
\252\ Proposed Rule 10D-1(a)(2)(ii).
\253\ Id.
\254\ Id.
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In light of the statutory purpose of Section 10D, we think it is
appropriate to require exchanges to adopt listing standards that
require issuers to comply with recovery policies that apply to
incentive-based compensation that is based on or derived from financial
information for periods that end on or after the effective date of Rule
10D-1. Issuer compliance would be required whether such incentive-based
compensation is received pursuant to a pre-existing contract or
arrangement, or one that is entered into after the effective date of
the exchange's listing standard.
Request for Comment
97. Is the proposed schedule for exchanges to file their proposed
listing rules and have them effective following the effective date of
proposed Rule 10D-1 workable and appropriate? Similarly, is the
proposal to require each listed issuer to adopt the required recovery
policy within 60 days following the effective date of the exchanges'
listing rules workable and appropriate? If not, what other schedule
should apply?
98. Should the Commission provide that the recovery policy will
apply to require recovery of all erroneously awarded incentive-based
compensation received by a current or former executive officer on or
after the effective date of Rule 10D-1 that results from attaining a
financial reporting measure based on or derived from financial
information for periods that end on or after the effective date of Rule
10D-1, as proposed? Alternatively, should the recovery policy apply to
incentive-based compensation received by an executive officer on or
after the effective date of the exchange's listing standard that
results from attaining a financial reporting measure based on or
derived from financial information for periods that end on or after the
effective date of Rule 10D-1? If neither of these alternatives, what
date(s) would be more appropriate and why? Should the Commission
consider the date of compensation agreements and the ability of issuers
to modify those agreements as part of the transition? If so, how?
99. Is there anything the Commission should do to address the
potential effect proposed Rule 10D-1 will have on existing compensation
plans and employment agreements that do not contemplate recovery under
a policy required by the rule and rule amendments implementing Section
10D? To what extent will issuers need to amend their existing
compensation plans and employment agreements to provide for the
application of the recovery policy? Should the recovery policy only
apply to new compensation plans and employment agreements entered into
after the effective date of the exchange's listing standard? Why or why
not?
100. As proposed, an exchange may not list an issuer that it has
delisted or that has been delisted from another exchange for failing to
comply with its recovery policy until it comes into compliance with
that policy.\255\ In this circumstance, should the exchange rules
prohibit the issuer from obtaining a new listing at the same or a
different exchange? Why or why not? If so, for how long?
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\255\ Proposed Rule 10D-1(b)(1)(vi), described in Section
II.C.2.c, above.
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101. Are there sufficient enforcement mechanisms to ensure
compliance with the listing standard? Why or why not?
General Request for Comment
We request and encourage any interested person to submit comments
on any aspect of our proposals, other matters that might affect the
amendments, and any suggestions for additional changes. With respect to
any comments, we note that they are of greatest assistance to our
rulemaking initiative if accompanied by supporting data and analysis of
the issues addressed in those comments and by alternatives to our
proposals, where appropriate.
III. Economic Analysis
As discussed above, Section 954 of the Dodd-Frank Act amends the
Exchange Act to include new Section 10D, which requires the Commission
to direct the exchanges and associations to prohibit the listing of
issuers that do not develop and implement policies to recover certain
incentive-based compensation. The policies must provide that, in the
event that the issuer is required to prepare an accounting restatement
due to material noncompliance with any financial reporting requirement
under the securities laws, the issuer will recover any compensation in
excess of what would have been paid under the accounting restatement
from any of its current or former executive officers who received
incentive-based compensation during the three-year period preceding the
date of the required restatement. Section 10D also calls for the
listing standards to require each issuer to develop and implement a
policy providing for disclosure of the issuer's policy on incentive-
based compensation that is based on financial information required to
be reported under the securities laws. We are proposing a new rule and
rule amendments to satisfy the statutory mandates of Section 10D.
We have performed an analysis of the main economic effects that may
flow from the rule and rule amendments being proposed today. We
consider the economic impact--including the costs and benefits and the
impact on efficiency, competition, and capital formation--of the
proposed rule requirements on issuers and other affected parties,
relative to the baseline discussed below.\256\ We also consider the
potential costs and benefits of reasonable alternative means of
implementing Section 10D. Where practicable, we have attempted to
quantify the effects of the proposed rule and rule amendments; however,
in certain cases, we are unable to do so
[[Page 41171]]
because we lack the data necessary to provide a reasonable estimate.
---------------------------------------------------------------------------
\256\ Section 3(f) of the Exchange Act and Section 2(c) of the
Investment Company Act require us, when engaging in rulemaking that
requires us to consider or determine whether an action is necessary
or appropriate in the public interest, to consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f); 15 U.S.C. 80a-2(c). Further, Section 23(a)(2) of the
Exchange Act requires us, when proposing rules under the Exchange
Act, to consider the impact that any new rule would have on
competition and to not adopt any rule that would impose a burden on
competition that is not necessary or appropriate in furtherance of
the purposes of the Exchange Act. See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
We request comment on all aspects of the economic effects,
including the costs and benefits of the proposals and possible
alternatives. We also request comment on any effect the proposed
requirements may have on efficiency, competition and capital formation.
We appreciate comments that include both qualitative information and
data quantifying the costs and the benefits identified in the analysis
or alternative implementations of the proposed rule and rule
amendments.
A. Baseline
The proposed rule and rule amendments require national securities
exchanges and national securities associations to establish listing
standards that would require each issuer to implement and disclose a
policy providing for the recovery of erroneously paid incentive-based
compensation. Consistent with Section 10D, the proposed rule and rule
amendments require that the recovery of incentive-based compensation be
triggered in the event the issuer is required to prepare an accounting
restatement due to material noncompliance with any financial reporting
requirement under the securities laws. In order to reduce the
likelihood of a material accounting error, executive officers may have
an enhanced incentive to ensure that greater care is exerted in
preparing accurate financial reports, or a reduced incentive to engage
in inappropriate accounting practices for the purpose of increasing
incentive-based compensation awarded to them.\257\ While these
incentives could result in high-quality financial reporting that would
benefit investors, they may also alter operating decisions of executive
officers or divert resources away from activities that may involve more
complex accounting judgments.
---------------------------------------------------------------------------
\257\ We note that not all executive officers affected by the
proposed rule and rule amendments may have the ability to directly
affect the financial reporting of the issuer.
---------------------------------------------------------------------------
The proposed requirement that an issuer implement a recovery policy
would introduce uncertainty about the amount of incentive-based
compensation the executive officer will be able to retain. As a result,
executive officers may demand that incentive-based compensation
comprise a smaller portion of their pay packages, or that they receive
a greater total amount of compensation, to account for the possibility
that the awarded incentive-based compensation may be reduced due to
future recovery. With these possible changes to the pay packages of
executive officers, overall executive compensation may become less
sensitive to the performance of the issuer, and the interests of the
executive officers could diverge from those of the shareholders.
Further, to the extent that executive officers respond negatively to
the expected effects of the compensation recovery policies developed
and implemented by issuers, the proposed rule and rule amendments may
cause affected issuers to be less able to attract and retain executive
talent, when competing for that talent against unlisted companies. We
note that there may be other factors affecting the ability of an issuer
to attract and retain executive talent. Further, the incremental effect
of the proposed rule and rule amendments is mitigated to the extent
that the labor markets for executives at listed issuers and at unlisted
issuers do not overlap.
To assess the economic impact of the proposed rule and rule
amendments, we are using as our baseline the current state of the
market without a requirement for listed issuers to implement and
disclose a compensation recovery policy consistent with Section 10D.
The proposed rule and rule amendments would dictate listing
standards that require the recovery of excess incentive-based
compensation that is based on financial reporting measures, including
stock price and total shareholder return (``TSR''). Performance-based
compensation can be either short-term or long-term, and each type can
potentially be tied to different measures of performance. One study
\258\ found that, in the short-term incentive plans of chief executive
officers (CEOs) at S&P 1500 companies in 2012, the three most common
financial reporting measures used as performance metrics were earnings
(36 percent), revenue (27 percent), and operating income (26 percent).
In contrast, in long-term incentive plans, the three most common
financial reporting measures used to compensate CEOs were TSR (48
percent), earnings (31 percent), and revenue (17 percent).\259\ While
earnings also was frequently used as a performance measure in long-term
incentive plans, TSR was the most frequent metric used for such plans.
The use of TSR was far less prevalent in short-term incentive plans,
where only 10 percent of plans used it.\260\ Based on Commission staff
analysis of 145 randomly sampled issuers drawn from the full population
of firms (both domestic and foreign) that filed an annual proxy
statement in calendar year 2013, we estimate that approximately 21
percent of issuers used stock price and/or TSR as an element of their
performance-based compensation.\261\
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\258\ See Equilar Measuring Short-Term and Long-Term Performance
in 2012 (May 28, 2013), available at http://www.equilar.com/publications/26-measuring-short-term-and-long-term-performance-in-2012.html.
\259\ See Equilar Measuring Short-Term and Long-Term Performance
in 2012 (May 28, 2013).
\260\ Performance-based compensation may be tied to multiple
measures of performance. The average number of performance measures
to evaluate performance in the short-term and long-term is 1.8 and
1.7, respectively. See Equilar Measuring Short-Term and Long-Term
Performance in 2012 (May 28, 2013).
\261\ We estimated the percentage of issuers that use stock
price and/or TSR as performance metrics based on Commission staff
analysis of information disclosed in annual proxy statements (DEF
14A). The sample comprises 145 proxy filers, which represents about
3 percent of the total number of DEF 14A filers in calendar year
2013. Staff manually examined the CD&A in each of the 145 proxy
statements to find that 21 percent of the 145 randomly sampled
issuers disclosed the use of stock price and/or TSR as compensation
performance metrics in 2013. Another 30 percent of the 145 randomly
sampled issuers do not disclose whether they use compensation
performance metrics; however, if these companies use stock price
and/or TSR as a compensation performance metric, it is likely not a
material element of their compensation because Item 402 of
Regulation S-K calls for disclosure in the CD&A if a performance
target is a material element of compensation policies and practices.
---------------------------------------------------------------------------
Under the proposed rule and rule amendments, the trigger for the
recovery of excess incentive-based compensation would be when the
issuer is required to prepare an accounting restatement as the result
of a material error that affects a financial reporting measure based on
which executive officers received incentive-based compensation. Hence,
not all accounting restatements would trigger a recovery of
compensation that was earned as a result of meeting performance
measures. Using incentive-based compensation tied to revenue as an
example, in order for that compensation to be required to be recovered,
there would have to be a material accounting error that affects
revenue. Based on one recent study, only 15 percent of all Item 4.02-
reported accounting restatements made between 2005 and 2012 were due to
errors involving revenue.\262\ If the issuers that
[[Page 41172]]
had a material accounting error in revenue had been subject to the
proposed rule requirements, those issuers that awarded incentive-based
compensation tied to the restated revenue or other measures that are
affected by the restatement of revenue would be required to recover the
incentive-based compensation paid to executive officers.\263\
---------------------------------------------------------------------------
\262\ See Scholz, S. 2013. ``Financial Restatement: Trends in
the United States: 2003-2012.'' Center for Audit Quality, available
at: http://thecaq.org/reports-and-publications/financial-restatement-trends-in-the-united-states-2003-2012/financial-restatement-trends-in-the-united-states-2003-2012. In referring to
findings of the study, we use the phrase Item 4.02-reported
accounting restatement when the issuer filed an Item 4.02 to Form 8-
K in connection with such restatement. The study characterizes these
as ``4.02 restatements'' and observes that the filing of Item 4.02
to Form 8-K is required when an accounting error renders previously-
filed financial statement unreliable. The study also comments that
these are generally more serious than other restatements, which it
refers to as ``non-4.02 restatements.''
\263\ Incentive-based compensation tied to financial reporting
measures that are affected by more reported items on the financial
statements is more likely to be recovered. For example, incentive-
based compensation tied to earnings or operating income is more
likely to be recovered because material accounting errors that
involve either revenue or expenses could impact these measures and
thereby trigger a required recovery. Between 2005 and 2012, 52
percent of significant restatements involved operating expenses. See
Scholz, S. 2013. ``Financial Restatement: Trends in the United
States: 2003-2012.'' Center for Audit Quality.
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Further, the incidence of events where incentive-based compensation
would be required to be recovered is affected by the number of
restatements based on material errors that occur. A recent study
reports that between 2005 and 2012 there was an average of 531 Item
4.02-reported accounting restatements per year, but the incidence of
accounting restatements steadily declined over this period.\264\ In
calendar year 2012, there were 255 Item 4.02-reported accounting
restatements, which represent approximately three percent of the
population of issuers that potentially could have had an Item 4.02-
reported accounting restatement.\265\ This suggests that an event that
would require an issuer to recover compensation (i.e., payment of
incentive-based compensation tied to a financial reporting measure and
occurrence of a material accounting error) would be relatively
infrequent.\266\
---------------------------------------------------------------------------
\264\ See Scholz, S. 2013. ``Financial Restatement: Trends in
the United States: 2003-2012.'' Center for Audit Quality.
\265\ In calendar year 2012, approximately 8,000 registrants
filed annual reports on Form 10-K and would be required to file Item
4.02 to Form 8-K. We note that the proposed rule and rule amendments
would affect a subset of registrants subject to reporting on Form 8-
K (i.e., the listed issuers).
\266\ These estimates are based on historical rates and types of
restatements, which may not be indicative of future rates and types
of restatements.
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The proposed rule and rule amendments would require exchanges to
apply the compensation recovery requirement to all listed issuers,
including emerging growth companies (EGCs), smaller reporting companies
(SRCs), foreign private issuers (FPIs), and controlled companies. We
estimate that proposed Rule 10D-1 would be applicable to 4,845
registrants.\267\ We estimate that, of those 4,845 registrants, there
are 706 SRCs, 376 EGCs, 511 FPIs (filing annual reports on Form 20-F),
and 128 MJDS issuers (filing annual reports on Form 40-F). There are a
limited number of registered management investment companies that also
would be affected by the proposed rule and rule amendments. We estimate
that there are approximately seven registered management investment
companies that are listed issuers and are internally managed, that may
have executive officers who receive incentive-based compensation.
---------------------------------------------------------------------------
\267\ We estimate the number of issuers subject to the proposed
rule based upon Commission staff analysis of issuers that filed
annual reports on Form 10-K, Form 20-F, or Form 40-F pursuant to
Section 12(b) of the Exchange Act in the period from 7/1/2013 to 6/
30/2014, regardless of the fiscal year of the filing. The staff used
text analysis of an issuer's Form 10-K to determine if the issuer is
an SRC. The staff performed a similar analysis of an issuer's Form
10-K and registration statement to determine if the issuer is an
EGC. Examining filings in this manner involves a certain degree of
error, and it is possible for issuers to be misclassified. Hence all
numbers in this analysis should be taken as estimates.
---------------------------------------------------------------------------
As outlined in the table below, we estimate that approximately 23
percent of all filers currently disclose some form of an executive
compensation recovery policy.\268\ We further estimate that
approximately four percent of SRCs, two percent of EGCs, three percent
of FPIs, and one percent of MJDS issuers disclose some form of a
recovery policy.
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\268\ We estimate the number of issuers that have disclosed some
form of recovery policy based on Commission staff analysis of
information disclosed in Form 10-K, Form 20-F, Form 40-F, and an
issuer's annual proxy statement (DEF 14A). Staff used text analysis
and keyword searches similar to those of Babenko, Bennett, Bizjak,
and Coles in their working paper Clawback Provisions (2012)
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023292. Examining filings in this manner
involves a certain degree of error, and it is possible for issuers
to be misclassified. Hence all numbers in this analysis should be
taken as estimates.
----------------------------------------------------------------------------------------------------------------
Number of Percent of
filers that Number of filers that
disclose a filers affected disclose a
recovery policy (total) recovery policy
----------------------------------------------------------------------------------------------------------------
All affected filers (total)............................... 1,116 4,845 23.0
SRCs...................................................... 29 706 4.1
EGCs...................................................... 9 376 2.4
FPIs...................................................... 17 511 3.3
MJDS...................................................... 1 128 0.8
All other filers.......................................... 1,060 3,124 33.9
----------------------------------------------------------------------------------------------------------------
We note that larger issuers are more likely to have already
implemented and disclosed a recovery policy. Using the staff estimates
discussed above, as of June 30, 2014, approximately 64 percent (305
issuers) of the issuers that comprise the S&P 500 and approximately 50
percent (713 issuers) of the issuers that comprise the S&P 1500 report
having a recovery policy of some form.\269\
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\269\ A report by Equilar finds that the prevalence of recovery
policies in Fortune 100 companies has increased from less than 18
percent in 2006 to 84 percent in 2011 and more than 89 percent in
2013. See Equilar Clawback Policy Report (2013), available at http://info.equilar.com/rs/equilar/images/equilar-2013-clawbacks-policy-report.pdf. This increasing trend in the implementation of recovery
policies is supported by Babenko, Bennett, Bizjak, and Coles in
their working paper Clawback Provisions (2012).
---------------------------------------------------------------------------
In addition to the issuers referenced above, some issuers may have
experience with recovering executive compensation given existing
provisions of law concerning the recovery of such compensation under
certain circumstances. Section 304 of SOX contains a recovery provision
that is triggered when a restatement is the result of issuer
misconduct. This provision applies only to CEOs and chief financial
officers (``CFOs'') and the amount of required recovery is limited to
compensation received in the 12-month period following the first public
issuance or filing with the Commission of the improper financial
statements.\270\ In addition, the Interim Final Rules under Section 111
of EESA, as amended by ARRA, required institutions receiving assistance
under TARP to mandate that Senior Executive Officers and the next
twenty most highly compensated employees repay compensation if awards
based on statements of earnings, revenues, gains,
[[Page 41173]]
or other criteria were later found to be materially inaccurate.\271\ As
discussed above, relative to either SOX or EESA, the compensation
recovery requirement of the proposed rule and rule amendments has a
different scope because it would affect any current or former executive
officer of all listed issuers and would be triggered when the issuer is
required to prepare an accounting restatement due to material
noncompliance of the issuer with any financial reporting requirement
under securities laws, regardless of issuer or executive misconduct or
the role of the executive in preparing the financial statements.
Finally, we note that currently issuers other than SRCs, EGCs, and FPIs
are required to disclose in the CD&A, if material, their policies and
decisions regarding adjustment or recovery of named executive officers'
compensation if the relevant performance measures are restated or
adjusted in a manner that would reduce the size of an award or
payment.\272\
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\270\ See 15 U.S.C. 7243.
\271\ Under EESA a ``Senior Executive Officer'' is defined as an
individual who is one of the top five highly paid executives whose
compensation is required to be disclosed pursuant to the Securities
Exchange Act of 1934. See Department of Treasury, TARP Standards for
Compensation and Corporate Governance; Interim Final Rule (June 15,
2009), available at http://www.gpo.gov/fdsys/pkg/FR-2009-06-15/pdf/E9-13868.pdf.
\272\ See Item 402(b)(2)(viii).
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Many of the issuers that disclose having recovery policies do not
require misconduct on the part of the executive to trigger
recovery.\273\ In a review by Commission staff \274\ of a random sample
of 104 issuers with disclosed recovery policies, 51 issuers (49
percent) did not require misconduct on the part of the executive, 34
issuers (33 percent) required misconduct on the part of the executive,
and 19 issuers (18 percent) did not specify. By contrast, the proposed
rule and amendments would require all listed issuers to have a recovery
policy that applies to any material accounting error, without regard to
misconduct.
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\273\ In a sample of 2,326 companies in the Corporate Library
database, DeHaan et al. (2013) find that 39 percent had compensation
recovery policies that did not require executive misconduct in order
to be triggered. DeHaan, Hodge, and Shevlin Does Voluntary Adoption
of a Clawback Provision Improve Financial Reporting Quality?
Contemporary Accounting Research 30 (2013) 1027-1062.
