[Federal Register Volume 87, Number 227 (Monday, November 28, 2022)]
[Rules and Regulations]
[Pages 73076-73142]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-23757]
[[Page 73075]]
Vol. 87
Monday,
No. 227
November 28, 2022
Part II
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Parts 229, 232, et al.
Listing Standards for Recovery of Erroneously Awarded Compensation;
Final Rule
Federal Register / Vol. 87 , No. 227 / Monday, November 28, 2022 /
Rules and Regulations
[[Page 73076]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 229, 232, 240, 249, 270, and 274
[Release Nos. 33-11126; 34-96159; IC-34732; File No. S7-12-15]
RIN 3235-AK99
Listing Standards for Recovery of Erroneously Awarded
Compensation
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: We are adopting a new rule and rule amendments to implement
Section 954 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (``Dodd-Frank Act''), which added Section 10D to
the Securities Exchange Act of 1934 (``Exchange Act''). In accordance
with Section 10D of the Exchange Act, the final rules direct the
national securities exchanges and associations that list securities to
establish listing standards that require each issuer to develop and
implement a policy providing for the recovery, in the event of a
required accounting restatement, of incentive-based compensation
received by current or former executive officers where that
compensation is based on the erroneously reported financial
information. The listing standards must also require the disclosure of
the policy. Additionally, the final rules require a listed issuer to
file the policy as an exhibit to its annual report and to include other
disclosures in the event a recovery analysis is triggered under the
policy.
DATES: The amendments are effective January 27, 2023.
FOR FURTHER INFORMATION CONTACT: Steven G. Hearne, Senior Special
Counsel, at (202) 551-3430, in the Office of Rulemaking, Division of
Corporation Finance, U.S. Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are adopting amendments to:
------------------------------------------------------------------------
Commission reference CFR citation (17 CFR)
------------------------------------------------------------------------
Regulation S-K............................
Item 10 through 1406.................. Sec. Sec. 229.10 through
229.1406.
Item 402.............................. Sec. 229.402.
Item 404.............................. Sec. 229.404.
Item 601.............................. Sec. 229.601.
Rule 10 through 903................... Sec. Sec. 232.10 through
232.903.
Rule 405.............................. Sec. 232.405.
Exchange Act \1\..........................
Rule 10D-1............................ Sec. 240.10D-1.
Schedule 14A.......................... Sec. 240.14a-101.
Form 20-F................................. Sec. 249.220f.
Form 40-F............................. Sec. 249.240f.
Form 10-K............................. Sec. 249.310.
Exchange Act and Investment Company Act of
1940 (``Investment Company Act'')\2\.
Form N-CSR............................ Sec. Sec. 249.331 and
274.128.
Investment Company Act....................
Rule 30a-2............................ Sec. 270.30a-2.
------------------------------------------------------------------------
Table of Contents
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78a et seq.
\2\ 15 U.S.C. 80a-1 et seq.
---------------------------------------------------------------------------
I. Introduction and Background
II. Discussion of Final Amendments
A. Issuers and Securities Subject To Exchange Act Rule 10D-1
1. Proposed Amendments
2. Comments
3. Final Amendments
B. Restatements
1. Restatements Triggering Application of Recovery Policy
a. Proposed Amendments
b. Comments
c. Final Amendments
2. Date the Issuer Is Required To Prepare an Accounting
Restatement
a. Proposed Amendments
b. Comments
c. Final Amendments
C. Application of Recovery Policy
1. Executive Officers Subject to Recovery Policy
a. Proposed Amendments
b. Comments
c. Final Amendments
2. Incentive-Based Compensation
a. Incentive-Based Compensation Subject to Recovery Policy
i. Proposed Amendments
ii. Comments
iii. Final Amendments
b. When Compensation Is ``Received'' and Time Period Covered
i. Proposed Amendments
ii. Comments
iii. Final Amendments
3. Recovery Process
a. Calculation of Erroneously Awarded Compensation
i. Proposed Amendments
ii. Comments
iii. Final Amendments
b. Board Discretion Regarding Whether To Seek Recovery
i. Proposed Amendments
ii. Comments
iii. Final Amendments
c. Board Discretion Regarding the Means of Recovery
i. Proposed Amendments
ii. Comments
iii. Final Amendments
D. Disclosure of Issuer Policy on Incentive-Based Compensation
1. Proposed Amendments
2. Comments
3. Final Amendments
E. Indemnification and Insurance
1. Proposed Amendments
2. Comments
3. Final Amendments
F. Transition and Timing
1. Proposed Amendments
2. Comments
3. Final Amendments
III. Other Matters
IV. Economic Analysis
A. Baseline
B. Analysis of Potential Economic Effects
1. Direct Effects on Issuers and Shareholders
2. Effects on U.S. Exchanges and Listings
3. Costs of Recovery
4. Effects on Financial Reporting
5. Effects on Executive Compensation
6. Effects of Disclosure and Tagging Requirements
7. Indemnification and Insurance
8. Effects May Vary for Different Types of Issuers
C. Alternatives
1. Exemptions for Certain Categories of Issuers
2. Excluding Incentive-Based Compensation Tied to Stock Price
3. Including Only ``Big R'' Restatements as Trigger Events
4. Other Alternatives Considered
V. Paperwork Reduction Act
A. Summary of the Collection of Information
B. Summary of the Final Amendments and Effect of the Final
Amendments on Existing Collections of Information
C. Burden and Cost Estimates Related to the Final Amendments
VI. Final Regulatory Flexibility Act Analysis
A. Need for, and Objectives of, the Final Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Final Amendments
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
Statutory Authority
I. Introduction and Background
Section 954 of the Dodd-Frank Act added 15 U.S.C. 78j-4 (``Section
10D'') to the Exchange Act. Title 15 Section 78j-4 (a) of the U.S. Code
(``Section 10D(a)'') requires the Securities and Exchange Commission
(the ``Commission'') to adopt rules directing the national securities
exchanges \3\
[[Page 73077]]
(``exchanges'') and the national securities associations \4\
(``associations'') to prohibit the listing of any security of an issuer
that is not in compliance with the requirements of 15 U.S.C. 78j-4(b)
(``Section 10D(b)''). Section 10D(b) of the Exchange Act requires the
Commission to adopt rules directing the exchanges to establish listing
standards that require each issuer to develop and implement a policy
providing:
---------------------------------------------------------------------------
\3\ A ``national securities exchange'' is an exchange registered
as such under 15 U.S.C. 78f (``Section 6 of the Exchange Act'').