\274\ In the staff review, 104 issuers out of the 1,116 issuers
that disclosed a recovery policy in the period 7/1/2013 to 6/30/2014
were randomly selected for an in depth examination of their recovery
policies. Each recovery policy disclosure was read, or if the
recovery policy was incorporated by reference, the original
disclosure was read. Staff examined each policy for (1) which
employees were covered, (2) what type of compensation was at risk
for recovery, (3) how much of that compensation was at risk for
recovery, (4) what type of event or events triggered a recovery
action, (5) if misconduct was required for a recovery action, and
(6) the timing of the window for which compensation was at risk for
recovery. The characterization of these policies, as set forth
below, is based on limited information available from public filings
and may involve some interpretation of otherwise ambiguous terms and
conditions. Hence, all numbers presented should be taken as
estimates.
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There appears to be considerable variation in the coverage of
employees subject to recovery under currently disclosed recovery
policies.\275\ Under the proposed rule and rule amendments, a listed
issuer's compensation recovery policy would require recovery of excess
incentive-based compensation received by an individual who served as an
executive officer of the issuer at any time during the performance
period for that incentive-based compensation. As a result, in some
cases recovery would be required from individuals who may be former
executive officers either at the time they receive the incentive-based
compensation or at the date when the listed issuer is required to
prepare an accounting restatement. In a review by Commission staff of
the random sample of 104 issuers with disclosed recovery policies noted
above, the recovery policies of 82 issuers (79 percent) applied to any
current executive officer; and only three of those 82 issuers had
recovery policies that applied to former executive officers.\276\
Therefore, the majority of issuers examined disclose having recovery
policies that require compensation recovery from a narrower range of
individuals than a recovery policy that would comply with the proposed
rule requirements.
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\275\ As of 2013 approximately 61 percent of S&P Fortune 100
companies had recovery policies that applied to key executives and
employees including named executive officers; approximately 13
percent applied to all employees; approximately seven percent
applied to just the CEO and/or CFO; and the remainder did not have a
recovery policy or did not specify coverage. See Equilar Clawback
Policy Report (2013).
\276\ Of the remaining 22 issuers in the sample, the recovery
policies of two applied to CEOs, two applied to both the CEO and
CFO, one applied to the COO, and 17 did not specify to whom the
recovery policy applied. From the current disclosure in public
filings, the staff generally could not determine whether the
definition of ``executive officers'' that issuers use for purposes
of their compensation recovery policies is consistent with the
definition of ``executive officer'' in the proposed rule and rule
amendments. A subset of issuers specified that only named executive
officers were covered, while others specified senior executives,
executive officers, or employees vice-president and above. For
purposes of this baseline discussion, we include these employees in
the category ``executive officer.''
---------------------------------------------------------------------------
The type and scope of compensation subject to recovery in currently
disclosed recovery policies also appears to vary across issuers. In the
staff's review of a random sample of 104 issuers that disclosed
recovery policies, the recovery policies of 64 issuers (62 percent)
applied to any form of performance-based compensation, and thus would
satisfy the requirements of the proposed rule in this regard. Further,
out of the 104 issuers with disclosed recovery policies, 29 issuers (28
percent) specified that only the excess performance-based compensation
was subject to recoupment, while 47 issuers (45 percent) specified that
all of the performance-based compensation was potentially
recoverable.\277\ Considered together, 76 of the 104 issuers (73
percent) examined may already have a recovery policy that covers excess
incentive-based compensation as would be required by the proposed rule
and rule amendments.
---------------------------------------------------------------------------
\277\ As discussed above, the characterization of these policies
is based on limited information available from public filings and
may involve some interpretation of otherwise ambiguous terms and
conditions. Hence, all numbers presented should be taken as
estimates.
---------------------------------------------------------------------------
Moreover, 94 issuers (90 percent) specified either a look-back
period of three years or did not specify a look-back period, which we
interpret as having a potentially indefinite look-back period.
Accordingly, a majority of the current policies the staff reviewed have
a look-back period that is the same length or longer than the look-back
period required in a recovery policy that would comply with the
proposed rule requirements. We note, however, that due to the limited
disclosure available in public filings, the staff was unable to
determine if the start and end dates of the look-back window would
cover the proposed required look-back period in the proposed rule. The
results of this random sample indicate that, for issuers with disclosed
recovery policies, the majority may already include look-back
provisions consistent with the requirements under the proposed rule and
rule amendments.
In summary, the staff's review of the disclosed recovery policies
of 104 issuers found:
------------------------------------------------------------------------
Proposed requirements Existing policies
------------------------------------------------------------------------
The recovery policy is ``no fault'' 51 of the 104 policies examined
in nature do not require misconduct on the
part of the executive.
[[Page 41174]]
Former executive officers are covered 101 of the 104 policies examined
do not disclose that former
executive officers are covered.
Excess incentive-based compensation 64 of the 104 policies examined
based on attainment of a financial apply to any form of performance-
reporting measure is recoverable based compensation. 76 of the
104 policies examined may
already allow for excess
incentive-based compensation to
be recovered.
Policy has a three year look-back 94 of the 104 policies examined
period may already have a look-back
period of three years or longer.
------------------------------------------------------------------------
B. Analysis of Potential Economic Effects
The discussion below analyzes the economic effects of the proposed
rule and rule amendments, including the anticipated costs and benefits
as well as the likely impact on efficiency, competition, and capital
formation. For purposes of this analysis, we address the potential
economic effects resulting from the statutory mandate and from our
exercise of discretion together, recognizing that it is often difficult
to separate the costs and benefits arising from these two sources.
Below we discuss the potential effects of the proposed rule and rule
amendments on financial reporting quality, on executive compensation
packages, on listed issuers, and on U.S. exchanges. We also discuss the
potential effects arising from the proposed rule's prohibition on
indemnification and payment or reimbursement of premiums for insurance
against recovery.
1. Potential Effects on Financial Reporting
In seeking to maximize the value of their financial investments,
shareholders rely on the financial reporting quality of issuers to make
informed investment decisions about the issuer's securities. High-
quality financial reporting should provide shareholders with an
accurate estimate of the issuer's performance and should be informative
about its firm value.\278\ An accounting restatement due to material
noncompliance with any financial reporting requirement under the
securities laws may cause shareholders to question the accuracy of
those estimates and may lead shareholders and other prospective
investors to substantially revise their beliefs about the issuer's
financial performance and prospects with potentially significant
effects on firm value.
---------------------------------------------------------------------------
\278\ For purposes of this economic analysis, high-quality
financial reporting means when financial disclosure is informative
about the actual performance of the issuer.
---------------------------------------------------------------------------
While incentive-based compensation is typically intended to provide
incentives to executives to maximize the value of the enterprise, thus
aligning their incentives with shareholders, it may also provide
executives with incentives that conflict with shareholders' reliance on
high-quality financial reporting. In particular, when setting the
compensation for executives, the board of directors of an issuer may
seek to align the interests of executives with those of the
shareholders by tying executive compensation to financial reporting
measures that the board believes will have a positive effect on firm
value. To the extent that executives are in a position to affect the
preparation of financial statements, this approach can, however, create
the incentive for executives to influence the preparation of financial
statements and related filings in ways that appear to achieve those
measures. For example, certain financial performance measures require
estimates and judgments, and if those estimates and judgements are
influenced by the performance incentives that are part of the executive
compensation packages, then the reported performance of the issuer may
not reflect actual enhancement to firm value.
In some instances, executives might have incentives to pursue
impermissible accounting methods under GAAP that result in a material
misstatement of financial performance.\279\ This potential for
deliberate misreporting raises a principal-agent problem that is
detrimental for shareholders.\280\ Although civil and criminal
penalties already create disincentives to deliberate misreporting, the
recovery requirements under the proposed rule and rule amendments would
reduce the financial benefits to executive officers who choose to
pursue impermissible accounting methods, and thus may add another
disincentive to engage in deliberate misreporting. The magnitude of
this effect would likely depend on the particular circumstances of an
issuer.
---------------------------------------------------------------------------
\279\ We also note that some estimates and judgments permissible
under GAAP may allow executives to realize higher compensation,
without resulting in a material misstatement of financial
performance and thus without triggering recovery consistent with
Section 10D.
\280\ Among other decisions, executives must decide the extent
of internal resources and personal attention to devote to achieving
high-quality financial reporting and assuring that the financial
disclosure is informative about the performance of the issuer. Given
that the expected costs and benefits associated with any level of
investment decision in financial reporting quality would ultimately
be reflected in the issuer's firm value, in absence of a principal-
agent problem, executives would likely decide to allocate the value
maximizing amount of resources to producing high-quality financial
statements and, as a result, the level of information value of the
financial reporting would likely be optimal. A principal-agent
problem, however, reduces the executive's incentive to allocate the
appropriate amount of resources to produce high-quality financial
statements, which reduces the information value of financial
reporting.
---------------------------------------------------------------------------
The proposed rule and rule amendments may also provide executives
with an increased incentive to take steps to reduce the likelihood of
inadvertent misreporting. Most directly, the executive may have the
ability to reduce the uncertainty in her compensation by devoting more
resources to the production of high-quality financial reporting,
thereby reducing the likelihood of a material accounting error. For
example, an executive could devote more labor or internal capital to
strengthening internal controls over financial reporting. One study
\281\ found that, after the implementation of a recovery policy, an
auditor is less likely to report a material weakness in an issuer's
internal controls over financial reporting, which is consistent with
issuers devoting more resources to internal controls over financial
reporting.
---------------------------------------------------------------------------
\281\ See Chan, Chen, Chen, and Yu The effects of firm-initiated
clawback provisions on earnings quality and auditor behavior Journal
of Accounting and Economics 54 (2012) 180-196.
---------------------------------------------------------------------------
Executives may also take other steps to reduce the likelihood of an
inadvertent misreporting. An executive could change the business
practices of the issuer, thereby affecting the opportunity for a
material accounting error to arise. For example, an executive could
simplify delivery terms of a project or a transaction in order to use
accounting standards that are more straightforward to apply and perhaps
require fewer accounting judgments,
[[Page 41175]]
which may reduce the likelihood of material accounting errors.\282\
Taking steps such as these does not necessarily affect the selection of
the project or transaction the issuer chooses to undertake (although it
could, as discussed below), but could result in greater investor
confidence in the quality of financial reporting and information value
of the financial statements, and thus have a positive impact on capital
formation.\283\
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\282\ For example, the executive could make accounting judgments
on loan loss reserves or expected returns on sales with complicated
returns criteria that are less likely to result in an accounting
restatement.
\283\ An academic study shows that, when market competition is
weak, the information environment affects the expected returns of
equity securities. In particular, when financial disclosure quality
is low, as measured by scaled accruals quality, companies with low
market competition, as measured by the number of shareholders of
record, have a higher expected return. All else being equal, higher
expected returns make raising capital more costly for the company.
See Armstrong, Core, Taylor, and Verrecchia When Does Information
Asymmetry Affect the Cost of Capital Journal of Accounting Research
Vol. 49 No. 1 March 2011. The academic literature has developed a
measure of the quality of financial reporting denoted accruals
quality. This measure quantifies how well accruals are explained
either by the cash flow from operations (past, current, and future
periods) or accounting fundamentals. For details on the construction
and interpretation of the measure see Dechow and Dichev The Quality
of Accruals and Earnings: The Role of Accrual Estimation Errors The
Accounting Review, Vol. 77, Supplement 2002 pp. 35-39; and Francis,
LaFond, Olsson, and Schipper The market pricing of accruals quality
Journal of Accounting and Economics 29 (2005) 295-327.
---------------------------------------------------------------------------
As a result of the proposed rule and rule amendments, we believe
that the increased incentives to generate high-quality financial
reporting may improve the overall quality of financial reporting. An
increase in the quality of financial reporting could result in
increased informational efficiency, enhanced investor confidence that
may result in greater market participation, and a reduced cost of
raising capital, thereby facilitating capital formation. While we lack
the data to quantify the potential benefits to shareholders from a
reduced likelihood of a material accounting error, evidence suggests
that penalties imposed by the market for accounting restatements are
likely to be substantial.\284\ For example, one recent study \285\
found that over the period 2005 to 2012 the market value of equity of
the average issuer declined by 2.3 percent upon announcement of a
significant financial restatement.\286\
---------------------------------------------------------------------------
\284\ These penalties would likely include both revaluation and
reputational effects, where the two types of effects are often
difficult to separate.
\285\ See Scholz, S. 2013. ``Financial Restatement: Trends in
the United States: 2003-2012.'' Center for Audit Quality.
\286\ In the 2005-2012 period, the average issuer paid
approximately 0.48 percent of its market value of equity to all
named executive officers in the form of non-salary compensation
during that time period. Non-salary compensation data is from
Standard and Poor's Executive Compensation database which tracks
compensation for the companies currently or previously in the S&P
1500 index. Moreover, this comparison is inexact, because the
proposed rule would require the recovery of only excess incentive-
based compensation, and not all non-salary compensation, thereby
reducing the percentage of market value paid to executives. The
proposed rule and rule amendments would however, also require a
recovery policy that applies to more than just the named executive
officers, thereby increasing the percentage of market value paid to
executives.
---------------------------------------------------------------------------
More broadly, the availability of more informative or accurate
information regarding the financial performance of issuers would also
have the effect of increasing the efficient allocation of capital among
corporate issuers. Because investors would be better informed about the
potential investment opportunities at any given point in time, they
would be more likely to allocate their capital according to its highest
and best use. This would benefit all issuers, even those whose
financial reporting would not be affected by the proposed rule
requirements on exchanges' listing standards. In particular, issuers
whose financial reporting is unaffected may have better access to
capital by virtue of investors being able to make more informed
comparisons between them and issuers whose financial reporting would
become more accurate as a result of the proposed rule
requirements.\287\ In contrast, without the proposed rule and rule
amendments, investors may improperly assess the value of the issuers
whose financial reporting is based on erroneous information, which
could result in an inefficient allocation of capital, inhibiting
capital formation and competition.
---------------------------------------------------------------------------
\287\ See Bushee and Leuz Economic consequences of SEC
disclosure regulation: evidence from the OTC bulletin board Journal
of Accounting and Economics 39 (2005) 233-264.
---------------------------------------------------------------------------
We are aware, however, that these potential benefits of the
proposed rule and rule amendments are not without associated costs.
Under the proposed rule and rule amendments, the increased allocation
of resources to the production of high-quality financial reporting may
divert resources from other activities that may be value enhancing.
Moreover, while the increased incentive to produce high-quality
financial reporting and thus reduce the likelihood of material
accounting errors should increase the informational efficiency of
investment opportunities, it may also encourage executives to forgo
value-enhancing projects if doing so would decrease the likelihood of a
financial restatement.\288\ For example, when choosing among investment
opportunities for the issuer, executives may have less incentive to
pursue those projects that would require more complicated accounting
judgments, so as to reduce the likelihood of an unintentional but
material accounting error.\289\ That is, the proposed rule and rule
amendments may create an incentive for an executive to forgo projects
for which it is more difficult to generate high-quality financial
reporting.\290\ This could have an adverse impact on the value of the
issuer to the extent that the foregone projects would have resulted in
greater value than those that were ultimately chosen.
---------------------------------------------------------------------------
\288\ Projects that increase the volatility of cash flows from
operations, the volatility of sales revenue, or percentage of soft
assets have been associated with an increased likelihood of an SEC
enforcement action (specifically, the likelihood of an issuer being
the subject of a SEC Accounting and Auditing Enforcement Release).
See Dechow and Dichev The Quality of Accruals and Earnings: The Role
of Accrual Estimation Errors The Accounting Review, Vol. 77,
Supplement 2002 pp. 35-39; Dechow, Ge, Larson, and Sloan Predicting
Material Accounting Misstatements Contemporary Accounting Research
Vol. 28 No. 1 (Spring 2011).
\289\ For example, the issuer could select projects that do not
add to the complexity of the required reporting systems, or select
projects that have a shorter performance period and therefore may
involve less difficult accounting judgments about the expected
future costs.
\290\ Babenko et al find that after the implementation of a
compensation recovery policy, issuers spend less on research and
development, file for fewer patents, and hold more cash. This is
consistent with executives changing their project selection policy
as the result of implementing a compensation recovery policy. See
Babenko, Bennett, Bizjak, and Coles Clawback Provisions Working
Paper (2015). We note, however, that the determination of whether or
not to select a particular project is likely related to many
characteristics of the project. These characteristics could include
the value the project creates, the cash flows the project returns in
the near term, and the strategic objectives of the issuer.
---------------------------------------------------------------------------
One study suggests that a compensation recovery policy could result
in an increased likelihood of an executive making suboptimal operating
decisions in order to affect specific financial reporting measures as a
result of the decreased incentive to use accounting judgments to affect
those financial reporting measures.\291\ For example, if an executive
is under pressure to meet an earnings target, rather than manage
earnings through
[[Page 41176]]
accounting judgments, an executive may elect to reduce or defer to a
future period research and development or advertising expenses. This
could improve reported earnings in the short-term, but could result in
a suboptimal level of investment that adversely affects performance in
the long run. The study also documents that the propensity of
executives to undertake such actions may be particularly high in
issuers that are characterized as having strong growth
opportunities.\292\ The incentive to use operating decisions to affect
financial reporting measures could be partially mitigated to the extent
that the board's compensation committee would expect this behavior
after the implementation of a recovery policy and construct metrics
that take into account the possibility of such actions. They might also
design internal controls to detect such actions, such as rigorous
budget variance analyses.
---------------------------------------------------------------------------
\291\ Chan, Chen, Chen, and Yu document that after the
implementation of a compensation recovery policy issuers reduce
accruals manipulation but increase real transaction management. They
further document that the increase in real transaction management
results in improved short-term performance, as measured by changes
in return on assets, but diminished long-term performance. In the
context of their study, real transaction management is when
executive officers structure operating decisions to affect reported
financial performance. See Chan, Chen, Chen, and Yu The effects of
firm-initiated clawback provisions on earnings quality and auditor
behavior Journal of Accounting and Economics 54 (2012) 180-196.
\292\ Id.
---------------------------------------------------------------------------
Under the proposed rule and rule amendments, if it appears that
previously filed financial statements may contain a material accounting
error, there may also be an incentive for issuers or individual
executives (to the extent they are in a position to do so) to cause the
company to delay investigating the error or to characterize as
immaterial an accounting error that would otherwise be properly
characterized as material. The incentive to delay is present because
only excess incentive-based compensation received in the three fiscal
years prior to the determination of a material accounting error is
subject to recovery under the proposed rule and rule amendments.\293\
The incentive to characterize an accounting error as immaterial that
would otherwise properly be characterized as material is present
because compensation recovery is only required after the conclusion a
material accounting error exists.\294\ To the extent that these
incentives discourage the timely and accurate reporting of material
accounting errors, it could result in loss of confidence in financial
information disclosures by investors and hinder capital formation.
---------------------------------------------------------------------------
\293\ For example, suppose that in November 2015 an issuer with
a fiscal year ending in December suspects that there is a material
accounting error in its financial statements. Further, suppose that
the executives of the issuer had received a large incentive-based
compensation award in 2012. If the issuer investigates immediately
and concludes in November 2015 that there was a material accounting
error, then incentive-based compensation received in 2012 is at risk
for recovery. The issuer might choose to delay its investigation
until 2016 in order to avoid this result.
\294\ See Files, Swanson, and Tse Stealth Disclosure of
Accounting Restatements The Accounting Review 84 (2009), 1495-1520;
Myers, Scholz, and Sharp Restating Under the Radar? Determinants of
Restatement Disclosure Choices and the Related Market Reactions
Working Paper (2013), available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1309786&download=yes.
---------------------------------------------------------------------------
These incentives to delay the conclusion that a restatement is
necessary or to mischaracterize material accounting errors are
mitigated, however, by several factors. For example, the proposed
definition of the date on which an issuer is required to prepare an
accounting restatement, which is the date on which the issuer
concludes, or reasonably should have concluded, that the issuer's
previously issued financial statements contain a material error would
provide an objective basis for assessing when the required three year
look-back period begins. Moreover, the potential for the issuer and
individual executives to incur additional legal liability, including
potential criminal prosecution, for the deliberate or negligent delay
in investigating and reporting a material accounting error or
mischaracterization of an accounting error, combined with the
likelihood that such conduct would be detected,\295\ may offset the
incentives arising from the required three year look-back period prior
to the determination of a material accounting error.
---------------------------------------------------------------------------
\295\ Outside auditors' oversight may play as an additional
mitigating factor.
---------------------------------------------------------------------------
2. Potential Effects on Executive Compensation
When setting the compensation for executives, the board of
directors of an issuer frequently incorporates into the total
compensation package a payout that is tied to one or more measures of
the issuer's performance. The purpose of tying compensation to
performance is to provide an incentive for executives to maximize the
value of the enterprise, thus aligning their incentives with other
shareholders. The proportion of the pay package that relies on
performance incentives generally depends on factors such as the level
of risk inherent in the issuer's business activities, the issuer's
growth prospects, and the scarcity and specificity of executive talent
needed by the issuer. It also may reflect personal preferences
influenced by characteristics of the executive such as age, wealth, and
aversion to risk. In particular, the executive's risk aversion may make
pay packages with strong performance incentives undesirable because of
the less predictable payments. These factors contribute not only to the
magnitude of the expected compensation, but also to how an executive
views and responds to the compensation.\296\
---------------------------------------------------------------------------
\296\ Executives typically have personal preferences regarding
the form of compensation received. To the extent that executives
have different levels of risk aversion, they can arrive at different
personal valuations of the same performance-based compensation
package. Hence, more risk-averse executives may require additional
compensation when paid in the form of less certain performance-based
compensation.
---------------------------------------------------------------------------
We anticipate that the requirements of the proposed rule and rule
amendments could meaningfully affect the size and composition of the
compensation packages awarded to executives of listed issuers. As noted
above, risk averse executives prefer predictable compensation, and the
mandatory implementation of a recovery policy that meets the
requirements of the proposed rule and rule amendments would introduce
an additional source of uncertainty in the compensation of the
executive. Moreover, because the mandated recovery policy would be
required to be ``no-fault'' in nature, the occurrence of a material
accounting error would require executives to return excess incentive-
based compensation even if they had no role in the material accounting
error. A recovery policy would, therefore, introduce uncertainty in the
amount of incentive-based compensation that executives will ultimately
retain, with those executives less directly involved with financial
reporting incurring relatively more uncertainty.
For executives who already have established compensation packages,
the proposed rule and rule amendments may create an incentive to
negotiate changes to their composition.\297\ In particular, because of
the increased uncertainty, risk averse executives may lower the value
that they attach to the incentive-based component of their pay and may
as a result demand an offset to bear the increased uncertainty. The
offset could come in the form of a smaller portion of pay being
comprised of incentive-based compensation,\298\ which could weaken
incentive alignment, i.e., pay-for-performance sensitivity,\299\ or
through an increase in expected total compensation, which would come at
a greater cost to the
[[Page 41177]]
issuer.\300\ Research suggests that as a result of bearing this new
source of uncertainty the total compensation of executives would
increase.\301\ The extent of any such increase would depend on the
structure and conditions of the labor market for executives as well as
other economic factors, including the negotiating environment and
particular preferences of executives.
---------------------------------------------------------------------------
\297\ See letters from Stuart R. Lombardi and Towers Watson.
\298\ We note that, if the offset comes as a reduced weight
placed on incentive-based compensation, the recoverable funds if a
material accounting error occurs would be reduced.
\299\ Pay-for-performance sensitivity is a measure of incentive
alignment used in academic research. The measure captures the
correlation of an executive officer's compensation with changes in
shareholder wealth. See, e.g., Jensen and Murphy, Journal of
Political Economy, Vol. 98, No. 2 (Apr., 1990), pp. 225-264.
\300\ Increased expected total compensation could come in the
form of an increase in base salary, incentive-based compensation, or
other compensation. While increasing the incentive-based component
of an executive's compensation package increases the variability of
the executive's compensation beyond the additional variability due
to the recovery policy, the issuer may find this to be the least
costly way to compensate the executive. For example, an issuer may
choose to increase the incentive-based compensation component,
instead of increasing base salary, because the executive's current
base salary is near the limit for tax deductibility under 162(m) of
the Internal Revenue Code and an increase in base salary may
therefore not be tax deductible.
\301\ See DeHaan, Hodge, and Shevlin Does Voluntary Adoption of
a Clawback Provision Improve Financial Reporting Quality?
Contemporary Accounting Research 30 (2013) 1027-1062; Babenko,
Bennett, Bizjak, and Coles Clawback Provisions Working Paper (2012).
---------------------------------------------------------------------------
Notably, under a recovery policy that implements the proposed rule
requirements, incentive-based compensation tied to stock price metrics
such as TSR is included within the scope of compensation that may be
subject to recovery. The stock price of an issuer incorporates investor
expectations of cash flows and future earnings of that issuer and can
be materially impacted by inaccurate reporting of financial
information. In particular, inaccurate financial information could lead
investors to incorrectly estimate future cash flows and potential
earnings of the issuer with concurrent effects on the valuation of its
stock. If the receipt of incentive-based compensation by executives is
tied to stock price, then executives could receive erroneously awarded
compensation and a subsequent accounting restatement due to material
noncompliance with a financial reporting requirement could trigger
recovery of such compensation tied to stock price.
While the economic effects associated with the inclusion of stock
price and TSR within the scope of financial reporting measures would be
the same as for the proposed rule and rule amendments in general, we
discuss below the more specific effects stemming from this inclusion.
Specifically, in the case of stock price and TSR, where the amount of
erroneously awarded compensation is not subject to mathematical
recalculation directly from the information in an accounting
restatement, the cost of recovering incentive-based compensation may be
higher. The significance of these costs would depend on the size and
financial condition of the issuer, as well as the board's approach to
determining the amount, if any, of excess incentive-based compensation
to be recovered following a material accounting error. Since the
proposed rule would require that this amount be based on a reasonable
estimate of the effect of the accounting restatement on the financial
reporting measure, a reasonable estimate of the ``but for'' price of
the stock (i.e., the stock price that would have been if financial
statements originally had been presented as later restated) must be
first determined.\302\
---------------------------------------------------------------------------
\302\ See Section II.C.3.a for a discussion of the determination
of the recoverable amount.
---------------------------------------------------------------------------
To reasonably estimate the ``but for'' price of the stock, there
are a number of possible methods with different levels of complexity of
the estimations and related costs.\303\ One such method, which is often
used in accounting fraud cases to determine the effects of corrective
disclosure on the market price of an issuer's stock, is an ``event
study.'' An event study captures the market's view of the valuation
impact of an event or disclosure. In the case of a restatement, the
event study estimates the drop in the stock price attributed to the
announcement \304\ that restated financial information is required,
separate from any change in the stock price due to market factors. An
event study therefore measures the net-of-market drop in the stock
price,\305\ which is a key input to establish the ``but for'' price at
which the security is presumed to have traded in the absence of the
inaccurate financial statements. In the context of an event study, to
determine the net-of-market drop in the stock price, certain decisions
have to be made, such as determining the appropriate proxy for the
market return and statistical adjustment method (i.e., a model to
account for the potential difference in risk between the company and
market); the model estimation period; the date and time that investors
learned about the restatement; and the length of time it took for
investors to incorporate the information from the restatement into the
issuer's stock price. If designed appropriately, the implementation of
a robust event study method would include an evaluation of the various
design choices that are anchored on objective and commonly accepted
practices by the industry and relevant literature.\306\ The effects of
these design choices may vary from case to case. Some of the potential
choices may have no effect on the results while other choices may
significantly drive the results and could generate considerable
latitude in calculating a reasonable estimate of the excess amount of
incentive-based compensation that was erroneously awarded.
---------------------------------------------------------------------------
\303\ The complexity of a particular methodology involves a
trade-off between the potential for more precise estimates of the
``but for'' price and the assumptions and expert judgments required
to implement such methodology.
\304\ Event studies can have multiple event dates. For example
an event study can measure the stock price impact attributed to the
announcement that amended filings are required, as well as the stock
price impact attributed to when the actual amended filings are made
available for the investors to examine.
\305\ Over the 2005-2012 period, the average stock price
reaction to restatements disclosed under Item 4.02 of Form 8-K was
negative 2.3 percent. See Scholz, S. 2013. ``Financial Restatement:
Trends in the United States: 2003-2012.'' Center for Audit Quality.
This study documents a substantial drop in the number and severity
of restatements in the years following the enactment of SOX. The
study includes 4,246 restatements reported by U.S. and foreign
filers registered with the Commission from 2005 to 2012 on Form 8-K
under Item 4.02. The number of restatement announcements peaked in
2006 (940), soon after implementation of SOX Section 404 internal
control reporting. In subsequent years, the number of Item 4.02
restatements declined significantly, with 255 reported in 2012, a
reduction of approximately 73 percent from the 2006 peak year.
Restatement periods are shorter in later years, declining from an
average 29 months in 2006 to 18 months in 2012.
\306\ The complexity of an event study depends on the
circumstances of the event and the particular approach taken. For
example, one event study could use a broad market index in
estimating a market model, while another event study could use a
more tailored index that may take into account industry specific
price movements but would require judgments on the composition of
the issuers in the more tailored index. For further discussion on
the complexities of event studies see Mitchell, M. and J. Netter,
``The Role of Financial Economics in Securities Fraud Cases:
Applications at the Securities and Exchange Commission,'' The
Business Lawyer, vol 49, Feb 1994, p. 565; Kothari, S.P, and J.
Warner, ``Econometrics of Event Studies,'' Handbook of Corporate
Finance: Empirical Corporate Finance (Elsevier/North-Holland), 2004;
and Campbell, John Y., A. Lo, and A. C. MacKinlay, The Econometrics
of Event Studies, NJ: Princeton University Press, 1997.
---------------------------------------------------------------------------
Under any reasonable methodology, calculating the ``but for'' price
can be complicated when stock prices are simultaneously affected by
information other than the announcement of a restatement on the event
date. Confounding information potentially affecting an issuer's stock
price on the event date could include other plans released by the
issuer related to potential corporate actions (e.g., mergers,
acquisitions, or capital raising), announcements of non-restatement
related performance indicators, and news related to macro-economic
events (e.g., news about the industry the issuer operates in, changes
to the state of the
[[Page 41178]]
economy, and information about expected inflation). Because an issuer
has influence over the timing of the release of issuer-specific
information, the issuer has the ability to complicate the estimation of
a reasonable ``but for'' price. For example, if an accounting
restatement is expected to have a negative effect on an issuer's stock
price, the executive has an incentive and often the ability to
contemporaneously release positive information in an attempt to
mitigate any reduction in the issuer's stock price. The strategic
release of confounding information may make it more difficult for
investors to evaluate the effect of the restatement on the performance
of the issuer.
The proposed rule and rule amendments do not require an event study
to calculate a reasonable estimate of the excess incentive-based
compensation tied to stock price to be recovered after a material
accounting error. Instead, the proposed rule and rule amendments would
permit an issuer to use any reasonable estimate of the effect of the
restatement on stock price and TSR. In addition, the proposed rule and
rule amendments allow the board of directors to forego recovery if the
aggregate direct costs of seeking recovery from a current or former
executive officer would exceed the amount of excess incentive-based
compensation to be recovered. We note that an issuer would need to
incur the direct costs associated with implementing a methodology to
reasonably estimate the ``but for'' price prior to determining whether
any amount of incentive-compensation is required to be recovered under
the proposed rule and rule amendments. In choosing a methodology to
derive a reasonable estimate of the effect of the accounting
restatement on stock price and/or TSR, issuers would likely weigh the
costs of implementing any methodology against the complexity of the
``but for'' price estimate and the potential need to justify that
estimate, under their unique facts and circumstances.
Some issuers may decide to use a methodology that is testable,
supported by published literature, or follows procedures that derive
from objective standards because such a methodology may reduce the
likelihood that the reasonableness of the amount of excess incentive-
based compensation required to be recovered would be challenged by
interested parties, including the executives subject to recovery and
the exchanges that are required to ensure that the proposed rule and
rule amendments are enforced as a listing standard. The implementation
of such methodology may be complex because it would likely include
extensive checks of the assumptions and design choices made to generate
the estimate of the ``but for'' price. If these issuers have a
reasonable basis to believe that some amount of incentive-based
compensation is required to be recovered, they may decide to retain an
expert for the implementation of such methodology and determination of
the ``but for'' price.
If an issuer chooses to retain an expert, the monetary costs that
would be incurred to estimate the ``but for'' price and subsequent
calculation of the amount of excess incentive-based compensation
required to be recovered could be substantial. In these circumstances,
we expect that the determination of the ``but for'' price would require
a significant number of hours of work by highly skilled experts. In
addition, once a ``but for'' price is estimated, the determination of
the amount of excess incentive-based compensation could involve complex
calculations and assumptions that may require additional hours of work
by the expert.\307\ To establish a proxy for billing rates of experts
who have specialized knowledge in financial economics, we examined
expert witness fees by areas of expertise. For example, based on survey
responses from 21 financial experts, SEAK, Inc. 2014 Survey of Expert
Witness Fees reports that the hourly fee for case review/preparation
ranges from $175 to $800 with an average fee of $337 per hour.\308\
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\307\ For example, if an executive receives at-the-money options
as a form of incentive-based compensation, where the number of
options is based on the current stock price, the issuer may
determine that a reasonable estimate of the amount to be recovered
involves recalculating both the number of options awarded as well as
the value of those options that would have been issued at a
different strike price.
\308\ See SEAK, Inc. 2014 Survey of Expert Witness Fees,
available at: http://store.seak.com/2014-survey-of-expert-witness-fees/.
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Other issuers may decide to use a methodology that results in less
complex implementations to estimate the ``but for'' price \309\
because, for example, by using simpler implementations, issuers may
already be in a position to determine with reasonable confidence that,
after taking into account a reasonable range of variation in the ``but
for'' price, no amount of incentive-based compensation tied to stock
price and/or TSR was erroneously awarded to executive officers in the
first place and consequently no recovery is required. If an issuer
chooses to implement a less complex methodology, the determination of
the ``but for'' price and subsequent calculation of the amount of
excess incentive-based compensation required to be recovered would
entail a significantly lower number of hours of work that can be likely
performed internally without retaining an expert.
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\309\ For example, issuers may use historical estimates of beta
that are publicly available on several sources to substitute for a
more complex estimation of the market model. The beta estimate of a
stock captures the correlation of that stock's return with the
return of the overall market over a certain period of time.
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Under any methodology, the variation in assumptions used to
determine a reasonable estimate of the ``but for'' price (e.g.,
determining a proxy for market returns; the date and time that
investors learned about the restatement; and the length of time it took
for investors to incorporate the information from the restatement into
the issuer's stock price) and of the amount of excess incentive-based
compensation may increase the level of perceived uncertainty that risk
averse executives attach to the incentive-based component of their pay.
This uncertainty may in turn make it more costly and difficult for
issuers to retain executive officers' talent, when competing for that
talent against unlisted companies. We note that there may be other
factors affecting the ability of an issuer to attract and retain
executive talent. Further, the incremental effect of the proposed rule
and rule amendments is mitigated to the extent that the labor markets
for executives at listed issuers and at unlisted issuers do not
overlap.
The significant complications of establishing a reasonable estimate
of the ``but for'' price, in conjunction with the likely monetary costs
incurred to calculate it, make it difficult to assess the relative
costs and benefits accruing to an issuer from enforcing a recovery
policy that covers compensation based on stock price and/or TSR. These
uncertainties also could undermine issuers' incentives to enforce their
recovery policies and make it more difficult for exchanges to monitor
compliance.\310\ This effect may be partially or entirely mitigated by
the requirement for issuers to provide documentation to the relevant
exchange of any reasonable estimates used or attempts to recover
compensation, which will assist exchanges in monitoring compliance and
incentivize
[[Page 41179]]
issuers to carefully document the considerations that went into the
determination to enforce (or not enforce) their recovery policy. On
balance, we think other aspects of the proposed rule and rule
amendments, such as the ability to use reasonable estimates and the
board's discretion not to pursue recovery when the direct enforcement
costs would exceed the amount to be recovered, may serve to mitigate
these costs; however, below we request comment on this aspect of the
proposed rule and rule amendments to help us better understand its
economic effects.
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\310\ Due to the discretion that an issuer may have in choosing
both the method and the assumptions underlying the method to
estimate a ``but for'' price, it may be difficult for an exchange to
determine if the ``but for'' price resulted in a reasonable estimate
of the excess incentive-based compensation required to be recovered.
This may make it more difficult for exchanges to monitor compliance.
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Notably, incentive-based compensation as defined in the proposed
rule and rule amendments would not include base salary; compensation
tied to operational metrics that are not financial reporting measures;
or compensation awarded solely at the issuer's discretion. These forms
of compensation would not be subject to recovery under a policy that
meets the proposed rule requirements. These exclusions may create the
incentive to shift compensation from forms that are subject to recovery
to forms that are not subject to such recovery. This would apply to
both re-negotiated compensation packages as well as newly instituted
ones. The incentive to shift compensation away from forms that are
subject to a recovery policy may affect the level of incentive
alignment between executive interests and shareholder interests in
terms of the enhancement of firm value, which depends on how well
performance metrics used as triggers in compensation contracts capture
the relationship between an executive's effort to enhance firm value
and the actual enhancement of firm value.
The incentive to substitute away from incentive-based compensation
tied to financial reporting measures may result in base salary or
performance-based compensation tied to operational metrics being a
larger portion of the executive officer's compensation package. This
could reduce pay-for-performance sensitivity and may reduce the
correlation between the executive officer's effort to enhance value and
executive compensation if these alternative metrics are poor
substitutes for financial reporting measures. In addition, as a result
of the proposed rule and rule amendments, an issuer's board of
directors may use increased discretion in setting compensation awards,
since compensation that is solely awarded at the discretion of the
board, such as bonuses, would not be subject to recovery under the
proposed rule and rule amendments. Issuers may adjust compensation
policies to be more dependent on the discretion of the board, which may
make it more difficult for investors to understand the incentives of
executives and may result in lower pay-for-performance
sensitivity.\311\
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\311\ If the issuer transitions to compensation that is not
payable on account of the attainment of one or more performance
goals, such as compensation payable solely at the discretion of the
board of directors, the issuer may lose the ability to deduct a
portion of executive compensation under Section 162(m) of the
Internal Revenue Code. This may mitigate the incentive for companies
to transition compensation away from performance-based metrics.
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The implementation of a mandatory recovery policy may also make it
less costly overall to use incentive-based compensation. Without a
recovery policy, as noted above, a compensation package with
significant incentive-based compensation components based on financial
reporting measures may provide incentives for an executive to engage in
conduct that could result in inaccurate financial reporting. If a
recovery policy encourages business practices and accounting judgments
that are less likely to result in a material accounting error, the
benefits to the issuer of having higher quality financial reporting
could more than offset the additional compensation executives require
to bear the increased uncertainty about the compensation they expect to
ultimately retain.\312\
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\312\ A voluntarily implemented recovery policy may not reduce
the expected cost of issuing incentive-based compensation because of
insufficient incentive for board members to enforce the recovery
after a material restatement. The proposed rule, which conditions
initial and continued listing of securities on compliance with the
recovery policy, substantially increases the incentives of board
members to enforce the policy.
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The proposed rule and rule amendments may have effects on the
competition among issuers for executive officers. By increasing
uncertainty and reducing the perceived value of the expected incentive-
based compensation of an executive, companies where the proposed rule
and rule amendments apply (i.e., listed issuers) may have more
difficulty attracting talented executives and, as such, may be at a
comparative disadvantage to companies that are not covered (i.e.,
unlisted issuers and private companies). It is unclear to what extent
the labor market for executives at listed issuers and the labor market
for executives at unlisted issuers and private companies overlap. The
more these labor markets are segmented, the lower the comparative
disadvantage potentially imposed by the proposed rule requirements.