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, because
the final rules exempt security futures products and standardized
options from their scope, any registered national securities
exchange that lists and trades only security futures products or
standardized options is not required to file a rule change in order
to comply.
\4\ A ``national securities association'' is an association of
brokers and dealers registered as such under 15 U.S.C. 78o-3
(``Section 15A of the Exchange Act''). 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
exchanges in this release. However, if any associations were to list
securities, the rules would apply to them.
---------------------------------------------------------------------------
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
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 incentive-based compensation (including stock
options awarded as compensation) that was received 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.
In seeking to implement this statutory mandate, we have been guided
by the language, structure, and legislative history of Section 10D. As
a part of the Dodd-Frank Act legislative process, in a 2010 report, the
Senate Committee on Banking, Housing and Urban Affairs stated that
``Section 954 [Section 10D] requires public companies to have a policy
to recover money that they erroneously paid in incentive compensation
to executive officers as a result of material noncompliance with
accounting rules.'' \5\ The Senate Report further clarified that
application of the recovery policy mandated by Section 10D ``does not
require adjudication of misconduct in connection with the problematic
accounting that required restatement.'' \6\
---------------------------------------------------------------------------
\5\ See Report of the Senate Committee on Banking, Housing, and
Urban Affairs, S.3217, Report No. 111-176 at 135-36 (Apr. 30, 2010)
(``Senate Report'') at 135.
\6\ Id.
---------------------------------------------------------------------------
The Senate Report highlighted the Committee's belief that it is
``unfair to shareholders for corporations to allow executive officers
to retain compensation that they were awarded erroneously.'' \7\ The
language and legislative history of the Dodd-Frank Act make clear that
Section 10D is premised on the notion that an executive officer should
not retain incentive-based compensation that, had the issuer's
accounting been correct in the first instance, would not have been
received by the executive officer, regardless of any fault of the
executive officer for the accounting errors. The Senate Report also
indicates that shareholders should not ``have to embark on costly legal
expenses to recoup their losses'' and that ``executives must return
monies that should belong to the shareholders.'' \8\
---------------------------------------------------------------------------
\7\ Id.
\8\ Id.
---------------------------------------------------------------------------
Informed by this legislative history, we read Section 10D to
express a simple proposition: executive officers of exchange-listed
issuers should not be entitled to retain incentive-based compensation
that was erroneously awarded on the basis of materially misreported
financial information that requires an accounting restatement. The
statute thus mandates that exchange-listed issuers maintain policies to
recover such compensation for the benefit of the issuers' owners--their
shareholders. In light of the straightforward nature of the goal
Congress sought to achieve, we have approached implementation of the
statute with the view that discretion to implement and execute these
mandated recovery policies generally should be limited.
For similar reasons, we believe Section 10D's mandated recovery
policies were intended to apply broadly. Because Congress specifically
referenced ``incentive-based compensation (including stock options
awarded as compensation),'' we infer that it intended the provision to
cover any incentive-based compensation that may be impacted by
financial reporting. Further, Congress did not define ``executive
officers'' narrowly by limiting the term to include only the named
executive officers or another subset of executives; rather it appears
that Congress intended the scope of the statute to reach more broadly
to include all of an issuer's executive officers.\9\ While this scope
may result in recovery from officers who did not play a direct role in
an accounting error or who did not help to set a ``tone at the top''
that affects financial reporting accuracy, we understand that effect to
be consistent with the statutory purpose of recovering compensation
erroneously paid to executive officers regardless of whether the
executive officer directly contributed to the error.