3. Additional Potential Effects on Listed Issuers
We anticipate several effects of the proposed rule and rule
amendments on listed issuers. Although we believe some issuers have
already implemented recovery policies broadly consistent with the
proposed rule requirements, the most immediate outcome of the proposed
rule and rule amendments would be the establishment of listing
standards that would result in issuers implementing recovery policies
consistent with Section 10D. Under such recovery policies, an immediate
benefit for a listed issuer would be the recovery of incentive-based
compensation that was erroneously paid to executive officers, which
would then be available for the issuer to invest in productive assets
that may generate value for shareholders. Although recovery of
erroneously paid compensation would provide an immediate benefit for
issuers and shareholders, we note that, in many cases, these funds are
not likely to be significant in the context of the issuer's business
operations, and thus this effect may not be as consequential as the
other, more indirect effects that we discussed above on financial
reporting quality and executive compensation packages.\313\
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\313\ Based on an analysis of executive compensation using
Standard & Poor's Compustat and Executive Compensation databases, in
fiscal year 2013 non-salary compensation for all named executive
officers combined was 0.4 percent of net income. This represents an
upper bound for the amount of incentive-based compensation for named
executive officers. This number does not include current and former
executive officers that would be covered by the proposed rule but
are not named executive officers.
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We also anticipate direct benefits to flow from the disclosure of
the recovery policy that are separate from any pecuniary recovery
following an accounting restatement. Currently, an issuer could have a
compensation recovery policy but choose not to disclose the existence
or the terms of that policy. Under the proposed rule and rule
amendments, the issuer's recovery policy would be required to be filed
as an exhibit to the issuer's annual report on Form 10-K, 20-F or 40-F
or, for registered management investment companies, on Form N-CSR. The
proposed rule and rule amendments also require the disclosure be
provided in interactive data format using XBRL. This may facilitate the
extraction and analysis of the information contained in the disclosure
across a large number of issuers or, eventually, over several years.
This requirement would impose additional costs and burdens on issuers,
[[Page 41180]]
but despite these costs, some shareholders and prospective investors
may benefit from the data tagging requirement to the extent that it is
helpful in extracting the tagged information across large number of
filings.
With this information investors would have a better understanding
of the incentives of the issuer's executive officers, owing to more
complete disclosure of the issuer's compensation policies, including
its recovery policy. Moreover, while all listed issuers would be
required to adopt and comply with a recovery policy satisfying the
requirements of the proposed rule and rule amendments, issuers would
have the choice to implement recovery policies that are more extensive
than these requirements. For example, issuers may choose to establish
more stringent recovery policies (e.g., a longer look-pack period, more
forms of compensation subject to recovery, or more individuals covered)
to provide a positive signal to the market regarding their approach to
executive compensation. If variation in the scope of issuers' recovery
policies emerges across issuers, disclosure of those policies may
improve allocative efficiency by allowing investors to make more
informed investment decisions based on a better understanding of the
incentives of the executives. The requirement to publish recovery
policies may make such variation more likely to emerge.\314\
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\314\ In the absence of a mandatory requirement for issuers to
implement and disclose a recovery policy, investors may be uncertain
about whether the implementation of a voluntary recovery policy by
an issuer is a credible signal of the issuer's approach to executive
compensation. By increasing the likelihood of a recovery policy
being enforced, the proposed rules and rule amendments may make the
signal more credible and allow issuers to differentiate themselves
based on variation in the scope of a recovery policy.
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Further, if at any time during the last completed fiscal year a
listed issuer's recovery policy required that issuer to recover excess
incentive-based compensation, the proposed rule and rule amendments
would require the issuer to disclose details of the recovery efforts
under proposed Item 402(w) of Regulation S-K. These disclosures would
allow existing and prospective shareholders to observe whether issuers
are enforcing their recovery policies consistent with Section 10D. This
would also help exchanges monitor compliance. Similarly, the
requirement to disclose instances in which the board does not pursue
recovery and its reasons for doing so (i.e., because the expense of
enforcing recovery rights would exceed the recoverable amount or
because the recovery would violate a home country's laws), would permit
shareholders to be aware of the board's actions in this regard and thus
potentially hold board members accountable for their decisions.
There are a number of direct costs for issuers resulting from the
proposed rule and rule amendments. As part of the implementation of a
recovery policy that meets the proposed rule requirements, issuers
would likely incur legal and consulting fees to develop policies that
comply with the proposed requirements and to modify the compensation
packages of executive officers to conform to those policies. Moreover,
even those issuers that already have recovery policies would likely
incur some costs to revise those policies to comply with the proposed
rule requirements. We note, however, that those issuers that currently
have recovery policies similar to the proposed rule requirements likely
would not incur significant additional costs. While we do not have the
data to quantify the implementation costs, we expect that these costs
will vary with the complexity of the compensation practices of the
issuer as well as the number of executive officers the recovery policy
will apply to. In addition to these implementation costs, issuers also
would incur direct costs to provide the required disclosures about
their compensation recovery policies, including costs to tag the
required disclosure in XBRL format, as described above. For purposes of
our Paperwork Reduction Act (PRA) Analysis, we estimate that the
proposed disclosure requirement would impose a minimal internal burden
of approximately one hour. If an issuer is required to recover
erroneously awarded compensation, the issuer would incur a direct cost
to prepare and disclose the information required by proposed Item
402(w) (and for registered management investment companies, new Item 12
to Form N-CSR and Item 22(b)(20) of Schedule 14A) and the corresponding
narrative. For purposes of our PRA, we estimate that proposed
disclosure requirement would impose a burden of approximately 21
hours.\315\
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\315\ See Section IV.C, below, for a more extensive discussion
of these disclosure burdens, including the monetization and
aggregation across issuers of these direct costs.
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There would also be costs attendant upon any recovery actions taken
under the new mandated recovery policy. The proposed rule and rule
amendments would require a recovery policy to recover excess
compensation that was paid based on the achievement of a financial
reporting measure that was later restated. The issuer would likely face
costs to calculate the amount to be recovered. This could be done
internally or the issuer could choose to retain an accountant or other
expert to calculate this amount. The costs of calculating the amount to
be recovered likely will vary depending on the nature of the
restatement, the type of compensation involved and the periods
affected. Given this variation, it is difficult to derive a precise
estimate of these costs; however, we believe that if outside
professionals are retained to assist with the calculations, they will
likely charge between $200 and $400 per hour for their services.\316\
Whatever the precise costs, we note they are likely to be significantly
less than the costs associated with performing the restatement itself.
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\316\ Staff estimate is based on wage information compiled by
the U.S. Bureau of Labor Statistics, Occupational Employment
Statistics for the Financial Analyst occupation. As of May 2014, the
median hourly wage for a financial analyst was $37.80 and the 90th
percentile hourly wage was $74.36. The hourly wage is multiplied by
a factor of 5.35 to account for bonuses, employee benefits, and
overhead.
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Depending on the circumstances, there may be other costs associated
with enforcing the mandatory recovery policy. For example, the issuer
may incur costs to trace specific shares to determine if the executive
sold shares that were awarded based on an erroneous financial reporting
measure. If the current or former executive officer is unwilling to
return excess incentive-based compensation, the issuer may incur legal
expenses to pursue recovery through litigation or arbitration. If the
aggregate direct costs incurred to seek recovery from an executive or
former executive officer would exceed the erroneously paid incentive-
based compensation, the proposed rule and rule amendments would allow
discretion on the part of the board of directors in determining whether
to pursue recovery. This discretion may mitigate the direct costs of
enforcement to issuers. Finally, if an issuer does not take action when
required under its recovery policy, then the issuer may also incur
costs associated with the listing exchange's proceedings to delist its
securities.
These effects of the proposed rule and rule amendments may vary
across different types of listed issuers. In particular, the effects of
implementing a recovery policy could be greater (or lower) on SRCs,
relative to non-SRCs, to the extent that SRCs use a higher (or lower)
proportion of incentive-based compensation than other issuers.
[[Page 41181]]
Analysis by Commission staff finds evidence that SRCs, on average, use
a lower proportion of performance-based compensation than non-SRCs,
suggesting a lower potential impact of the proposed rule and rule
amendments on SRCs.\317\ However, there is also evidence that companies
that are typically required to restate financial disclosures are
generally smaller than those that are not required to restate financial
disclosures, suggesting that there could be a greater incidence of
recoveries at SRCs.\318\ One academic study suggests that the
likelihood of reporting a material weakness in internal controls over
financial reporting decreases as the size of the issuer increases.\319\
This may imply that, relative to non-SRCs, the proposed rule and rule
amendments may cause executives at SRCs to devote proportionately more
resources to the production of high-quality financial reporting.
Finally, to the extent that implementation of the proposed rule and
rule amendments entails fixed costs, SRCs, because of their smaller
size, would incur a greater proportional compliance burden than larger
issuers.
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\317\ Commission staff analyzed the composition of total
compensation paid to all named executive officers whose compensation
was reported in the Summary Compensation Table for 50 randomly
selected SRCs and 50 randomly selected non-SRCs in fiscal year 2013.
Staff found that, on average, SRCs pay 60 percent of total
compensation in base salary versus 36 percent for non-SRCs; SRCs pay
13 percent of total compensation in stock awards versus 27 percent
for non-SRCs; and SRCs pay 5 percent of total compensation in non-
equity incentive plan compensation versus 16 percent for non-SRCs.
Since the Summary Compensation Table does not provide sufficient
information to determine if stock awards or non-equity incentive
plan compensation would constitute ``incentive-based compensation''
as defined in the proposed rule, these differences should be taken
as maximum estimated differences of incentive-based compensation for
named executives. Staff did not find significant differences between
SRCs and non-SRCs in the percent of compensation paid as a bonus, in
option awards, in nonqualified deferred compensation, or in other
compensation. We also note that the proposed rule covers a broader
set of employees than the named executives required to report within
the Summary Compensation Table.
\318\ See Scholz, S. 2013. ``Financial Restatement: Trends in
the United States: 2003-2012.'' Center for Audit Quality.
\319\ See Doyle, Ge, and McVay Determinants of weaknesses in
internal control over financial reporting Journal of Accounting and
Economics 44 (2007) 193-223.
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The proposed rule and rule amendments also may affect EGCs
differently than non-EGCs. Relative to non-EGCs, EGCs can be
characterized as having higher expected growth in the future and
potentially higher risk investment opportunities.\320\ As such,
relative to non-EGCs, the market valuations of EGCs may be driven more
by future prospects than by the value of current assets. As discussed
previously, a recovery policy could reduce the incentive of an
executive officer to invest in certain value-enhancing projects that
may increase the likelihood of a material accounting error. The reduced
incentive of executive officers could have a greater adverse effect for
EGCs, relative to non-EGCs, to the extent that executives at EGCs are
more likely to forgo value-enhancing growth opportunities as a result
of the proposed rule and rule amendments, which as discussed above, may
have a larger impact on the market value of equity of EGCs, relative to
non-EGCs. However, EGCs also tend to be smaller than non-EGCs,\321\
which may imply that EGCs have a higher likelihood of an accounting
restatement and a higher likelihood of reporting a material weakness in
internal controls over financial reporting. Similar to SRCs, this may
imply that, relative to non-EGCs, the proposed rule and rule amendments
may cause executives at EGCs to devote proportionately more resources
to the production of high-quality financial reporting.
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\320\ In an analysis of 270 EGCs with fiscal year 2013 data
available in the Standard & Poor's Compustat and the CRSP monthly
stock returns databases, Commission staff found that on average EGCs
have higher research and development expenses as a percent of total
assets. Further, on average EGCs have a lower book-to-market ratio,
which is indicative of shareholders expecting higher than average
growth in the future. For this analysis staff set book-to-market to
the 0.025 and 0.975 percentile for values outside of that range;
staff set research and development to the 0.975 percentile for
values about that level; and staff restricted the analysis to
companies that issued common equity and were listed on NYSE, NYSE
MKT, or NASDAQ.
\321\ Using the same dataset referenced in note 322 above, staff
found that the average market capitalization of EGCs is
approximately $1.08 billion while the average market capitalization
of non-EGCs is approximately $6.09 billion. Staff also found that
the smallest EGCs tend to be similar in market capitalization to the
smallest non-EGCs, with the 10th percentile of the distributions of
the market capitalization of EGCs and non-EGCs being approximately
$48 million and $45 million, respectively. Conversely, staff found
that the largest EGCs tend to have substantially lower market
capitalizations than the largest non-EGCs, with the 90th percentile
of the distributions of the market capitalization of EGCs and non-
EGCs being approximately $2.49 billion and $11.59 billion.
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4. Potential Effects on U.S. Exchanges
Proposed Rule 10D-1 would affect U.S. exchanges by requiring them
to adopt listing standards that prohibit the initial or continued
listing of an issuer that does not comply with the proposed rule and
rule amendments. The requirement places a direct burden on exchanges to
amend applicable listing standards. This burden could involve deploying
legal and regulatory personnel to develop listing standards that comply
with the proposed rule requirements. Moreover, the exchanges are likely
to incur some costs associated with tracking the compliance of each
issuer. We anticipate these costs to be minimal as exchanges likely
already have robust compliance tracking systems and personnel that are
dedicated to ensuring listing standards are met. Finally, if an issuer
chooses not to implement a recovery policy or does not take action when
required under its recovery policy, the exchanges would incur costs to
enforce the listing standards required by the proposed rule and rule
amendments. This would also result in a loss of the revenue associated
with the delisted issuer.
In the event that issuers alter their decisions regarding where to
list due to the proposed rule and rule amendments, revenue of U.S.
exchanges may be affected. For example, there could be revenue effects
for U.S. exchanges if issuers choose to list their securities on a
foreign exchange without such a compensation recovery policy
requirement. More generally, if the mandated listing requirements are
perceived to be particularly burdensome for listed issuers, this could
adversely impact the competitive position of U.S. exchanges vis-
[agrave]-vis those foreign exchanges that do not enforce similar
listing standards. However, given the costs associated with
transferring a listing and the broad applicability of the proposed rule
to securities listed on U.S. exchanges, we do not believe it is likely
that the proposed rule requirements would compel a typical issuer in
the short-term to find a new trading venue not subject to these
requirements. The proposed rule and rule amendments may result in a
loss of potential revenue to exchanges to the extent that issuers, who
would have decided to list on an exchange in the absence of the
proposed rule requirements, choose to forgo listing or delay listing
until the issuers' circumstances change.\322\ The magnitude of this
effect on exchanges is not quantifiable given the absence of data. It
could be significant because the loss in potential revenue from the
total number of issuers that have chosen to forgo or delay listing
aggregates over
[[Page 41182]]
time, thus having lasting impact on the exchanges' revenue.
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\322\ We note that capital formation could be hindered if an
issuer chooses to forgo or delay listing because of the proposed
rule and rule amendments and the alternative methods of raising
capital result in less liquid securities being issued or less
thorough disclosures being required. We also note that other factors
may affect the decision for an issuer to list and any effect from
the proposed rule and rule amendments would be incremental to these
other factors.
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While we believe the typical issuer is unlikely to transfer listing
in the short-term as a result of the proposed rule and rule amendments,
the potential response of foreign issuers is less clear. On one hand,
by virtue of listing on a U.S. exchange, a foreign issuer has
demonstrated willingness to list outside of the issuer's home country.
The issuer presumably chose to list on a U.S. exchange because the
particular U.S. exchange is an advantageous trading venue for the
issuer's securities. Although the direct costs are not expected to be
substantial, the proposed rule and rule amendments would increase the
compliance burden on listed issuers and could thereby potentially
reduce the advantage of listing on a U.S. market. As a result, foreign
issuers could choose to delist from U.S. exchanges. Further, foreign
issuers that are not currently listed on U.S. exchanges, but are
considering listing on a non-home country exchange, may choose to list
on a foreign exchange because of the increased burden of our proposed
rule and rule amendments. At the same time, we understand that many
foreign issuers list on a U.S. exchange to signal their high quality,
which is achieved by subjecting themselves to more rigorous corporate
governance rules and regulations. As a result, many foreign issuers may
gain the ability to raise capital at a reduced cost compared to their
home market by listing on U.S. exchanges. Hence, some foreign issuers
seeking access to U.S. capital markets may view the requirements as
beneficial. Therefore, the revenue effect on U.S. exchanges resulting
from the behavior of foreign issuers is unclear, because while some
foreign issuers may choose to delist as a result of the proposed rule
and rule amendments, others may choose to list because of them.
Finally, the proposed rule and rule amendments apply to all issuers
who list securities on a national securities exchange. As such there
are unlikely to be competitive effects between national securities
exchanges due to all national securities exchanges being affected by
the proposed rule requirements.
5. Indemnification and Insurance
The benefits discussed above would result from an executive's
changes in behavior as a result of incentive-based compensation being
at risk for recovery should a material accounting error occur. These
benefits would be substantially undermined if the issuer were able to
indemnify the executive for the loss of compensation. Moreover,
shareholders would bear the cost of providing such indemnification.
Therefore, the proposed rule and rule amendments expressly prohibit
listed issuers from indemnifying executives against the loss of
erroneously awarded compensation or paying or reimbursing executives
for insurance premiums to cover losses incurred under the recovery
policy.
Although reimbursement of insurance premiums by issuers would be
prohibited, the insurance market may develop a policy that would allow
an executive, as an individual, to purchase insurance against the loss
of incentive-based compensation when the material accounting error is
not attributable to the executive. In that event, an executive would be
able to hedge the risk that results from a recovery policy. If an
executive purchased this type of insurance policy, the benefits of the
issuer's recovery policy could be reduced to the extent that insurance
reduces the executive's incentive to ensure accurate financial
reporting. However, to the extent an insurance policy does not cover
losses resulting from the recovery of compensation attributed to a
material accounting error that resulted from inappropriate actions by
the insured executive, then incentives would remain for the executive
to ensure accurate financial reporting.
The development of this type of private insurance policy for
executives would also have implications for issuers. Overall, it could
make it less costly for an issuer to compensate an executive after
implementing a recovery policy. Without insurance, an issuer that
implemented a recovery policy would likely have to adjust compensation
to account for the loss in expected incentive-based compensation in
addition to the increased uncertainty in incentive-based compensation.
If an active insurance market develops such that the executive could
hedge against the uncertainty caused by the recovery policy, then
market-determined compensation packages would likely increase to cover
the cost of such policy. While the proposed rule and rule amendments
explicitly prohibit issuers from reimbursing an executive for the cost
of such insurance policy, a market-determined compensation package
would likely account for the hedging cost and incorporate it into the
base salary of the executive's compensation. This increase would likely
be less than the increase in the market-determined compensation
packages if an insurance policy was unavailable because a risk averse
executive would no longer need to bear recovery policy induced
uncertainty.
C. Alternatives
Below we discuss possible alternatives to the proposed rule and
rule amendments we considered and their likely economic effects.
1. Exemptions for Certain Categories of Issuers
We considered exempting (or permitting the exchanges to exempt)
SRCs and EGCs from proposed Rule 10D-1. As discussed above, the
proposed rule and rule amendments may impose certain disproportionate
costs on SRCs and EGCs. However, SRCs and EGCs may have an increased
likelihood of reporting a material accounting error and may be more
likely to report a material weakness in internal controls over
financial reporting, due to their smaller size relative to non-SRCs and
non-EGCs. As such, we believe the benefits of the proposed rule and
rule amendments may be particularly salient for these categories of
issuers. For these reasons, SRCs or EGCs would not be exempt from the
proposed rule and rule amendments.
One commenter suggested that we consider exempting FPIs, arguing
that home countries would generally have a greater interest in
determining whether issuers should have recourse against
executives.\323\ As discussed previously in the context of foreign
issuers generally, the potential effect of the proposed rule and rule
amendments on FPIs is difficult to predict. On the one hand, due to the
potential differences in home country law, the proposed rule
requirements may be especially burdensome for FPIs relative to non-
FPIs.\324\ On the other hand, there is evidence that many FPIs may be
listing on U.S. exchanges in part in order to credibly signal to
investors their willingness and ability to be subjected to stricter
governance standards.\325\ While FPIs may face a relatively higher
burden from the proposed rule and rule amendments, they also may
experience a relatively higher benefit.