---------------------------------------------------------------------------
\9\ While Section 10D applies broadly to all executive officers
and Congress did not specify a subset of executive officers, the
Senate Report makes clear it is not intended to apply to rank-and-
file employees. See Senate Report at 136 (``This policy is required
to apply to executive officers, a very limited number of employees,
and is not required to apply to other employees'').
---------------------------------------------------------------------------
In addition to the benefits and purposes that Congress identified
when enacting Section 10D, our implementation of the statute has been
informed by certain additional benefits of the recovery requirement. As
discussed in Section IV.B., the recovery requirement may provide
executive officers with an increased incentive to take steps to reduce
the likelihood of inadvertent misreporting and will reduce the
financial benefits to executive officers who choose to pursue
impermissible accounting methods, which we expect will further
discourage such behavior. These increased incentives may improve the
overall quality and reliability of financial reporting, which further
benefits investors. These additional benefits further support our view
that the most appropriate means of implementing the Section 10D mandate
is to require robust recovery policies that will help to ensure that
executive officers at exchange-listed issuers do not retain the
benefits of erroneously awarded incentive-based compensation.
On July 1, 2015, the Commission proposed a new rule, and rule and
form amendments \10\ to implement the provisions of Section 10D.\11\ On
October 14, 2021, the Commission reopened the comment period for the
Proposing Release to allow interested persons further opportunity to
analyze and comment upon the proposed rules in light of developments
since the publication of the Proposing Release and the Commission's
further consideration of the statutory mandate.\12\ In the Reopening
Release, the Commission stated that it was considering, and requested
public comment on, certain revisions to the proposals included in the
Proposing Release, including a broader
[[Page 73078]]
interpretation of the statutory term ``an accounting restatement due to
material noncompliance.'' \13\ The Commission re-opened the comment
period again on June 8 2022, in connection with the addition to the
comment file of a memorandum prepared by Commission staff providing
additional analysis on compensation recovery policies and accounting
restatements.\14\ We have received numerous comment letters pursuant to
our initiative to receive advance public comment in implementing the
Dodd-Frank Act,\15\ in response to the Proposing Release, and in
response to the reopening releases.\16\ Commenters broadly supported
the objectives of the proposed rules, although commenters offered
various recommendations and expressed various concerns regarding the
proposed implementation. As discussed further below, after reviewing
and considering the public comments and recommendations and guided by
our understanding of the goal Congress was trying to achieve, we are
adopting the proposed rules substantially as proposed, but with certain
modifications to broaden the scope of covered restatements, clarify the
rules, and address comments received on the proposals.
---------------------------------------------------------------------------
\10\ See Listing Standards for Recovery of Erroneously Awarded
Compensation, Release No. 34-75342 (Jul. 1, 2015) [80 FR 41144 (July
14, 2015)] (``Proposing Release'').
\11\ Public Law 111-203, 124 Stat. 1900 (2010).
\12\ See Reopening of Comment Period for Listing Standards for
Recovery of Erroneously Awarded Compensation, Release No. 34-93311
(Oct. 14, 2021) [86 FR 58232 (Oct. 21, 2021)] (``Reopening
Release'').
\13\ See generally, Reopening Release.
\14\ See Reopening of Comment Period for Listing Standards for
Recovery of Erroneously Awarded Compensation, Release No. 34-95057
(June 8, 2022) [87 FR 35938 (June 14, 2022)] (``Second Reopening
Release''). See also Memorandum from the Division of Economic and
Risk Analysis (June 8, 2022) (submitted to the comment file in
connection with Second Reopening Release) (``2022 staff
memorandum'').
\15\ Comment letters related to the executive compensation
provisions of the Dodd-Frank Act provided prior to the Proposing
Release are available at http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml.
\16\ Comment letters related to the Proposing Release, the
Reopening Release, and the Second Reopening Release are available at
https://www.sec.gov/comments/s7-12-15/s71215.htm. A comment letter
from two members of Congress raised concerns about the Reopening
Release. See comment letter from Sen. Pat Toomey and Sen. Richard
Shelby, dated Feb. 1, 2022 (``Toomey/Shelby''). Specifically, the
letter criticized the Commission for reopening the comment period on
the Proposing Release and seeking comment on a number of regulatory
alternatives without updating the cost-benefit analysis and analysis
required by 44 U.S.C. 3501 et seq. (``Paperwork Reduction Act'' or
``PRA'') and 5 U.S.C. 601 et seq. (``Regulatory Flexibility Act'' or
``RFA'') and urged the Commission to repropose the rulemaking. The
letter asserted that the approach taken in the Reopening Release
significantly impaired the public's ability to comment thoughtfully
on the proposals and was inconsistent with 5 U.S.C. 551 through 559
(``Administrative Procedure Act''). In response to these concerns,
we note that the Reopening Release included a robust discussion of
the broader interpretation of the statutory term under consideration
and certain potential changes and solicited comment on that
interpretation and those potential changes. The 2022 staff
memorandum in connection with the Second Reopening Release analyzed
the benefits and costs of the potential changes. The 2022 staff
memorandum also considered the impact on smaller registrants. Given
the discussion included in the Proposing Release, the Reopening
Release, the Second Reopening Release, and the 2022 staff
memorandum, and in this adopting release, we believe the final rules
satisfy the requirements of the Administrative Procedure Act and
other applicable statutes and that a reproposal is unnecessary.