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\323\ See letter from the American Bar Association.
\324\ We note that if recovery of excess incentive-based
compensation would violate home country law, the proposed rule and
rule amendments permit the board of directors discretion to forgo
recovery as impracticable, subject to certain conditions.
\325\ See Doidge, Karolyi, and Stulz Why Do Foreign Firms Leave
U.S. Equity Markets? The Journal of Finance, Vol. LXV, No. 4, August
2010.
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2. Excluding Incentive-Based Compensation Tied to Stock Price
As discussed above, the proposed rule and rule amendments may
result in
[[Page 41183]]
issuers incurring significant costs to recover incentive-based
compensation tied to stock price. If incentive-based compensation tied
to stock price were excluded from the proposed rule and rule
amendments, issuers would not incur the costs associated with recovery.
However, a significant component of the total performance-based
compensation would be excluded from the scope of the proposed rule and
rule amendments without generating the related potential benefits. In
addition, the exclusion of performance-based compensation tied to stock
price would provide issuers with an incentive to shift compensation
away from forms subject to recovery to forms tied to market-based
metrics such as stock price and TSR that would not be subject to
recovery.
The economic effect of any incentive to shift away from
compensation subject to recovery is difficult to predict due to the
nature of incentive-based compensation tied to stock price. On one
hand, incentive-based compensation tied to metrics that are market-
based, such as stock price or TSR, could be highly correlated with the
interests of shareholders and therefore may be beneficial to
shareholders. On the other hand, because market-based measures may be
influenced by factors that are unrelated to the performance of the
executive officer, these metrics may not fully capture or represent the
effort and actions taken by the executives. In particular, market-based
measures incorporate expectations about future earnings, which may not
be closely tied to the executive officer's current performance. In
contrast, the use of accounting-based measures, such as those derived
from revenue, earnings, and operating income, can be tailored to match
a specific performance period and provide direct measures of financial
outcomes.\326\ To this end, accounting-based measures of performance--
although not directly tied to issuer value enhancement--may better
capture the effect of an executive's actions during the relevant
performance period. Therefore, if incentive-based compensation tied to
stock price was excluded, the incentive to substitute away from
accounting-based measures to market-based measures of performance may
result in compensation that is less tied to the consequences of an
executive's actions during the performance period.
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\326\ Six of the eight most frequently used metrics to award
compensation in short-term incentive plans were accounting-based
measures. Those measures are earnings, revenue, operating income,
EBITDA, cash flow, and return on capital. See Equilar Measuring
Short-Term and Long-Term Performance in 2012.
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The optimal compensation package likely contains a mix of
incentive-based compensation tied to market-based measures and
accounting-based measures. Empirically, the use of market-based
performance metrics is more prevalent in long-term incentive plans than
in short-term incentive plans.\327\ Using market-based measures of
performance in short-term incentive plans may be undesirable for the
executive in that the stock price may be volatile and may not reflect
the executive's efforts to enhance firm value in the performance
period. The relatively higher use of market-based measures in long-term
incentive plans could reflect that in the long-term the executive's
efforts to enhance firm value may be more likely to be incorporated in
the market value of the firm. Short-term and long-term performance-
based compensation may act as complements, with the different
performance measures used to award each type reflecting the
compensation committee's effort to align the executive's interests with
those of the shareholders. The exclusion of incentive-based
compensation tied to stock price may affect the relative mix of short-
term and long-term performance-based compensation, or the performance
measures that each type is linked to, and as such a recovery policy may
have large economic effects through a change in the incentives of the
executive.
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\327\ See Equilar Measuring Short-Term and Long-Term Performance
in 2012.
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3. Other Alternatives Considered
One commenter suggested that the Commission specifically authorize
the use of a nonqualified deferred compensation plan (e.g., a
``holdback plan'' or ``bonus bank'') to aid in the recovery of
erroneously awarded incentive-based compensation.\328\ A bonus bank
would likely reduce the enforcement costs of recovering erroneously
awarded incentive-based compensation. On the other hand, a bonus bank
may further augment any increase in compensation necessary to offset
the expected cost to the executive of a recovery policy. This is due to
the executive not having access to the funds she has earned and having
to delay consumption that would otherwise be possible. Further, as the
commenter acknowledged, a bonus bank implicitly makes the executive a
creditor to the issuer, resulting in reduced risk-taking incentives for
the executive. While for some companies reduced risk-taking incentives
may be value increasing, for other companies reduced risk-taking
incentives may be value decreasing. Further, by making the executive a
creditor to the issuer, a bonus bank reduces the incentive alignment
between equity holders and the executive officer.
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\328\ See letter from Clark Consulting.
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One commenter suggested that the Commission also require issuers to
recover a proportionate amount of the compensation tied to qualitative
variables or board judgment after a material accounting error.\329\
Relative to the proposed rule and rule amendments, this alternative
implementation would reduce the incentive to alter the composition of
an executive's compensation package to more heavily weight qualitative
variables or board judgment, while increasing the incentive to more
heavily weight base salary as well as performance-based compensation
tied to metrics other than financial reporting measures. To the extent
that performance compensation based on qualitative variables and board
judgment allows the board to compensate the executive officer for
performance that is otherwise difficult to measure, the reduced weight
on this form of performance-based compensation could make it more
difficult for the board to align the executive officer's interests with
those of the shareholders. On the other hand, reduced weight on this
form of performance-based compensation could make it easier for
shareholders to understand the incentives of the executive officer.
Because a greater amount of performance-based compensation would be at
risk for recovery, implementing this alternative implementation could
also increase the amount of expected compensation the executive officer
would require in order to voluntarily bear the increased uncertainty.
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\329\ See letter from AFL-CIO.
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D. Request for Comment
We request data to quantify the costs and benefits described
throughout this release. We seek estimates of these costs and benefits,
as well as any costs and benefits not already identified, that may
result from the adoption of the proposed rule and rule amendments. We
also request qualitative feedback on the nature of the economic
effects, including the benefits and costs, we have identified and any
benefits and costs we may have overlooked.
To assist in our consideration of the economic effects of the
proposed rule and rule amendments, we request comment on the following:
[[Page 41184]]
1. We request comment on all aspects of the economic effects,
including the costs and benefits of the proposed rule and rule
amendments, and identification and assessment of any effects not
discussed herein. In addition, we seek estimates and views regarding
these costs and benefits for particular types of issuers, including
SRCs, EGCs, FPIs, registered management investment companies, and
issuers that only have listed debt or preferred equity securities, as
well as the costs or benefits for any other types of issuers that may
result from the adoption of these proposed amendments.
2. What, if any, effects on financial reporting or executive
compensation practices might arise from the requirement for listed
issuers to recover erroneously awarded incentive-based compensation as
proposed?
3. Would proposed Rule 10D-1 lead to higher quality financial
reporting? If so, explain how this would occur, and how the rule might
be revised to mitigate any adverse unintended consequences?
4. Would proposed Rule 10D-1 incentivize listed issuers to conclude
that a material error is not material in order to avoid recovery of
incentive-based compensation? Would the proposed rule and rule
amendments incentivize listed issuers to delay investigating or
reporting a material error?
5. What is the likely effect of the requirement on executive
compensation practices of listed companies, and how would this effect
likely vary according to the issuer's size or line of business?
6. What is the likely burden that listed issuers would incur to
modify the compensation packages of executive officers?
7. What would be the burden if issuers were required to recover
only the amount of excess incentive-based compensation tied to
accounting-based performance metrics? Would the burden be different in
the case of recovery of excess incentive-based compensation tied to
market-based performance metrics? What are the benefits of each
approach?
8. What implementation issues, if any, would issuers encounter in
conducting an event study or otherwise establishing the ``but-for''
price?
9. What is the cost of establishing a ``but for'' price and
determining the amount of excess incentive-based compensation to be
recovered? What factors affect the determination of reasonable
estimates of the ``but for'' price and of this amount? Would issuers
seek expert help in making such determinations? If so, what would be
the costs to issuers of retaining such experts?
10. Would it be more difficult for exchanges to monitor compliance
with the proposed rule and rule amendments for compensation tied to
market-based performance metrics? Is the documentation required to
support the analyses of the issuer sufficient for compliance
monitoring? If not, what other documentation should be required?
11. Would there be any significant transition costs imposed on
listed issuers as a result of the proposals, if adopted? Please be
detailed and provide quantitative data or support, as practicable.
12. How is this rulemaking likely to affect the market for
executive officers?
13. What is the likely effect of this rulemaking on the decision to
be a listed issuer in the United States, and how does this effect vary
according to the size or line of business of the issuer?
14. Are there additional alternatives to the proposals we should
consider that would satisfy the requirements of new Section 10D of the
Exchange Act? If so, please describe.
IV. Paperwork Reduction Act
A. Background
Certain provisions of the proposed rule and rule amendments contain
a ``collection of information'' within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\330\ The Commission is submitting the
proposed rule and rule amendments to the Office of Management and
Budget (``OMB'') for review in accordance with the PRA.\331\ An agency
may not conduct or sponsor, and a person is not required to comply
with, a collection of information unless it displays a currently valid
OMB control number. The titles for the collections of information are:
\332\
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\330\ 44 U.S.C. 3501 et seq.
\331\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\332\ The paperwork burden from Regulation S-K is imposed
through the forms that are subject to the requirements in those
regulations and is reflected in the analysis of those forms. To
avoid a Paperwork Reduction Act inventory reflecting duplicative
burdens and for administrative convenience, we assign a one-hour
burden to Regulation S-K.
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``Regulation S-K'' (OMB Control No. 3235-0070);
``Regulation 14A and Schedule 14A'' (OMB Control No. 3235-0059);
``Regulation 14C and Schedule 14C'' (OMB Control No. 3235-0065);
``Form 10-K'' (OMB Control No. 3235-0063);
``Form 20-F'' (OMB Control No. 3235-0288);
``Form 40-F'' (OMB Control No. 3235-0381);
``Rule 20a-1 under the Investment Company Act of 1940,
Solicitations of Proxies, Consents, and Authorizations'' (OMB Control
No. 3235-0158); and
``Form N-CSR'' under the Securities Exchange Act of 1934 and under
the Investment Company Act of 1940, Certified Shareholder Report of
Registered Management Investment Companies'' (OMB Control No. 3235-
0570).
Regulation S-K was adopted under the Securities Act and the
Exchange Act. Regulations 14A and 14C and the related schedules, Form
10-K, Form 20-F and Form 40-F were adopted under the Exchange Act. Rule
20a-1 was adopted under the Investment Company Act, and Form N-CSR was
adopted under the Exchange Act and Investment Company Act. The
regulations, schedules and forms set forth the disclosure requirements
for proxy and information statements and annual reports filed by
issuers to help shareholders make informed voting and investment
decisions. Our proposed rule and rule amendments to existing
regulations, schedules and forms are intended to implement new Section
10D of the Exchange Act.
The hours and costs associated with preparing and filing the forms
and preparing, filing and sending the schedules constitute reporting
and cost burdens imposed by each collection of information. Compliance
with the amendments is mandatory. Responses to the information
collections will not be kept confidential and there is no mandatory
retention period for the information disclosed.
B. Summary of Proposed Rule and Rule Amendments
We are proposing new Rule 10D-1 under the Exchange Act and
amendments to Items 601, 402 and 404 of Regulation S-K, Schedule 14A,
Form 20-F, Form 40-F, and Form N-CSR to implement the provisions of
Section 954 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010, which added Section 10D to the Securities
Exchange Act of 1934. Section 10D requires the Commission to adopt
rules directing the exchanges and associations to prohibit the listing
of any security of an issuer that is not in compliance with Section
10D's requirements concerning disclosure of the issuer's policy on
incentive-based compensation and recovery of erroneously awarded
compensation. In accordance with the statute, proposed Rule 10D-1
directs the exchanges to establish listing standards that, among other
things, require each issuer to adopt and comply with a policy
[[Page 41185]]
providing for recovery, under certain circumstances, of incentive-based
compensation received by current or former executive officers and to
file all disclosure with respect to that policy in accordance with
Commission rules.
To implement Section 10D(b)(1), we are proposing to add new
disclosure provisions to Items 601 and 402 of Regulation S-K, Schedule
14A, Form 20-F, Form 40-F, and Form N-CSR. The new disclosure
provisions would require each listed issuer to file the issuer's
policy, if applicable, regarding recovery of incentive-based
compensation from its executive officers as an exhibit to its Exchange
Act annual report or, in the case of a listed registered management
investment company, its Form N-CSR annual report. A new instruction to
the Summary Compensation Table would require that any amounts recovered
pursuant to the listed issuer's policy reduce the amount reported in
the applicable column and total column for the fiscal year in which the
amount recovered initially was reported.
In addition, if during the last completed fiscal year, either a
restatement was completed that required recovery of excess incentive-
based compensation pursuant to a listed issuer's recovery policy, or
there was an outstanding balance of excess incentive-based compensation
from the application of the policy to a prior restatement, proposed
Item 402(w) would require the listed issuer to disclose: \333\
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\333\ See proposed Item 402(w) of Regulation S-K, proposed Item
6.F of Form 20-F, and proposed Paragraph (17) of Paragraph B of Form
40-F. We also are proposing to amend the instructions to Items
404(a) of Regulation S-K so that a listed issuer that complies with
Item 402(w) disclosure requirements would not need to disclose any
incentive-based compensation recovery pursuant to those
requirements. We are also proposing to amend Form N-CSR and Item 22
of Schedule 14A to require registered management investment
companies that would be subject to Rule 10D-1 to provide information
that would mirror the disclosure requirements of proposed Item
402(w).
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For each restatement,
[cir] The date on which the listed issuer was required to prepare
an accounting restatement;
[cir] The aggregate dollar amount of excess incentive-based
compensation attributable to the restatement;
[cir] The estimates used to determine the excess incentive-based
compensation attributable to such accounting restatement, if the
financial reporting measure related to a stock price or total
shareholder return metric; and
[cir] The aggregate dollar amount of excess incentive-based
compensation that remained outstanding as of the end of the last
completed fiscal year;
The name of each person, if any, from whom during the last
completed fiscal year the listed issuer decided not to pursue recovery,
the amount forgone from each such person, and a brief description of
the listed issuer's reasons for not pursuing recovery; and
The name of, and amount due from, each person from whom,
at the end of its last completed fiscal year, excess incentive-based
compensation had been outstanding for 180 days or longer since the date
the issuer determined the amount the person owed.
We propose that the same disclosure requirements apply to listed
U.S. issuers and listed foreign private issuers, including MJDS filers.
These disclosure requirements would increase the amount of information
that listed U.S. issuers and listed foreign private issuers must
compile and disclose in their schedules and forms. For listed U.S.
issuers, other than registered management investment companies, the
proposed amendments to Items 402 and 601 of Regulation S-K would
require additional disclosure in Exchange Act annual reports and proxy
or information statements filed on Schedule 14A or Schedule 14C
relating to an annual meeting of shareholders, or a special meeting in
lieu of an annual meeting, at which directors are to be elected and
would increase the burden hour and cost estimates for each of those
forms. For a listed management investment company registered under the
Investment Company Act of 1940, the proposed amendments to Form N-CSR
and Schedule 14A would require additional disclosure and would increase
the burden hour and cost estimates associated with Form N-CSR and Rule
20a-1, if the registered investment company pays incentive-based
compensation. For a listed foreign private issuer filing an annual
report on Form 20-F, Form 40-F or, if a foreign private issuer elects
to use U.S. registration and reporting forms, on Form 10-K, the
proposed amendments to those forms and the proposed amendment to Item
402(a)(1), respectively, would require additional disclosure in annual
reports and would increase the burden hour and costs estimates for each
of these forms. The disclosure required by proposed Item 402(w),
proposed paragraph 22(b)(20) to Schedule 14A, proposed new Item 12 to
Form N-CSR, and proposed Item 6.F of Form 20-F would be required to be
block-text tagged in XBRL.
C. Paperwork Reduction Act Burden Estimates
As proposed, the information a listed U.S. issuer is required to
compile and disclose regarding its policy on incentive-based
compensation pursuant to Item 402(w) would supplement information that
U.S. issuers that are not registered management investment companies,
smaller reporting companies or emerging growth companies are already
required to provide elsewhere in their executive compensation
disclosure, if material. Specifically, these issuers are required to
provide information relating to the compensation of the named executive
officers, including policies and decisions regarding the adjustment or
recovery of awards or payments if the relevant performance measures
upon which they are based are restated or otherwise adjusted in a
manner that would reduce the size of an award or payment.\334\ With
respect to registered management investment companies subject to
proposed Rule 10D-1, information mirroring the proposed Item 402(w)
disclosure would be included in annual reports on Form N-CSR and in
proxy statements and information statements relating to the election of
directors.\335\ Such information would also supplement existing
disclosures.
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\334\ See Item 402(b)(2)(viii) of Regulation S-K.
\335\ Proposed Item 12 of Form N-CSR; proposed Item 22(b)(20) of
Schedule 14A. We are also proposing to amend General Instruction D
to Form N-CSR to permit registered management investment companies
subject to proposed Rule 10D-1 to answer the information required by
proposed Item 12 by incorporating by reference from the company's
definitive proxy statement or definitive information statement.
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Similarly, for a listed foreign private issuer filing an annual
report on Form 20-F or, if a foreign private issuer elects to use U.S.
registration and reporting forms, on Form 10-K, the proposed amendments
would supplement existing disclosures. Currently, Item 7.B of Form 20-F
requires disclosure of transactions between the issuer and senior
management of the nature and extent of any transactions that are
material to the company or related party that are unusual in their
nature or conditions involving services to which the company was a
party. Although this disclosure requirement generally would require
disclosure of the recovery of excess incentive-based compensation, it
may not elicit the same information required to be provided under the
proposed rule and rule amendments.
We arrived at the estimates discussed below by reviewing our burden
estimates for similar disclosure and
[[Page 41186]]
considering our experience with other tagged data initiatives. We
believe that the preparation of the information required by proposed
Item 402(w) and the corresponding narrative disclosure provisions is
comparable to an issuer's preparation of the disclosure required by the
amendments to enhance certain aspects of proxy disclosure.\336\ The
amendments in that release were largely designed to enhance existing
disclosure requirements. Similarly, we believe that the proposed Item
402(w) amendments would enhance the disclosure that is already required
by Item 402 of Regulation S-K and disclosure that is required by
Section 10D(b)(1). We believe that certain of the information required
to prepare the new disclosure would be readily available to some U.S.
issuers because this information, if material, is required to be
gathered, determined or prepared in order to satisfy the other
disclosure requirements of Item 402 of Regulation S-K. For other listed
issuers, we believe that the information required to prepare the new
disclosure requirement will not impose a significant burden because the
issuer controls and possesses this information, which is a compilation
of facts related to an issuer's implementation of its recovery policy
if during the last completed fiscal year the issuer was required to
recover excess incentive-based compensation or there was an outstanding
balance of excess incentive-based compensation not recovered pursuant
to that policy. In the Proxy Disclosure Enhancements release, we
estimated that the amendments would impose on average an incremental
burden of 25 hours for accelerated filers and 17 hours for non-
accelerated filers to prepare their proxy and information statements.
We believe the proposed disclosure regarding an issuer's policy on
recovery of erroneously awarded compensation requires less new
information than the amendments in the Proxy Disclosure Enhancements
Release. We believe the primary cost elements for issuers preparing the
proposed disclosure would be determining the types of incentive-based
compensation awards an issuer grants to executive officers that could
be subject to recovery under the issuer's recovery policy and, if
necessary, gathering the information regarding the application and
implementation of this recovery policy if required by a restatement.
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\336\ See Release No. 33-9089, Proxy Disclosure Enhancements,
(Dec. 16, 2009) [74 FR 68334] (``Proxy Disclosure Enhancements'').
The release adopted amendments to make new or revised disclosures
about: Compensation policies and practices that present material
risks to the company; stock and option awards of executives and
directors; director and nominee qualifications and legal
proceedings; board leadership structure; the board's role in risk
oversight; and potential conflicts of interest of compensation
consultants that advise companies and their boards of directors.
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As a result, we estimate that the average incremental burden for an
issuer to prepare the new narrative disclosure would be 21 hours. This
estimate includes the time and cost of preparing disclosure that has
been appropriately reviewed by management, in-house counsel, outside
counsel and members of the board of directors, as well as block-text
tagging the data in XBRL format. Because this estimate is an average,
the burden could be more or less for any particular company, and may
vary depending on a variety of factors, such as the degree to which
companies use the services of outside professionals or internal staff
and resources to tag the data in XBRL. Issuers subject to Item 402(w)
would provide the required disclosures by either including the
information directly in Exchange Act annual reports or incorporating
the information be reference from a proxy statement on Schedule 14A or
information statement on Schedule 14C. For purposes of our PRA
estimates, consistent with past amendments to Item 402,\337\ we have
assumed that all of the burden relating to the new narrative disclosure
requirements would be associated with Form 10-K, even if registrants
include the new disclosure required in Form 10-K by incorporating that
disclosure by reference from the proxy statement on Schedule 14A.\338\
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\337\ We took a similar approach in connection with the rules
for Summary Compensation Table disclosure required by the 2006
amendments to Item 402. See Executive Compensation and Related
Person Disclosure, Release No. 33-8732A, n. 326 (Aug. 29, 2006) [71
FR 53158].
\338\ Similarly, for purposes of the PRA estimates, we are also
assuming that all of the burden relating to the new narrative
disclosure requirements for registered investment companies would be
associated with Form N-CSR, and therefore, we are not allocating a
separate burden estimate for Rule 20a-1.
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We believe that the requirement to file a listed issuer's recovery
policy as an exhibit to its annual report pursuant to proposed Item
601(b)(96) and the corresponding provisions (and for registered
investment companies, as an exhibit to its annual report on Form N-CSR
pursuant to proposed Item 13(a)(2) of Form N-CSR) will be minimal. A
listed issuer will be required simply to file the policy that it
otherwise would be required to have pursuant to the listing standards
of the exchange on which it lists securities. We estimate this burden
to be approximately one hour.
As a result of the estimates discussed above, we estimate for
purposes of the PRA that the total incremental burden on all listed
issuers with respect to the proposed amendments would be 5,961 hours
for internal company time and $203,700 for the services of outside
professionals. The total incremental burden for Form 10-K would be
5,246 hours for internal company time and $138,600 for the services of
outside professionals.\339\ The total incremental burden for Form N-CSR
would be 23 hours for internal company time and $2,100 for the services
of outside professionals.\340\ The total incremental burden for Form
20-F would be 553 hours for internal company time and $50,400 for the
services of outside professionals and for Form 40-F would be 139 hours
for internal company time and $12,600 for the services of outside
professionals.\341\ For Form 10-K and
[[Page 41187]]
Form N-CSR we estimate that 75% of the burden of preparation is carried
by the company internally and that 25% of the burden of preparation is
carried by outside professionals retained by the company at an average
cost of $400 per hour. For Forms 20-F and 40-F we estimate that 25% of
the burden of preparation is carried by the company internally and that
75% of the burden of preparation is carried by outside professionals
retained by the company at an average cost of $400 per hour. There is
no change to the estimated burden of Regulation S-K because the burdens
that this regulation imposes are reflected in our revised estimates for
the forms. Similarly, there is no change to the estimated burden of
Schedule 14A, Schedule 14C and Rule 20a-1 because, as noted above, the
burdens associated with the proposed disclosures are allocated to Form
10-K and Form N-CSR, respectively.
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\339\ This includes one hour to file the recovery policy as an
exhibit to the annual report as well as the burden associated with
providing Item 402(w) disclosure, when applicable. We estimate the
number of responses for filing the recovery policy based on the
number of listed domestic issuers filing annual reports in 2014, or
4,206 issuers. Proposed Item 402(w) would require disclosure when a
listed issuer completes a restatement that requires recovery of
excess incentive-based compensation pursuant to its compensation
recovery policy or when there is an outstanding balance of excess
incentive-based compensation from the application of the policy to a
prior restatement. To estimate the burden associated with this
disclosure, we looked to the number of listed issuers that filed an
Item 4.02 Form 8-K (Non-Reliance on Previously Issued Financial
Statements) in 2014, or 66 issuers. To calculate the total annual
incremental burden arising from the new narrative disclosure, we
multiplied the estimated number of annual responses (66) by 21
burden hours. We note that the number of restatements filed in any
given year will vary and that, depending on the nature of their
recovery efforts, certain issuers may be required to provide Item
402(w) disclosure for more than one year.
\340\ We estimate seven registered management investment
companies that are listed issuers and are internally managed that
may have executive officers who receive incentive-based
compensation. Of these seven, we assume for PRA purposes that one
registered management investment company per year will be required
to prepare the new narrative disclosure required by proposed new
Item 12 of Form N-CSR. As indicated below, for Form N-CSR, we
estimate that 75% of the burden of preparation will be carried by
the registrant internally and the remaining 25% of the burden will
be carried by outside professionals retained by the company at an
average cost of $400 per hour. On the basis of the foregoing, we
estimate an aggregate internal burden hour of 22 hours ((7
registrants x 1 hour per registrant to file the policy pursuant to
proposed new Item 13(a)(2)) + (1 registrant x 21 hours per
registrant to prepare the new narrative disclosure required by
proposed new Item 12x75%) = 23 hours), and estimate an aggregate
increase of $2,100 for the services of outside professionals (1
registrant x 21 hours per registrant to retain outside professionals
to prepare the new narrative disclosure required by proposed new
Item 12x25% x $400 per hour) = $2,100).
\341\ Consistent with our estimates for Form 10-K, we estimate
the number of responses for filing the recovery policy based on the
number of listed foreign private issuers and MJDS issuers filing
annual reports in 2014, or 639 issuers. To estimate the burden
associated with the disclosure required when a foreign private
issuer or MJDS issuer is required to pursue recovery pursuant to its
policy, we looked to the number of listed foreign private issuers
and MJDS issuers that restated financial statements in 2014, or 8
foreign private issuers filing on Form 20-F and 2 MJDS issuers
filing on Form 40-F. To calculate the total annual incremental
burden arising from the new narrative disclosure, we multiplied the
estimated number of annual responses (8 and 2, respectively) by 21
burden hours and allocated the resulting burden estimate to the
relevant form.
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We derived our new burden hour and cost estimates by estimating the
total amount of time it would take a listed issuer to prepare and
review the disclosure requirements contained in the final rules. This
estimate represents the average burden for all listed issuers, both
large and small. In deriving our estimates, we recognize that the
burdens will likely vary among individual listed issuers based on a
number of factors, including the size and complexity of their
organizations. We believe that some listed issuers will experience
costs in excess of this average in the first year of compliance with
the amendments and some issuers may experience less than the average
costs. A summary of the proposed changes is included in the table
below.
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\342\ The number of responses reflected in the table equals the
three-year average of the number of schedules and forms filed with
the Commission and currently reported by the Commission to OMB.
Table 1--Calculation of Incremental PRA Burden Estimates \342\
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Current Proposed Increase in
annual annual Current Increase in Proposed Current professional professional Proposed professional
responses responses burden hours burden hours burden hours costs costs costs
(A) (B) (C) (D) (E) = C + D (F) (G) = F + G
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Form 10-K.................................................. 8137 8137 12,198,095 5,246 12,203,089 $1,627,400,000 $138,600 $1,627,538,600
Form 20-F.................................................. 942 942 623,021 553 623,795 743,277,230 50.400 743,277,630
Form 40-F.................................................. 205 205 22,034 139 22,425 26,440,500 12,600 26,453,100
Form N-CSR................................................. 6,576 6,576 177,799 23 177,822 3,189,771 2,100 3,191,871
------------------------------------------------------------------------------------------------------------------------------------
Total.................................................. 15,860 15,860 13,020,949 5,961 13,026,910 2,400,257,501 203,700 2,400,461,201
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
D. Solicitation of Comments
We request comments in order to evaluate: (1) Whether the proposed
collection of information is necessary for the proper performance of
the functions of the agency, including whether the information would
have practical utility; (2) the accuracy of our estimate of the burden
of the proposed collection of information; (3) whether there are ways
to enhance the quality, utility and clarity of the information to be
collected; and (4) whether there are ways to minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.\343\
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\343\ We request comment pursuant to 44 U.S.C. 3506(c)(2)(B).
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Any member of the public may direct to us any comments concerning
the accuracy of these burden estimates and any suggestions for reducing
these burdens. Persons submitting comments on the collection of
information requirements should direct the comments to the Office of
Management and Budget, Attention: Desk Officer for the Securities and
Exchange Commission, Office of Information and Regulatory Affairs,
Washington, DC 20503, and should send a copy to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090, with reference to File No. S7-12-15.
Requests for materials submitted to OMB by the Commission with regard
to these collections of information should be in writing, refer to File
No. S7-12-15, and be submitted to the Securities and Exchange
Commission, Office of FOIA Services, 100 F Street NE., Washington, DC
20549-0213. OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication of
this release. Consequently, a comment to OMB is best assured of having
its full effect if OMB receives it within 30 days of publication.
V. Small Business Regulatory Enforcement Fairness Act
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (SBREFA),\344\ we solicit data to determine whether the
proposed rule and rule amendments constitute a ``major'' rule. Under
SBREFA, a rule is considered ``major'' where, if adopted, it results or
is likely to result in:
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\344\ 5 U.S.C. 801 et seq.
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An annual effect on the economy of $100 million or more
(either in the form of an increase or a decrease);
A major increase in costs or prices for consumers or
individual industries; or
Significant adverse effects on competition, investment or
innovation.
Commenters should provide empirical data on (1) the potential
annual effect on the economy; (2) any increase in costs or prices for
consumers or individual industries; and (3) any potential effect on
competition, investment or innovation.
VI. Initial Regulatory Flexibility Act Analysis
This Initial Regulatory Flexibility Analysis (``IRFA'') has been
prepared in accordance with the Regulatory Flexibility Act.\345\ This
IRFA involves proposals to direct the exchanges and associations to
prohibit the listing of a security of an issuer that is not in
compliance with Section 10D's requirements concerning recovery of
erroneously awarded compensation and to implement disclosure
requirements related to the recovery of such compensation.
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\345\ 5 U.S.C. 603.
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[[Page 41188]]
A. Reasons for, and Objectives of, the Proposed Action
We are proposing a new rule and rule amendments to implement the
provisions of Section 954 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010, which adds Section 10D to the
Securities Exchange Act of 1934. Section 10D requires the Commission to
adopt rules directing the exchanges and associations to prohibit the
listing of any security of an issuer that is not in compliance with
Section 10D's requirements concerning disclosure of the issuer's policy
on incentive-based compensation and recovery of erroneously awarded
compensation. In accordance with the statute, the proposed rule would
direct the exchanges to establish listing standards that require each
issuer to adopt and comply with a policy providing for the recovery of
incentive-based compensation based on financial information required to
be reported under the securities laws that is received by current or
former executive officers, and to file all disclosure with respect to
that policy in accordance with Commission rules.
The primary objective of the proposed rule and rule amendments is
to require that all listed issuers have a policy in place to recover
compensation based on material noncompliance with any financial
reporting requirement. This policy would require executives to return
erroneously awarded compensation without the need for shareholders to
embark on costly litigation.\346\ The disclosure requirements in the
proposed rule and rule amendments are intended to promote consistent
disclosure among issuers as to both the substance of a listed issuer's
recovery policy and how the listed issuer implements that policy in
practice.
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\346\ Senate Report at 135-36.
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B. Legal Basis
We are proposing the rule and rule amendments pursuant to Sections
6, 7, 10, and 19(a) of the Securities Act; Sections 10D, 13, 14, 23(a)
and 36 of the Exchange Act and Sections 20, 30, and 38 of the
Investment Company Act of 1940.
C. Small Entities Subject to the Proposed Action
The proposals would affect, among other entities, exchanges that
list securities and listed issuers subject to our proxy rules. The
Regulatory Flexibility Act defines ``small entity'' to mean ``small
business,'' ``small organization,'' or ``small governmental
jurisdiction.'' \347\ The Commission's rules define ``small business''
and ``small organization'' for purposes of the Regulatory Flexibility
Act for each of the types of entities regulated by the Commission.
Exchange Act Rule 0-10(e) provides that the term ``small business'' or
``small organization,'' when referring to an exchange, means any
exchange that: (1) Has been exempted from the reporting requirements of
Exchange Act Rule 601; \348\ and (2) is not affiliated with any person
(other than a natural person) that is not a small business or small
organization, as defined under Exchange Act Rule 0-10.\349\ No
exchanges are small entities because none meet these criteria.
Securities Act Rule 157 \350\ and Exchange Act Rule 0-10(a) \351\
define an issuer, other than an investment company, to be a ``small
business'' or ``small organization'' if it had total assets of $5
million or less on the last day of its most recent fiscal year and is
engaged or proposing to engage in an offering of securities which does
not exceed $5 million. The proposed rule and rule amendments would
affect small entities that have a class of securities that are
registered under Section 12(b) of the Exchange Act. We estimate that
there are approximately 27 listed issuers, other than registered
investment companies, that may be considered small entities. An
investment company, including a business development company, is
considered to be a ``small business'' if it, together with other
investment companies in the same group of related investment companies,
has net assets of $50 million or less as of the end of its most recent
fiscal year.\352\ We believe that certain of the rule and rule
amendments would affect small entities that are investment companies,
including business development companies, with a class of securities
registered under Section 12(b) of the Exchange Act. We estimate that
there are approximately 13 listed investment companies, including
business development companies, that may be considered small entities.
---------------------------------------------------------------------------
\347\ 5 U.S.C. 601(6).
\348\ 17 CFR 242.601.
\349\ 17 CFR 240.0-10(e).
\350\ 17 CFR 230.157.
\351\ 17 CFR 240.0-10(a).
\352\ 17 CFR 270.0-10(a).
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D. Reporting, Recordkeeping, and Other Compliance Requirements
Under the proposals, the exchanges will be directed to prohibit the
listing of an equity security of an issuer that does not comply with
Section 10D's requirements concerning development and implementation of
a policy requiring recovery of erroneously awarded incentive-based
compensation, and disclosure of that policy. Large and small entities
would be subject to the same recovery and disclosure requirements.
Proposed Rule 10D-1 would require exchanges to adopt listing
standards that would require a listed issuer (including a small entity)
to develop and implement a policy providing that, in the event that the
issuer is required to prepare an accounting restatement due to material
noncompliance with any financial reporting requirement, the issuer will
recover from any of its current or former executive officers who
received incentive-based compensation during the preceding three-year
period based on the erroneous data, any such compensation in excess of
what would have been paid under the accounting restatement.
If during the last completed fiscal year, either a restatement was
completed that required recovery of excess incentive-based compensation
pursuant to the listed small entity's compensation recovery policy, or
there was an outstanding balance of excess incentive-based compensation
from the application of the policy to a prior restatement, proposed
Item 402(w) would require the listed small entity to disclose and
provide in block-text tagged XBRL format:
For each restatement,
[cir] The date on which the listed issuer was required to prepare
an accounting restatement;
[cir] The aggregate dollar amount of excess incentive-based
compensation attributable to the restatement; and
[cir] The aggregate dollar amount of excess incentive-based
compensation that remained outstanding as of the end of the last
completed fiscal year;
The name of each person subject to recovery of excess
incentive-based compensation attributable to an accounting restatement,
if any, from whom during the last completed fiscal year the listed
small entity decided not to pursue recovery, the amount forgone from
each such person, and a brief description of the listed small entity's
reasons for not pursuing recovery; and
The name of, and amount due from, each person from whom,
at the end of its last completed fiscal year, excess incentive-based
compensation had been outstanding for 180 days or longer since the date
the small entity determined the amount the person owed.
In addition, proposed Item 601(b)(96) and the corresponding amendment
to Form N-CSR would require a listed
[[Page 41189]]
small entity to file, as an exhibit to its Exchange Act annual report
or, in the case of a listed registered management investment company,
its Form N-CSR annual report, its policy regarding the recovery of
erroneously awarded incentive-based compensation.
The proposals will impose additional requirements on small entities
in order to comply with the new listing standards and to collect,
record and report the disclosures. For example, it can reasonably be
expected that listed small entities would need to engage the
professional services of attorneys to develop their recovery policies
and would also need the services of both attorneys and accountants to
implement those policies in the event of an accounting restatement.
Such services will likely be needed to compute recoverable amounts,
especially for incentive-based compensation based on stock price or
total shareholder return metrics. Small entities also will incur costs
to tag the required disclosures in XBRL format and may need to engage
the services of outside professionals to assist with this process.
Our existing disclosure rules require smaller reporting companies
to provide compensation information for named executive officers for
the last two completed fiscal years in the Summary Compensation Table
pursuant to Item 402(n) of Regulation S-K. We also believe that small
entities do not typically grant their executive officers complex
incentive-based compensation awards or use many different types of
incentive-based compensation awards, which would significantly minimize
the impact of the proposal, including the proposed reporting
requirements, on small entities. To the extent a small entity may not
currently be required to disclose the information the proposals require
in the event there is a restatement and the restatement requires
application of the small entity's recovery policy, this information
should be readily available to the small entity as it controls how it
implements its recovery policy. Where a small entity may be required to
disclose this type of information in such filings pursuant to Item
404(a) of Regulation S-K, the proposed new instruction to Item 404 will
provide that Item 404 disclosure is not required if the transaction
involves the recovery of excess incentive-based compensation that is
disclosed pursuant to Item 402(w).
In addition, we believe that the impact of the proposals on small
entities will be lessened because the proposals apply only to listed
issuers, and the quantitative listing standards applicable to issuers
listing securities on an exchange, such as market capitalization,
minimum revenue, and shareholder equity requirements, will serve to
limit the number of small entities that would be affected.
E. Duplicative, Overlapping or Conflicting Federal Rules
As noted above, other statutes and rules administered by the
Commission address the recovery of executive compensation. Section 304
of SOX provides for recovery of executive compensation when there has
been material noncompliance of the issuer, as a result of misconduct,
with any financial reporting measure. In addition, existing CD&A
disclosure requirements call for disclosure of an issuer's policies and
decisions regarding recovery of executive compensation in the event of
an accounting restatement, to the extent material. Outside of the
federal securities laws, EESA contains an executive compensation
recovery provision applicable to financial institutions that sell
troubled assets to the Secretary of the Treasury under TARP. As
explained above, the proposed rule and rule amendments are generally
broader in scope, and more specific in detail, than these existing
provisions. For example, the proposed rule and rule amendments--unlike
Section 304 of SOX--would require recovery in the event of an
accounting restatement regardless of issuer misconduct. Similarly, the
clawback provisions in EESA apply only to financial institutions that
sold troubled assets to and have not repaid the Treasury, whereas the
proposed rules apply to all listed issuers. Thus, although there may be
some overlap between the proposed rule and rule amendments and these
existing provisions, we do not believe the proposed rule and rule
amendments would duplicate or conflict with other federal rules or
statutes.
F. Significant Alternatives
The Regulatory Flexibility Act directs us to consider alternatives
that would accomplish our stated objectives, while minimizing any
significant adverse impact on small entities. In connection with the
proposed disclosure amendments, we considered the following
alternatives:
Clarifying, consolidating or simplifying compliance and
reporting requirements under the rules for small entities;
Exempting small entities from all or part of the
requirements; and
Establishing different compliance or reporting
requirements or timetables that take into account the resources
available to small entities.