Moreover, in response to both the Reopening and Second Reopening
Releases, we received numerous comments from members of the public
on the potential changes and additional disclosures, including
comments on their economic effects, and we have considered those
comments in adopting the final rules.
---------------------------------------------------------------------------
II. Discussion of Final Amendments
New Exchange Act Rule 10D-1 sets forth the listing requirements
that exchanges and associations that list securities are directed to
establish pursuant to Section 10D of the Exchange Act. Amendments to
Regulation S-K, Form 10-K, Form 20-F, Form 40-F, and for certain
investment companies, Form N-CSR and Schedule 14A, require disclosure
of the listed issuer's policy on recovery of incentive-based
compensation and information about actions taken pursuant to such
recovery policy.
New Exchange Act Rule 10D-1 and the rule amendments adopted in this
release supplement existing provisions \17\ by directing the exchanges
to establish listing standards that require issuers to: \18\
---------------------------------------------------------------------------
\17\ See 15 U.S.C. 7243 (providing that the chief executive
officer (``CEO'') and chief financial officer (``CFO'') of an issuer
must reimburse the issuer for bonus or other incentive-based or
equity-based compensation resulting from an accounting restatement
due to the material noncompliance of the issuer, as a result of
misconduct) and 17 CFR 229.402(b) (requiring disclosure of company
policies and decisions regarding the adjustment or recovery of
awards or payments to named executive officers in the issuer's
Compensation Discussion and Analysis (``CD&A'')). The CD&A
disclosure requirement is principles-based in that it identifies the
disclosure concept and provides several non-exclusive examples.
Under 17 CFR 229.402(b)(1), companies must explain all material
elements of their named executive officers' compensation by
addressing mandatory principles-based topics in CD&A. 17 CFR
229.402(b)(2) sets forth nonexclusive examples of the kind of
information that should be addressed in CD&A, if material.
\18\ Exchanges may adopt listing standards with requirements
that are more extensive than those of Rule 10D-1. Listed issuers
may, of course, adopt policies more extensive than those called for
by the listing standards, so long as those policies at a minimum
satisfy the listing standards.
---------------------------------------------------------------------------
Develop and implement written policies for recovery of
incentive-based compensation based on financial information required to
be reported under the securities laws, applicable to the issuers'
executive officers, during the three completed fiscal years immediately
preceding the date that the issuer is required to prepare an accounting
restatement; and
Disclose those compensation recovery policies in
accordance with Commission rules, including providing the information
in tagged data format.
To assure that issuers listed on different exchanges are subject to
the same disclosure requirements regarding erroneously awarded
compensation recovery policies, amendments to the Commission's
disclosure rules require all issuers listed on any exchange to file
their written compensation recovery policy as an exhibit to their
annual reports,\19\ to indicate by check boxes on their annual reports
whether the financial statements of the registrant included in the
filing reflect a correction of an error to previously issued financial
statements and whether any such corrections are restatements that
required a recovery analysis,\20\ and to disclose any actions an issuer
has taken pursuant to such recovery policy.\21\
---------------------------------------------------------------------------
\19\ See 17 CFR 229.601(b)(97), 17 CFR 240.14a-101, 17 CFR
249.220f, 17 CFR 249.240f, and 17 CFR 274.128 Item 19(a)(2).
\20\ See 17 CFR 249.220f, 17 CFR 249.240f, and 17 CFR 249.310.
But see Section II.D.3. regarding check box disclosure on 17 CFR
274.128.
\21\ See 17 CFR 229.402(w) (``Item 402(w) of Regulation S-K''),
17 CFR 240.14a-101(b)(20), 17 CFR 249.220f Item 6.F., 17 CFR
249.240f Item 19, and 17 CFR 274.128 Item 18.
---------------------------------------------------------------------------
A. Issuers and Securities Subject To Exchange Act Rule 10D-1
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.
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.\22\
---------------------------------------------------------------------------
\22\ In this regard, Section 10D differs from other Dodd Frank
Act 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, to provide
exemptions, or to take into account whether the requirements
disproportionately burden small issuers.
---------------------------------------------------------------------------
1. Proposed Amendments
The Commission proposed to require exchanges to apply the
disclosure and recovery policy requirements to all listed issuers, with
only limited exceptions. As Section 10D refers to ``any security'' of
an issuer, the Commission proposed that the listing
[[Page 73079]]
standards and other requirements apply without regard to the type of
securities issued, including to issuers of listed debt or preferred
securities that do not have listed equity.\23\ The Commission did
however propose to exempt security futures products and standardized
options because the Commission recognized that information about the
compensation practices at the clearing agencies that issue these
securities is less relevant to investors,\24\ and to exempt the
securities of certain registered investment companies from the proposed
listing standards because the Commission recognized that the
compensation structures of issuers of these securities render
application of the rules unnecessary.\25\
---------------------------------------------------------------------------
\23\ 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. See proposed Rule
10D-1(b)(1)(vi).
\24\ ``Equity security'' as defined in 15 U.S.C. 78c(a)(11)
includes any security future on any stock or similar security. A
``security future'' as defined in 15 U.S.C. 78c(a)(55) means ``a
contract of sale for future delivery of a single security or of a
narrow-based security index.'' ``Security futures product'' as
defined in 15 U.S.C. 78c(a)(56) and 7 U.S.C. 1a(32) include a
security future or any put, call, straddle, option or privilege on
any security future. Security futures products may be traded on
exchanges registered under 15 U.S.C. 78f and associations registered
under 15 U.S.C. 78o-3 without such securities being subject to the
registration requirements of the Securities Act and the Exchange Act
so long as they are cleared by a clearing agency that is registered
under 15 U.S.C. 78q-1 or that is exempt from registration under 15
U.S.C. 78q-1(b)(7). See 15 U.S.C. 77c(a)(14), 15 U.S.C. 78l(a), 17
CFR 240.12h-1(e). Comparable regulatory treatment exists for
standardized options, which are defined in 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. See 17 CFR
230.238, 17 CFR 240.12a-9, 17 CFR 240.12h-1(d).
\25\ The Commission proposed to exempt the listing of any
security issued by a registered management investment company if
such 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. The Commission additionally proposed to exempt the listing
of any security issued by a unit investment trust.
---------------------------------------------------------------------------
The Commission did not propose to otherwise exempt categories of
listed issuers, such as emerging growth companies (``EGCs''),\26\
smaller reporting companies (``SRCs''),\27\ foreign private issuers
(``FPIs''),\28\ and controlled companies.\29\ The Commission further
did not propose to grant the exchanges discretion to decide whether
certain categories of securities should be exempted from the Section
10D listing standards.
---------------------------------------------------------------------------
\26\ See 15 U.S.C. 77b(a)(19) and 15 U.S.C. 78c(a)(80).
\27\ See 17 CFR 240.12b-2.
\28\ See 17 CFR 240.3b-4(c). The Commission did propose to
permit a FPI to make a determination regarding impracticability to
recover in limited circumstances where doing so would violate home
country law. See Section II.C.3.b, of the Proposing Release and
Section II.C.3.b. for a discussion of impracticability of recovery.
\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.
---------------------------------------------------------------------------
2. Comments
We received substantial comment on whether certain classes of
issuers and securities should be subject to the proposal. Some
commenters supported the scope of issuers covered by the proposal.\30\
Other commenters recommended that the Commission exercise its exemptive
authority to exclude certain issuers and classes of securities from the
requirements.\31\
---------------------------------------------------------------------------
\30\ See, e.g., comment letters from American Federation of
Labor and Congress of Industrial Organizations (``AFL-CIO'');
Americans for Financial Reform (Sept. 14, 2015) (``AFR 1''); Better
Markets, Inc. (Sept. 14, 2015) (``Better Markets 1''); Council of
Institutional Investors (Aug. 27, 2015) (``CII 1''); California
Public Employees' Retirement System (Sept. 14, 2015) (``CalPERS
1''); CFA Institute (Sept. 14, 2015) (``CFA Institute 1''); Robert
E. Rutkowski (Sept. 15, 2015) (``Rutkowski 1''); and State Board of
Administration (``SBA''). Some of these commenters contended that
investors deserve the same protections regardless of the category of
listed issuer. See comment letters from AFL-CIO; CII 1; the Office
of the Comptroller of the State of New York; and Public Citizen
(Nov. 19, 2021) (``Public Citizen 2'').
\31\ See, e.g., comment letters from American Bar Association
Committee on Federal Regulation of Securities of the Section of
Business Law (Feb. 11, 2016) (``ABA 1''); Davis Polk & Wardwell LLP
(Sept. 11, 2015) (``Davis Polk 1''); Duane Morris LLP (``Duane'');
Financial Services Roundtable (``FSR''); Freshfields Bruckhaus
Deringer (``Freshfields''); Japanese Bankers Association (``Japanese
Bankers''); Kaye Scholer LLP (``Kaye Scholer''); SAP SE (``SAP'');
Sullivan & Cromwell LLP (Sept. 22, 2015) (``S&C 1''); TELUS
Corporation (``TELUS''); and UBS Group AG (``UBS'').