In some respects, we have used performance standards in crafting
the proposals. Specifically:
Proposed Rule 10D-1 uses a standard-based definition of
``incentive based compensation'' subject to recovery;
Proposed Rule 10D-1 provides boards of directors with
limited discretion to determine whether and how much compensation to
pursue and broader discretion to determine the means of recovery; and
Proposed Rule 10D-1 adopts a standard-based approach to
determining the amount of excess incentive-based compensation subject
to recovery.
We believe that high quality financial reporting is important for
promoting investor confidence in the financial markets. The proposed
rule and rule amendments would further this objective by requiring that
all listed issuers have policies requiring the recovery of executive
compensation that was received based on material noncompliance with
financial reporting requirements. The disclosure requirements in the
proposed rule and rule amendments would require clear disclosure of a
listed issuer's policy on recovery of incentive-based compensation, and
provide investors with useful information regarding the application of
that policy. We believe that our proposed rule and rule amendments will
promote consistent compliance with recovery obligations and related
disclosure across all listed issuers without unduly burdening small
entities. We note that the proposal provides issuers flexibility to
forgo recovery in circumstances where the costs of enforcing recovery
would exceed the recoverable amounts. This will help to limit costs for
all issuers subject to the rule, including small entities.
Although we preliminarily believe that an exemption for small
entities from coverage of the proposals would not be appropriate, we
seek comment on whether we should exempt small entities from any of the
proposed requirements or scale the proposed disclosure amendments to
reflect the characteristics of small entities and the needs of their
investors.\353\
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\353\ See Sections II.A.1 and II.D, above, and related requests
for comment.
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At this time, we do not believe that different compliance methods
or timetables for small entities would be appropriate. The proposals
are intended to further the statutory goal of assuring that executive
officers do not retain
[[Page 41190]]
incentive-based compensation that they received erroneously. The
specific disclosure requirements in the proposals will promote
consistent disclosure among all issuers, including small entities.
Separate compliance requirements or timetables for small entities could
interfere with achieving the goals of the statute and our proposals.
Nevertheless, we solicit comment on whether different compliance
requirements or timetables for small entities would be appropriate, and
consistent with the purposes of Section 954 of the Act.\354\
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\354\ See Section II.F, above, and related requests for comment.
---------------------------------------------------------------------------
G. Solicitation of Comments
We encourage the submission of comments with respect to any aspect
of this Initial Regulatory Flexibility Analysis. In particular, we
request comments regarding:
How the proposed rule and rule amendments can achieve
their objective while lowering the burden on small entities;
The number of small entities that may be affected by the
proposed rule and rule amendments;
Whether small entities should be exempt from the rule and
rule amendments;
The existence or nature of the potential impact of the
proposed amendments on small entities discussed in the analysis; and
How to quantify the impact of the proposed rule and rule
amendments.
Respondents are asked to describe the nature of any impact and
provide empirical data supporting the extent of the impact. Such
comments will be considered in the preparation of the Final Regulatory
Flexibility Analysis, if the proposed rule and rule amendments are
adopted, and will be placed in the same public file as comments on the
proposed rule and rule amendments themselves.
VII. Statutory Authority and Text of the Proposed Amendments Amendments
The amendments contained in this release are being proposed under
the authority set forth in Sections 6, 7, 10, and 19(a) of the
Securities Act, Sections 10D, 13, 14, 23(a) and 36 of the Exchange Act,
and Sections 20, 30, and 38 of the Investment Company Act of 1940.
List of Subjects in 17 CFR Parts 229, 240, 249 and 274
Reporting and recordkeeping requirements, Securities, Investment
companies.
Text of the Proposed Amendments
For the reasons set out in the preamble, the Commission proposes to
amend title 17, chapter II, of the Code of Federal Regulations as
follows:
PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND
CONSERVATION ACT OF 1975--REGULATION S-K
0
1. The general authority citation for part 229 is revised to read as
follows:
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 777iii,
77jjj, 77nnn, 77sss, 78c, 78i, 78j, 78j-3, 78l, 78m, 78n, 78n-1,
78o, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30,
80a-31(c), 80a-37, 80a-38(a), 80a-39, 80b-11, and 7201 et seq.; and
18 U.S.C. 1350.
* * * * *
0
2. Section 229.402, as proposed to be amended at 78 FR 60559 [Oct. 1,
2013] and 80 FR 26329 [May 7, 2015], is further amended by:
0
a. Revising paragraph (a)(1);
0
b. Adding Instruction 5 to paragraph (c);
0
c. Adding Instruction 5 to paragraph (n); and
0
d. Adding paragraph (w).
The revision and additions read as follows:
Sec. 229.402 (Item 402) Executive compensation.
(a) * * *
(1) Treatment of foreign private issuers. A foreign private issuer
will be deemed to comply with this Item if it provides the information
required by Items 6.B, 6.E.2 and 6.F of Form 20-F (17 CFR 240.220f),
with more detailed information provided if otherwise made publicly
available or required to be disclosed by the issuer's home jurisdiction
or a market in which its securities are listed or traded, or paragraph
(17) of General Instruction B of Form 40-F (17 CFR 240.240f), as
applicable. A foreign private issuer that elects to provide domestic
Item 402 disclosure shall provide the disclosure required by Item
402(w) in its annual report or registration statement, as applicable.
* * * * *
(c) * * *
Instructions to Item 402(c). * * *
5. Any amounts recovered pursuant to a listed registrant's
erroneously awarded compensation recovery policy shall reduce the
amount reported in the applicable Summary Compensation Table column for
the fiscal year in which the amount recovered initially was reported as
compensation, and shall be identified by footnote.
* * * * *
(n) * * *
Instructions to Item 402(n). * * *
5. Any amounts recovered pursuant to the erroneously awarded
compensation recovery policy of a smaller reporting company that is a
listed registrant shall reduce the amount reported in its applicable
Summary Compensation Table column for the fiscal year in which the
amount recovered initially was reported as compensation, and shall be
identified by footnote.
* * * * *
(w) Disclosure of a listed registrant's action to recover
erroneously awarded compensation. If at any time during the last
completed fiscal year either a restatement that required recovery of
excess incentive-based compensation pursuant to the listed registrant's
compensation recovery policy was completed or there was an outstanding
balance of excess incentive-based compensation from the application of
the policy to a prior restatement, the listed registrant shall provide
the following information:
(1) For each restatement:
(i) The date on which the listed registrant was required to prepare
an accounting restatement, as defined in 17 CFR 240.10D-1(c)(2);
(ii) The aggregate dollar amount of excess incentive-based
compensation attributable to such accounting restatement;
(iii) The estimates that were used in determining the excess
incentive-based compensation attributable to such accounting
restatement, if the financial reporting measure related to a stock
price or total shareholder return metric; and
(iv) The aggregate dollar amount of excess incentive-based
compensation that remains outstanding at the end of the last completed
fiscal year;
(2) If during the last completed fiscal year the listed registrant
decided not to pursue recovery from any individual subject to recovery
of excess incentive-based compensation attributable to an accounting
restatement, for each such individual, the name and amount forgone and
a brief description of the reason the listed registrant decided in each
case not to pursue recovery;
(3) The name of each individual from whom, as of the end of the
last completed fiscal year, excess incentive-based compensation had
been outstanding for 180 days or longer since the date the issuer
determined the amount the individual owed, and the
[[Page 41191]]
dollar amount of outstanding excess incentive-based compensation due
from each such individual; and
(4) The disclosure required to be provided pursuant to this
paragraph (w) shall appear with, and in the same format as, the rest of
the disclosure required to be provided pursuant to this Item 402 and,
in addition, shall be electronically formatted using the eXtensible
Business Reporting Language (XBRL) interactive data standard in
accordance with the EDGAR Filer Manual (17 CFR 232.11) as an exhibit to
definitive Schedule 14A (17 CFR 240.14a-101) or definitive Schedule 14C
(17 CFR 240.14c-101), as applicable, and Form 10-K (17 CFR 249.310).
The XBRL format disclosure required to be provided pursuant this
paragraph (w) must be block-text tagged.
Instructions to Item 402(w).
1. A listed registrant is a registrant that had a class of
securities listed on a national securities exchange registered pursuant
to section 6 of the Exchange Act (15 U.S.C. 78f) or a national
securities association registered pursuant to section 15A of the
Exchange Act (15 U.S.C. 78o-3) at any time during its last completed
fiscal year.
2. A compensation recovery policy is the policy required by the
listing standards adopted pursuant to 17 CFR 240.10D-1.
3. Excess incentive-based compensation is the erroneously awarded
compensation computed as provided in 17 CFR 240.10D-1(b)(1)(iii) and
the applicable listing standards for the listed registrant's
securities.
4. For Item 402(w)(1), if the aggregate dollar amount of excess
incentive-based compensation has not yet been determined, disclose this
fact and explain the reason(s).
5. The information required by Item 402(w) must be disclosed only
in proxy or information statements that call for Item 402 disclosure
and the listed registrant's annual report on Form 10-K. The information
required by this Item 402(w) will not be deemed to be incorporated by
reference into any filing under the Securities Act, except to the
extent that the listed registrant specifically incorporates it by
reference.
* * * * *
0
3. Amend Sec. 229.404 by:
0
a. Removing ``or'' at the end of Instruction 5.a.i. to the Instructions
to Item 404(a);
0
b. Removing the ``.'' and adding in its place ``;or'' in Instruction
5.a.ii. to the Instructions to Item 404(a); and
0
c. Adding Instruction 5.a.iii. to the Instructions to Item 404(a).
The addition reads as follows:
Sec. 229.404 (Item 404) Transactions with related persons, promoters
and certain control persons.
* * * * *
Instructions to Item 404(a). * * *
5.a. * * *
iii. The transaction involves the recovery of excess incentive-
based compensation, as defined in Instruction 3 to Sec. 229.402(w),
that is disclosed pursuant to Item 402(w) (Sec. 229.402(w)).
* * * * *
0
4. Amend Sec. 229.601 adding paragraphs (96) and (97) to the exhibit
table in paragraph (a) and adding paragraphs (b)(96) and (97) to read
as follows:
Sec. 229.601 (Item 601) Exhibits.
(a) * * *
Exhibit Table
--------------------------------------------------------------------------------------------------------------------------------------------------------
Securities Act Forms Exchange Act Forms
----------------------------------------------------------------------------------------------------------------
S-4 F-4 8-K
S-1 S-3 SF-1 SF-3 \1\ S-8 S-11 F-1 F-3 \1\ 10 \2\ 10-D 10-Q 10-K ABS-EE
--------------------------------------------------------------------------------------------------------------------------------------------------------
* * * * * * *
(96) Listed Registrant Policy Relating ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... X ......
to Recovery of Erroneously Awarded
Compensation..........................
(97) Listed Registrant Compensation ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... X ......
Recovery Disclosure under Item 402(w)
of Regulation S-K in XBRL Electronic
Format................................
* * * * * * *
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ An exhibit need not be provided about a company if: (1) With respect to such company an election has been made under Form S-4 or F-4 to provide
information about such company at a level prescribed by Form S-3 or F-3; and (2) the form, the level of which has been elected under Form S-4 or F-4,
would not require such company to provide such exhibit if it were registering a primary offering.
\2\ A Form 8-K exhibit is required only if relevant to the subject matter reported on the Form 8-K report. For example, if the Form 8-K pertains to the
departure of a director, only the exhibit described in paragraph (b)(17) of this section need be filed. A required exhibit may be incorporated by
reference from a previous filing.
(b) * * *
(96) Listed Registrant Policy Relating to Recovery of Erroneously
Awarded Compensation. A listed registrant must provide as an exhibit to
its Exchange Act annual report the policy required by the applicable
listing standards adopted pursuant to 17 CFR 240.10D-1. For purposes of
this Item, a listed registrant is a registrant that had a class of
securities listed on a national securities exchange registered pursuant
to section 6 of the Exchange Act (15 U.S.C. 78f) or a national
securities association registered pursuant to section 15A of the
Exchange Act (15 U.S.C. 78o-3) at any time during its last completed
fiscal year.
(97) Listed Registrant Compensation Recovery Disclosure under Item
402(w) of Regulation S-K in XBRL Electronic Format. The compensation
recovery disclosure required to be provided by a listed registrant
under Item 402(w) of Regulation S-K (Sec. 229.402(w)) in electronic
format using the XBRL interactive data standard in accordance with the
EDGAR Filer Manual (17 CFR 232.11). The exhibit must be block-text
tagged.
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
5. The authority citation for part 240 is revised to read as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78j-4, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o,
78o-4, 78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm,
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.,
and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C.5221(e)(3); 18 U.S.C. 1350;
and Pub. L. 111-203, 939A, 124 Stat.1376 (2010), unless otherwise
noted.
* * * * *
0
6. Add Sec. 240.10D-1 to read as follows:
Sec. 240.10D-1--Listing standards relating to recovery of erroneously
awarded compensation.
(a) Pursuant to section 10D(a) of the Act (15 U.S.C. 78j-4(a)):
(1) National securities exchanges and associations. The rules of
each national securities exchange registered pursuant to section 6 of
the Act (15 U.S.C. 78f) and each national securities association
registered pursuant to section 15A of the Act (15 U.S.C. 78o-3), to the
extent such national securities association lists securities in an
automated inter-dealer quotation system must, in accordance with the
provisions of this section, prohibit the initial or continued listing
of any security of an issuer that is not
[[Page 41192]]
in compliance with the requirements of any portion of paragraph (b) or
(c) of this section.
(2) Implementation. (i) Each national securities exchange and
national securities association that lists securities must file with
the Commission, no later than 90 days after publication of this section
in the Federal Register, proposed rules or rule amendments that comply
with this section. Such rules or rule amendments that comply with this
section must be approved by the Commission and be effective no later
than one year after publication of this section in the Federal
Register.
(ii) Each listed issuer shall adopt the recovery policy required by
this section no later than 60 days following the effective date of the
listing standard referenced in paragraph (a)(2)(i) of this section.
Each listed issuer shall comply with that recovery policy for all
incentive-based compensation received by executive officers on or after
the effective date of this section that results from attainment of a
financial reporting measure based on or derived from financial
information for any fiscal period ending on or after the effective date
of this section. Each listed issuer shall provide the required
disclosures in the applicable Commission filings required on or after
the effective date of the listing standard referenced in paragraph
(a)(2)(i) of this section.
(b) Required standards. The requirements of this section are as
follows:
(1) Recovery of erroneously awarded compensation. The issuer shall
adopt and comply with a written policy providing that, in the event
that the issuer is required to prepare an accounting restatement due to
the material noncompliance of the issuer with any financial reporting
requirement under the securities laws, the issuer will recover the
amount of erroneously awarded incentive-based compensation as provided
below. The issuer shall file all disclosures with respect to such
recovery policy in accordance with the requirements of the federal
securities laws.
(i) To be subject to the issuer's recovery policy, incentive-based
compensation:
(A) Must have been received while the issuer has a class of
securities listed on a national securities exchange or a national
securities association; and
(B) Must have been received by an individual who served as an
executive officer of the issuer at any time during the performance
period for that incentive-based compensation.
(ii) The issuer's recovery policy shall apply to any incentive-
based compensation received during the three completed fiscal years
immediately preceding the date that the issuer is required to prepare a
restatement of its previously issued financial statements to correct a
material error. In addition to these last three completed fiscal years,
the recovery policy shall apply to any transition period (that results
from a change in the issuer's fiscal year) within or immediately
following those three completed fiscal years. However, a transition
period that comprises a period of nine to 12 months would be deemed a
completed fiscal year. A ``transition period'' refers to the period
between the last day of the issuer's previous fiscal year end and the
first day of its new fiscal year. An issuer's obligation to recover
excess incentive-based compensation is not dependent on if or when the
restated financial statements are filed.
(iii) The amount of incentive-based compensation subject to the
issuer's recovery policy (the ``erroneously awarded compensation'')
shall be the amount of incentive-based compensation received that
exceeds the amount of incentive-based compensation that otherwise would
have been received had it been determined based on the accounting
restatement, and shall be computed without regard to any taxes paid.
For incentive-based compensation based on stock price or total
shareholder return, where the amount of erroneously awarded
compensation is not subject to mathematical recalculation directly from
the information in an accounting restatement:
(A) The amount shall be based on a reasonable estimate of the
effect of the accounting restatement on the stock price or total
shareholder return upon which the incentive-based compensation was
received; and
(B) The issuer shall maintain documentation of the determination of
that reasonable estimate and provide such documentation to the exchange
or association.
(iv) The issuer must recover erroneously awarded compensation in
compliance with its recovery policy except to the extent that it would
be impracticable to do so. Recovery would be impracticable only if the
direct expense paid to a third party to assist in enforcing the policy
would exceed the amount to be recovered, or if recovery would violate
home country law. Before concluding that it would be impracticable to
recover any amount of erroneously awarded compensation based on expense
of enforcement, the issuer must first make a reasonable attempt to
recover that erroneously awarded compensation. The issuer shall
document such reasonable attempt(s) to recover, and provide that
documentation to the exchange or association. Before concluding that it
would be impracticable to recover any amount of erroneously awarded
compensation based on violation of home country law, the issuer must
obtain an opinion of home country counsel, not unacceptable to the
applicable national securities exchange or association, that recovery
would result in such a violation, and shall provide such opinion to the
exchange or association. In addition, the home country law must have
been adopted in such home country prior to the date of publication in
the Federal Register of proposed Rule 10D-1. In either case, the
issuer's committee of independent directors responsible for executive
compensation decisions, or in the absence of such a committee, a
majority of the independent directors serving on the board, shall make
any determination that recovery would be impracticable.
(v) The issuer is prohibited from indemnifying any executive
officer or former executive officer against the loss of erroneously
awarded compensation.
(vi) An issuer that has been delisted from any national securities
exchange or national securities association for failing to comply with
the recovery policy required by this section may not list its
securities on any national securities exchange or national securities
association until the issuer comes into compliance with that policy.
(2) General exemptions. The requirements of this section shall not
apply to the listing of:
(i) A security futures product cleared by a clearing agency that is
registered pursuant to section 17A of the Act (15 U.S.C. 78q-1) or that
is exempt from the registration requirements of section 17A(b)(7)(A)
(15 U.S.C. 78q-1(b)(7)(A)).
(ii) A standardized option, as defined in Sec. 240.9b-1(a)(4),
issued by a clearing agency that is registered pursuant to section 17A
of the Act (15 U.S.C. 78q-1).
(iii) Any security issued by a unit investment trust, as defined in
15 U.S.C. 80a-4(2).
(iv) Any security issued by a management company, as defined in 15
U.S.C. 80a-4(3), that is registered under section 8 of the Investment
Company Act of 1940 (15 U.S.C. 80a-8), if such management company has
not awarded incentive-based compensation to any executive officer of
the company in any of the last three fiscal years, or in the case of a
company that has been listed for less than three fiscal years, since
the listing of the company.
[[Page 41193]]
(c) Definitions. Unless the context otherwise requires, all terms
used in this section have the same meaning as in the Act and the rules
and regulations thereunder. In addition, unless the context otherwise
requires, the following definitions apply for purposes of this section:
(1) Accounting restatement. For purposes of this rule, an
accounting restatement is the result of the process of revising
previously issued financial statements to reflect the correction of one
or more errors that are material to those financial statements.
(2) Date on which an issuer is required to prepare an accounting
restatement. For purposes of Section 10D of the Act (15 U.S.C. 78j-4),
the date on which an issuer is required to prepare an accounting
restatement is the earlier to occur of:
(i) The date the issuer's board of directors, a committee of the
board of directors, or the officer or officers of the issuer authorized
to take such action if board action is not required, concludes, or
reasonably should have concluded, that the issuer's previously issued
financial statements contain a material error; or
(ii) The date a court, regulator or other legally authorized body
directs the issuer to restate its previously issued financial
statements to correct a material error.
Note to paragraph (c)(2): The date specified in paragraph
(c)(2)(i) of this section generally is expected to coincide with the
occurrence of the event described under Item 4.02(a) of Exchange Act
Form 8-K (17 CFR 249.308). Neither date specified in paragraph
(c)(2) of this section is predicated on if or when a Form 8-K is
filed.