---------------------------------------------------------------------------
A number of commenters expressed concern regarding application of
the rules to FPIs,\32\ and suggested that application of the rules
could impose inconsistent standards \33\ and questioned the feasibility
of implementation by FPIs.\34\ Some of these commenters recommended
that the Commission unconditionally exempt FPIs,\35\ noting that FPIs
have been exempted from many of the Commission's executive compensation
regulations and are not subject to Section 16 of the Exchange Act,\36\
and that other U.S. listing standards permit FPIs to comply with home
country standards rather than the U.S. listing standard
requirements.\37\ Commenters alternatively recommended that the
Commission exempt FPIs where the home country has an appropriate
governance regime or law governing erroneously awarded
compensation.\38\
---------------------------------------------------------------------------
\32\ See, e.g., comment letters from ABA 1 (suggesting that the
general presumption against the extraterritorial application of
United States law, as well as the general principle of international
comity, should apply); Davis Polk 1; Duane; FSR (noting the burden
of having to comply with U.S.-based executive compensation
governance in addition to home country laws); Freshfields; Japanese
Bankers (suggesting that ``a penalty on restatement of financial
statements prepared in accordance with the home country accounting
standard should be determined by judicial ruling of the home
country, and should not be governed by the U.S. listing rules'');
Kaye Scholer; SAP; S&C 1; TELUS; and UBS.
\33\ See, e.g., comment letters from the U.S. Chamber of
Commerce Center for Capital Markets Competitiveness (Sept. 14, 2015)
(``CCMC 1'') (suggesting that ``affected [issuers] may find
themselves endeavoring to comply with contradictory laws in multiple
jurisdictions creating conflicts that cannot be addressed with a
single solution''); Freshfields (expressing concerns regarding
potential conflicts between the proposed listing standard and home
country rules and noting potential conflicts with home country laws,
stock exchange requirements, or corporate governance arrangements);
and S&C 1 (stating that ``[r]equiring a non-U.S. issuer to comply
with U.S. and home country requirements would upset the regulatory
framework established by the home country and potentially impose
inconsistent standards''). See also comment letter from Duane
(suggesting the rule could force issuers to choose between violating
home country law or the listing standards).
\34\ See comment letters from CCMC 1; and Kaye Scholer
(suggesting that an issuer's home country has a more appropriate
interest in determining whether companies domiciled there should be
subject to a compensation recovery requirement). See also comment
letters from ABA 1 (noting that such issuers generally adhere to
IFRS, which sets forth criteria for determining when a restatement
is required that differ from GAAP, such that applying the rule to
FPIs may lead to inconsistent treatment among issuers); and Davis
Polk 1.
\35\ See comment letters from ABA 1; Davis Polk 1; Duane; FSR;
Freshfields; Japanese Bankers; Kaye Scholer; SAP; S&C 1; TELUS; and
UBS.
\36\ See, e.g., comment letter from FSR (noting that FPIs have
been exempted from many of the executive compensation regulations
enacted under the Dodd-Frank Act, as well as disclosure requirements
under Item 402 of Regulation S-K, and further stating that because
such issuers are not subject to Section 16, the proposed rules would
require such issuers to design and implement new executive
compensation governance structures).
\37\ See comment letters from UBS (citing the NYSE Group, Inc.
(``NYSE'') audit committee independence rule); and Duane (citing
Exchange Act Section 10C). See also comment letter in response to
the Reopening Release from Cravath, Swaine & Moore LLP (``Cravath'')
(noting the burden placed on FPIs that may be subject to different
corporate governance standards in their home countries).
\38\ See, e.g., comment letters from Freshfields; and TheCityUK
(suggesting permitting compliance with home country provisions that
provide for similarly rigorous disciplines meeting the same goals).
---------------------------------------------------------------------------
One commenter urged the Commission to exempt all registered
investment companies unconditionally, rather than the proposed
exemption for registered unit investment trusts (``UITs'') and for
registered management
[[Page 73080]]
investment companies (``listed funds'') that have not awarded
incentive-based compensation in the last three fiscal years.\39\ The
commenter asserted that the legislative history of the Dodd-Frank Act
does not indicate that the purpose of Section 10D was to address abuses
with respect to listed funds; that listed funds have been exempted from
certain prior compensation-related rulemakings; and that listed fund
financial statements are less complex than operating company financial
statements, resulting in accounting restatements being rare for listed
funds.\40\ The commenter therefore believed that the costs to affected
listed funds would outweigh the benefits. The commenter also stated
that the proposal could affect more than the small number of internally
managed listed funds that the Commission estimated in the proposal,
because some externally managed listed funds may pay some or all of the
funds' chief compliance officers' compensation.
---------------------------------------------------------------------------
\39\ See comment letter from Investment Company Institute (Sept.
14, 2015). ICI submitted a comment letter on the original proposal
in 2015 as well as on the Reopening Release (Nov. 22, 2021). Because
the letters largely made the same points, the letters are referred
to collectively as if they were a single letter (``ICI''). Another
commenter supported the Commission's proposed conditional exemption
for listed funds, while also urging the Commission to exempt them
and certain other issuers unconditionally, but without any further
analysis supporting this recommendation for listed funds. See
comment letter from FSR.
\40\ See comment letter from ICI.
---------------------------------------------------------------------------
Another commenter urged the Commission to extend the proposed
conditional exemption to externally managed business development
companies (``BDCs'').\41\ The commenter asserted that the same policy
considerations supporting the conditional exemption for listed funds
apply to externally managed BDCs, and that provisions of the Investment
Advisers Act of 1940 \42\ and the Investment Company Act effectively
prohibit these BDCs from offering certain incentive compensation plans
to their officers.\43\
---------------------------------------------------------------------------
\41\ See comment letter from Clifford Chance et al.
\42\ 15 U.S.C. 80b-1 through 15 U.S.C. 80b-21.
\43\ See comment letter from Clifford Chance et al.
---------------------------------------------------------------------------
We received limited comment on the Commission's proposal to exempt
security futures products and standardized options. One commenter
generally supported the proposed exemption and no other commenters
objected to the proposal to exempt security futures products and
standardized options, or otherwise addressed this aspect of the
proposal.\44\ Some commenters recommended exemptions for debt-only
issuers \45\ and controlled companies.\46\
---------------------------------------------------------------------------
\44\ See comment letter from ABA 1.
\45\ See, e.g., comment letters from ABA 1; Davis Polk 1 (noting
protections from the indenture contract and Trust Indenture Act, the
ability to negotiate for indenture covenants, and that a wholly-
owned subsidiary of a reporting company are not required to provide
executive compensation disclosure); FSR (suggesting that the harm
that the proposal is designed to address is immaterial to such
investors and that a public parent issuer would have oversight over
its executive compensation and financial statements); Jesse M. Fried
(``Fried''); and Society for Corporate Governance (formerly Society
of Corporate Secretaries & Governance Professionals) (Sept. 18,
2015) (``SCG 1''). See also comment letter in response to the
Reopening Release from Davis Polk (Nov. 22, 2021) (``Davis Polk 3'')
(further noting that debt-only issuers are exempt from many rules
related to executive compensation). In contrast, one commenter
specifically opposed such an exemption. See comment letter from
Better Markets 1.
\46\ See comment letters from Duane; and Fried (both suggesting
that debt-only and controlled companies may have greater control
over executive officers and can employ incentives, such as extra pay
or threat of termination, that would dwarf the incentive effect of a
potential compensation recovery).
---------------------------------------------------------------------------
Some commenters expressed support for requiring recovery by SRCs
and EGCs as proposed,\47\ while others recommended that the Commission
exempt SRCs and EGCs, citing the costs and burdens associated with
imposing compensation recovery policies containing the detail and scope
contemplated by the proposal.\48\ As an alternative to exemption, these
commenters recommended deferring compliance for these issuers.\49\ In
response to the Reopening Release, a number of commenters additionally
noted the burdens on smaller issuers and recommended
accommodations.\50\
---------------------------------------------------------------------------
\47\ See, e.g., comment letters from Better Markets 1; CalPERS 1
(noting small issuers may offer substantial incentive compensation
packages); Public Citizen (Sept. 14, 2015) (``Public Citizen 1'')
(suggesting such issuers lack the wider and potentially more
vigilant shareholder base of larger companies); and SBA
(recommending that strong governance practices should be applied at
early growth stages). See also comment letter from CFA Institute 1
(suggesting it would not be appropriate or necessary to scale the
proposed disclosure requirements for smaller or EGCs).
\48\ See, e.g., comment letters from ABA 1 (further suggesting
that such issuers should not be required to disclose their reasons
for not pursuing recovery or the aggregate amount of excess
compensation remaining outstanding at fiscal year-end); Compensia;
Mercer; and National Association of Corporate Directors (``NACD'').
See also Annual Report for Fiscal Year 2021: Office of the Advocate
for Small Business Capital Formation (``2021 OASB Annual Report''),
available at https://www.sec.gov/files/2021-OASB-Annual-Report.pdf,
at 68 (recommending generally that in engaging in rulemaking that
impacts small businesses, the Commission tailor the disclosure and
reporting framework to the complexity and size of operations of
companies, either by scaling obligations or delaying compliance for
the smallest of the public companies, particularly as it pertains to
potential new or expanded disclosure requirements).
\49\ See, e.g., comment letters from ABA 1; Compensia; Mercer;
and NACD.
\50\ See, e.g., comment letters in response to the Reopening
Release from Committee on Federal Regulation of Securities of the
Section of Business Law of the American Bar Association (Jan. 24,
2022) (``ABA 2''); CCMC (Nov. 22, 2021) (``CCMC 2''); and Hunton
Andrews Kurth (``Hunton'').
---------------------------------------------------------------------------
3. Final Amendments
After considering the comments, we are adopting rules to require
exchanges to apply the disclosure and compensation recovery policy
requirements to all listed issuers,\51\ with only limited exceptions,
substantially as proposed.\52\ Under the final rules, an issuer would
be subject to delisting if it does not adopt and comply with its
compensation recovery policy.\53\ In a clarification to the proposal,
17 CFR 240.10D-1(a) as adopted provides that the requirements of
Section 10D apply to each exchange and association to the extent such
exchange or association lists securities. Accordingly, the requirements
will not apply to exchanges that only trade securities pursuant to
unlisted trading privileges but do not list securities.\54\ We are
exempting the listing of certain security futures products,
standardized options, securities issued by unit investment trusts, and
the securities issued by certain registered investment companies from
the mandated listing standards, as proposed.\55\
---------------------------------------------------------------------------
\51\ In a modification from the proposal, the rule refers to a
national securities association that lists securities generally,
rather than the more specific reference to an association that
``lists securities in an automated inter-dealer quotation system.''