(3) Executive officer. For purposes of Section 10D of the Act (15
U.S.C. 78j-4), an executive officer is the issuer's president,
principal financial officer, principal accounting officer (or if there
is no such accounting officer, the controller), any vice-president of
the issuer in charge of a principal business unit, division or function
(such as sales, administration or finance), any other officer who
performs a policy-making function, or any other person who performs
similar policy-making functions for the issuer. Executive officers of
the issuer's parent(s) or subsidiaries shall be deemed executive
officers of the issuer if they perform such policy making functions for
the issuer. In addition, when the issuer is a limited partnership,
officers or employees of the general partner(s) who perform policy-
making functions for the limited partnership are deemed officers of the
limited partnership. When the issuer is a trust, officers or employees
of the trustee(s) who perform policy-making functions for the trust are
deemed officers of the trust.
Note to paragraph (c)(3): Policy-making function is not intended
to include policy-making functions that are not significant. If
pursuant to Item 401(b) of Regulation S-K (Sec. 229.401(b)) the
issuer identifies a person as an executive officer, it is presumed
that the Board of Directors has made that judgment and that the
persons so identified are the executive officers for purposes of
Section 10D of the Act (15 U.S.C. 78j-4), as are such other persons
enumerated in this paragraph (c)(3) but not in Item 401(b).
(4) Incentive-based compensation. For purposes of Section 10D (15
U.S.C. 78j-4), incentive-based compensation is any compensation that is
granted, earned or vested based wholly or in part upon the attainment
of a financial reporting measure. Financial reporting measures are
measures that are determined and presented in accordance with the
accounting principles used in preparing the issuer's financial
statements, any measures that are derived wholly or in part from such
measures, and stock price and total shareholder return. A financial
reporting measure need not be presented within the financial statements
or included in a filing with the Commission.
(5) Material noncompliance. For purposes of Section 10D (15 U.S.C.
78j-4), a restatement to correct an error that is material to
previously issued financial statements shall be deemed to result from
material noncompliance of the issuer with a financial reporting
requirement under the securities laws.
(6) Received. For purposes of Section 10D (15 U.S.C. 78j-4),
incentive-based compensation is deemed received in the issuer's fiscal
period during which the financial reporting measure specified in the
incentive-based compensation award is attained, even if the payment or
grant of the incentive-based compensation occurs after the end of that
period.
0
7. Amend Section 240.14a-101, by adding Item 22(b)(20) and Item 25 to
read as follows:
Sec. 240.14a-101 Schedule 14A. Information required in proxy
statement.
SCHEDULE 14A INFORMATION
* * * * *
Item 22. * * *
(b) * * *
(20) In the case of a Fund that is an investment company registered
under the Investment Company Act of 1940 (15 U.S.C. 80a) that is
required to develop and implement a policy regarding the recovery of
erroneously awarded compensation pursuant to Sec. 240.10D-1(b)(1), if
at any time during the last completed fiscal year either a restatement
that required recovery of excess incentive-based compensation pursuant
to the Fund's compensation recovery policy was completed or there was
an outstanding balance of excess incentive-based compensation from the
application of the policy to a prior restatement, the Fund shall
provide the following information:
(i) For each restatement:
(A) The date on which the Fund was required to prepare an
accounting restatement, as defined in Sec. 240.10D-1(c)(2);
(B) The aggregate dollar amount of excess incentive-based
compensation attributable to such accounting restatement;
(C) The estimates that were used in determining the excess
incentive-based compensation attributable to such accounting
restatement, if the financial reporting measure related to a stock
price or total shareholder return metric; and
(D) The aggregate dollar amount of excess incentive-based
compensation that remains outstanding at the end of the last completed
fiscal year;
(ii) If during the last completed fiscal year the Fund decided not
to pursue recovery from any individual subject to recovery of excess
incentive-based compensation attributable to an accounting restatement,
for each such individual, the name and amount forgone and a brief
description of the reason the Fund decided in each case not to pursue
recovery; and
(iii) The name of each individual from whom, as of the end of the
last completed fiscal year, excess incentive-based compensation had
been outstanding for 180 days or longer since the date the issuer
determined the amount the individual owed, and the dollar amount of
outstanding excess incentive-based compensation due from each such
individual.
Instructions to paragraph 22(b)(20).
1. Information provided under this paragraph is deemed to satisfy
the requirements of paragraphs (b)(8) and (b)(11) of Item 22 with
respect to the recovery of erroneously awarded compensation pursuant to
Sec. 240.10D-1(b)(1).
2. A compensation recovery policy is the policy required by the
listing standards adopted pursuant to Sec. 240.10D-1.
3. Excess incentive-based compensation'' is the erroneously awarded
compensation computed as provided in Sec. 240.10D-1(b)(1)(iii) and the
applicable listing standards for the Fund's securities.
[[Page 41194]]
4. If the aggregate dollar amount of excess incentive-based
compensation has not yet been determined, disclose this fact and
explain the reason(s).
* * * * *
Item 25. Exhibits.
Provide the information required to be disclosed by Item 402(w) of
Regulation S-K (17 CFR 229.402(w)), or Item 22(b)(20) of this Schedule
14A, in an exhibit to this Schedule 14A electronically formatted using
the eXtensible Business Reporting Language (XBRL) interactive data
standard in accordance with the EDGAR Filer Manual (17 CFR 232.11). The
exhibit must be block-text tagged.
* * * * *
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
8. The authority citation for part 249 is revised to read as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78a et seq., 78c, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78j-3, 78l, 78m, 78n, 78n-1, 78o, 78p, 78q,
78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37,
80b-3, 80b-4 80b-11, and 7201 et seq.; 12 U.S.C. 5461 et seq.; and
18 U.S.C. 1350, unless otherwise noted.
* * * * *
* * * * *
0
9. Amend Form 20-F (referenced in Sec. 249.220f) by adding Item 6.F
and Instructions to Item 6.F, and adding Instruction 17 to the
Instructions as to Exhibits, of Form 20-F, to read as follows:
Note: The text of Form 20-F does not, and this amendment will
not, appear in the Code of Federal Regulations.
FORM 20-F
* * * * *
Item 6. Directors, Senior Management and Employees
* * * * *
F. Disclosure of a listed issuer's action to recover erroneously
awarded compensation. If at any time during the last completed fiscal
year either a restatement that required recovery of excess incentive-
based compensation pursuant to the listed issuer's compensation
recovery policy was completed or there was an outstanding balance of
excess incentive-based compensation from the application of the policy
to a prior restatement, the listed issuer shall, in its annual report
on Form 20-F, provide the following information:
(1) For each restatement:
(i) The date on which the listed issuer was required to prepare an
accounting restatement, as defined in Rule 10D-1(c)(2) under the
Exchange Act (17 CFR 240.10D-1(c)(2));
(ii) The aggregate dollar amount of excess incentive-based
compensation attributable to such accounting restatement;
(iii) The estimates that were used in determining the excess
incentive-based compensation attributable to such accounting
restatement, if the financial reporting measure related to a stock
price or total shareholder return metric; and
(iv) The aggregate dollar amount of excess incentive-based
compensation that remains outstanding at the end of the last completed
fiscal year;
(2) If during the last completed fiscal year the listed issuer
decided not to pursue recovery from any individual subject to recovery
of excess incentive-based compensation attributable to an accounting
restatement, for each such individual, the name and amount forgone and
a brief description of the reason the listed issuer decided in each
case not to pursue recovery; and
(3) The name of each individual from whom, as of the end of the
last completed fiscal year, excess incentive-based compensation had
been outstanding for 180 days or longer since the date the issuer
determined the amount the individual owed, and the dollar amount of
outstanding excess incentive-based compensation due from each such
individual.
(4) The disclosure required to be provided by Item 6.F shall appear
with, and in the same format as, the rest of the disclosure required to
be provided by Item 6 and, in addition, shall be electronically
formatted using the eXtensible Business Reporting Language (XBRL)
interactive data standard in accordance with the EDGAR Filer Manual (17
CFR 232.11) as an exhibit to this Form. The XBRL format disclosure
required to be provided by this Item 6.F must be block-text tagged.
Instructions to Item 6.F.
1. For purposes of this Item, a ``listed issuer'' is an issuer that
had a class of securities listed on a national securities exchange
registered pursuant to section 6(a) of the Exchange Act (15 U.S.C. 78f)
or a national securities association registered pursuant to section
15A(a) of the Exchange Act (15 U.S.C. 78o-3) at any time during its
last completed fiscal year.
2. A ``compensation recovery policy'' is the policy required by the
listing standards adopted pursuant to Rule 10D-1 under the Exchange Act
(17 CFR 240.10D-1).
3. ``Excess incentive-based compensation'' is the erroneously
awarded compensation computed as provided in Rule 10D-1(b)(1)(iii)
under the Exchange Act (17 CFR 240.10D-1(b)(1)(iii)) and the applicable
listing standards for the listed issuer's securities.
4. If the aggregate dollar amount of excess incentive-based
compensation has not yet been determined, disclose this fact and
explain the reason(s).
5. The information required by Item 6.F must be disclosed only in
annual reports and does not apply to registration statements on Form
20-F. The information required by this Item 6.F will not be deemed to
be incorporated by reference into any filing under the Securities Act,
except to the extent that the listed issuer specifically incorporates
it by reference.
* * * * *
Item 7. Major Shareholders and Related Party Transactions
* * * * *
Instructions to Item 7.B * * *
4. Disclosure need not be provided pursuant to this Item if the
transaction involves the recovery of excess incentive-based
compensation that is disclosed pursuant to Item 6.F.
* * * * *
INSTRUCTIONS AS TO EXHIBITS
* * * * *
96. A listed issuer must provide as an exhibit to its Exchange Act
annual report on Form 20-F the compensation recovery policy required by
the applicable listing standards adopted pursuant to Rule 10D-1 under
the Exchange Act (17 CFR 240.10D-1) . For purposes of this paragraph, a
``listed issuer'' is a registrant that had a class of securities listed
on a national securities exchange registered pursuant to section 6 of
the Exchange Act (15 U.S.C. 78f) or a national securities association
registered pursuant to section 15A of the Exchange Act (15 U.S.C. 78o-
3) at any time during its last completed fiscal year.
97. The compensation recovery disclosure is required to be provided
by a listed issuer under Item 6.F in electronic format using the XBRL
interactive data standard in accordance with the EDGAR Filer Manual (17
CFR 232.11). The exhibit must be block-text tagged. 17 through 95 and
98 through 99 [Reserved]
* * * * *
0
10. Amend Form 40-F (referenced in Sec. 249.240f) by adding paragraph
(17) to General Instruction B and Instructions to paragraph (17) of
General Instruction B to read as follows:
[[Page 41195]]
Note: The text of Form 40-F does not, and this amendment will
not, appear in the Code of Federal Regulations.
FORM 40-F
* * * * *
(17) Recovery of erroneously awarded compensation.
(a) A listed issuer shall include as exhibit 96 the compensation
recovery policy required by the applicable listing standards adopted
pursuant to Exchange Act Rule 10D-1 (17 CFR 240.10D-1).
(b) If at any time during the last completed fiscal year either a
restatement that required recovery of excess incentive-based
compensation pursuant to the listed issuer's compensation recovery
policy was completed or there was an outstanding balance of excess
incentive-based compensation from the application of the policy to a
prior restatement, the listed issuer shall, in its annual report on
Form 40-F, provide the following information:
(1) For each restatement:
(i) The date on which the listed issuer was required to prepare an
accounting restatement, as defined in Exchange Act Rule 10D-1(c)(2) (17
CFR 240.10D-1(c)(2));
(ii) The aggregate dollar amount of excess incentive-based
compensation attributable to such accounting restatement;
(iii) The estimates that were used in determining the excess
incentive-based compensation attributable to such accounting
restatement, if the financial reporting measure related to a stock
price or total shareholder return metric; and
(iv) The aggregate dollar amount of excess incentive-based
compensation that remains outstanding at the end of the last completed
fiscal year;
(2) If during the last completed fiscal year the listed issuer
decided not to pursue recovery from any individual subject to recovery
of excess incentive-based compensation attributable to an accounting
restatement, for each such individual, the name and amount forgone and
a brief description of the reason the listed issuer decided in each
case not to pursue recovery; and
(3) The name of each individual from whom, as of the end of the
last completed fiscal year, excess incentive-based compensation had
been outstanding for 180 days or longer since the date the issuer
determined the amount the individual owed, and the dollar amount of
outstanding excess incentive-based compensation due from each such
individual.
(4) The disclosure required to be provided by paragraph (17) of
General Instruction B shall appear with, and in the same format as
generally required for, the rest of the disclosure required to be
provided by General Instruction B and, in addition, shall be
electronically formatted using the eXtensible Business Reporting
Language (XBRL) interactive data standard in accordance with the EDGAR
Filer Manual (17 CFR 232.11) as exhibit 97 to this Form. The XBRL
format disclosure required to be provided by paragraph (17) of General
Instruction B must be block-text tagged.
Instructions to paragraph (17).
1. For purposes of this paragraph, a ``listed issuer'' is an issuer
that had a class of securities listed on a national securities exchange
registered pursuant to section 6 of the Exchange Act (15 U.S.C. 78f) or
a national securities association registered pursuant to section 15A of
the Exchange Act (15 U.S.C. 78o-3) at any time during its last
completed fiscal year.
2. A ``compensation recovery policy'' is the policy required by the
listing standards adopted pursuant to Exchange Act Rule 10D-1 (17 CFR
240.10D-1).
3. ``Excess incentive-based compensation'' is the erroneously
awarded compensation computed as provided in Exchange Act Rule 10D-
1(b)(1)(iii) (17 CFR 240.10D-1(b)(1)(iii)) and the applicable listing
standards for the listed issuer's securities.
4. If the aggregate dollar amount of excess incentive-based
compensation has not yet been determined, disclose this fact and
explain the reason(s).
5. The information required by paragraph (17) of General
Instruction B must be disclosed only in annual reports and does not
apply to registration statements on Form 40-F. The information required
by this paragraph (17) will not be deemed to be incorporated by
reference into any filing under the Securities Act, except to the
extent that the listed issuer specifically incorporates it by
reference.
* * * * *
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
11. The general authority citation for Part 274 is revised to read as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78j-4,
78l, 78m, 78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L.
111-203, sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.
* * * * *
0
12. Amend Form N-CSR (referenced in 17 CFR 274.128) by:
0
a. Revising General Instruction D;
0
b. Redesignating Item 12 as Item 13;
0
c. Adding new Item 12;
0
d. Redesignating paragraph (a)(2) of newly designated Item 13
(Exhibits) as paragraph (a)(4); and
0
e. Adding paragraphs (a)(2) and (a)(3) to redesignated Item 13
(Exhibits).
The additions read as follows:
Note: The text of Form N-CSR does not, and this amendment will
not, appear in the Code of Federal Regulations.
FORM N-CSR
* * * * *
GENERAL INSTRUCTIONS * * *
D. Incorporation by Reference
A registrant may incorporate by reference information required by
Items 4, 5, 12, and 13(a)(1). No other Items of the Form shall be
answered by incorporating any information by reference. The information
required by Items 4, 5, and 12 may be incorporated by reference from
the registrant's definitive proxy statement (filed or required to be
filed pursuant to Regulation 14A (17 CFR 240.14a-1 et seq.)) or
definitive information statement (filed or to be filed pursuant to
Regulation 14C (17 CFR 240.14c-1 et seq.)) which involves the election
of directors, if such definitive proxy statement or information
statement is filed with the Commission not later than 120 days after
the end of the fiscal year covered by an annual report on this Form.
All incorporation by reference must comply with the requirements of
this Form and the following rules on incorporation by reference: Rule
10(d) of Regulation S-K under the Securities Act of 1933 (17 CFR
229.10(d)) (general rules on incorporation by reference, which, among
other things, prohibit, unless specifically required by this Form,
incorporating by reference a document that includes incorporation by
reference to another document, and limits incorporation to documents
filed within the last 5 years, with certain exceptions); Rule 303 of
Regulation S-T (17 CFR 232.303) (specific requirements for
electronically filed documents); Rules 12b-23 and 12b-32 under the
Exchange Act (additional rules on incorporation by reference for
reports filed pursuant to Sections 13 and 15(d) of the Exchange Act);
and Rules 0-4, 8b-23, and 8b-32 under the Investment Company Act of
1940 (17 CFR 270.0-4, 270.8b-23, and 270.8b-32) (additional rules on
incorporation by reference for investment companies).
* * * * *
Item 12. Recovery of Erroneously Awarded Compensation
In the case of a registrant that is required to develop and
implement a
[[Page 41196]]
policy regarding the recovery of erroneously awarded compensation
pursuant to Rule 10D-1(b)(1) under the Exchange Act (17 CFR 240.10D-1),
if at any time during the last completed fiscal year either a
restatement that required recovery of excess incentive-based
compensation pursuant to the registrant's compensation recovery policy
was completed or there was an outstanding balance of excess incentive-
based compensation from the application of the policy to a prior
restatement, the registrant shall provide the following information:
(a) For each restatement:
(1) The date on which the registrant was required to prepare an
accounting restatement, as defined in Rule 10D-1(c)(2) under the
Exchange Act (17 CFR 240.10D-1(c)(2));
(2) The aggregate dollar amount of excess incentive-based
compensation attributable to such accounting restatement;
(3) The estimates that were used in determining the excess
incentive-based compensation attributable to such accounting
restatement, if the financial reporting measure related to a stock
price or total shareholder return metric; and
(4) The aggregate dollar amount of excess incentive-based
compensation that remains outstanding at the end of the last completed
fiscal year;
(b) If during the last completed fiscal year the registrant decided
not to pursue recovery from any individual subject to recovery of
excess incentive-based compensation attributable to an accounting
restatement, for each such individual, the name and amount forgone and
a brief description of the reason the registrant decided in each case
not to pursue recovery; and
(c) The name of each individual from whom, as of the end of the
last completed fiscal year, excess incentive-based compensation had
been outstanding for 180 days or longer since the date the issuer
determined the amount the individual owed, and the dollar amount of
outstanding excess incentive-based compensation due from each such
individual.
Instructions
1. The information required by this Item is only required in an
annual report on Form N-CSR.
2. A ``compensation recovery policy'' is the policy required by the
listing standards adopted pursuant to Rule 10D-1 under the Exchange Act
(17 CFR 240.10D-1).
3. ``Excess incentive-based compensation'' is the erroneously
awarded compensation computed as provided in Rule 10D-1(b)(1)(iii)
under the Exchange Act (17 CFR 240.10D-1(b)(1)(iii)) and the applicable
listing standards for the listed registrant's securities.
4. If the aggregate dollar amount of excess incentive-based
compensation has not yet been determined, disclose this fact and
explain the reason(s).
Item 13. Exhibits
(a) * * *
(2) Any policy required by the listing standards adopted pursuant
to Rule 10D-1 under the Exchange Act (17 CFR 240.10D-1) by the
registered national securities exchange or registered national
securities association upon which the registrant's securities are
listed.
Instruction to Paragraph (a)(2)
The exhibit required by this paragraph (a)(2) is only required in
an annual report on Form N-CSR.
(3) Unless the information required by Item 12 is answered by
incorporating by reference from the registrant's definitive proxy
statement or definitive information statement pursuant to General
Instruction D, provide the information required to be disclosed by Item
12 in an exhibit to this Form electronically formatted using the
eXtensible Business Reporting Language (XBRL) interactive data standard
in accordance with the EDGAR Filer manual (17 CFR 232.11). The exhibit
must be block-text tagged.
Instruction to Paragraph (a)(3)
The exhibit required by this paragraph (a)(3) is only required in
an annual report on Form N-CSR.
* * * * *
By the Commission.
Dated: July 1, 2015.
Brent J. Fields,
Secretary.
[FR Doc. 2015-16613 Filed 7-13-15; 8:45 am]
BILLING CODE 8011-01-P