In addition, we are simplifying the rule by not adopting proposed
Rule 10D-1(b)(1)(vi), which would have specifically provided that an
issuer that had been delisted for failing to comply with its
recovery policy may not list its securities on an exchange, and an
exchange would not be permitted to list a delisted issuer until the
issuer comes into compliance with its recovery policy, because such
a delisted issuer that remained out of compliance with the recovery
policy would already not be permitted to list its securities on an
exchange by function of 17 CFR 240.10D-1(a)(1), which requires
exchanges to ``prohibit the initial or continued listing of any
security of an issuer that is not in compliance with the
requirements of any portion of this section.''
\52\ See 17 CFR 240.10D-1(a)(3).
\53\ Under the 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. See Section
II.D.3.
\54\ Such exchanges may not list securities until their listing
standards comply with the requirements of Rule 10D-1. Exchanges that
do not list securities should consider updating any applicable
listing standards to comply with the requirements of Rule 10D-1 or
including an appropriate limitation acknowledging that they may only
trade securities pursuant to unlisted trading privileges.
\55\ See 17 CFR 240.10D-1(c)(1) through (4).
---------------------------------------------------------------------------
As the Commission stated in the Proposing Release, Section 10D does
not distinguish among issuers or types of
[[Page 73081]]
securities, and does not instruct the Commission to exempt any
particular types of issuers or securities or direct the Commission to
permit the exchanges to provide for such exemptions. In evaluating
whether to exempt specific categories of issuers and securities, in
addition to the views of commenters, we have considered whether
providing exemptions from the requirements of Section 10D would be
consistent with our understanding of the purpose of this statutory
provision. We have also considered the incidence of restatements by
different categories of issuers and whether, in light of such
incidence, exempting these classes of issuers would be necessary or
appropriate in the public interest and consistent with the protection
of investors. Although we recognize commenters' concerns regarding
application of the rule to FPIs, SRCs, and EGCs, as discussed more
fully below, we have determined not to exempt these categories of
issuers from the final rules.
With respect to application of the final amendments to FPIs, we
note that Section 10D does not exempt FPIs. While the Commission could
exercise its discretion to exempt such issuers by rule, we decline to
do so. We acknowledge some of the practical concerns regarding
implementation of the recovery policy raised by commenters, as
discussed above; however, these concerns are not unique to FPIs and, in
any event, do not in our view justify exempting such issuers from the
obligation to recover incentive-based compensation that was erroneously
awarded. We believe that shareholders of FPIs listed in the United
States should benefit from recovery of erroneously awarded compensation
in the same manner as shareholders of domestic issuers. Moreover, the
recovery requirements will help to encourage reliable financial
reporting by listed issuers, which is as important for investors in
FPIs as for other issuers. Studies have shown that foreign companies
present a similar risk of restatement as other companies \56\ and that
U.S. issuers who are non-accelerated filers \57\ accounted for
approximately 53% of restatements.\58\ To the extent that recovery
under Rule 10D-1 would be wholly inconsistent with a foreign regulatory
regime, we have included an impracticability accommodation, as
discussed in Section II.C.3.b., which may alleviate some of the
implementation challenges faced by FPIs.
---------------------------------------------------------------------------
\56\ See 2020 Financial Restatements: A Twenty-Year Review,
Audit Analytics (2021) (``A Twenty-Year Review'') (analyzing data
related to accounting restatements, including specific analysis for
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 private
issuers). Foreign companies in this study included both FPIs and
foreign companies filing on Form 10-K.
\57\ 17 CFR 240.12b-2.
\58\ See A Twenty-Year Review.
---------------------------------------------------------------------------
We also do not view the application of the final amendments to FPIs
listed on U.S. national exchanges as an extraterritorial application of
U.S. law. The statutory language generally identifies the types of
conduct that trigger the relevant requirement and, by extension, the
focus of the statute for the purpose of an extraterritoriality
analysis.\59\ Having identified the activity regulated by the statutory
provision, we can determine whether a person is engaged in conduct that
the statutory provision regulates and whether this conduct occurs
within the United States. The statutory focus of Section 10D is on
``the listing of any security of an issuer'' on a national securities
exchange. The recovery policies mandated by Section 10D apply only to
those foreign issuers who have chosen to access the U.S. capital
markets by listing on a U.S. national exchange. We thus do not view the
final rules as an extraterritorial application of U.S. legal
requirements.
---------------------------------------------------------------------------
\59\ See Morrison v. National Australia Bank, Ltd., 130 S. Ct.
2869, 2884 (2010) (identifying the focus of statutory language to
determine what conduct was relevant in determining whether the
statute was being applied to domestic conduct).
---------------------------------------------------------------------------
With respect to the application of the rule to SRCs and EGCs, we
note that, unlike in other provisions of the Dodd-Frank Act, Congress
did not direct the Commission to consider differential treatment for
certain classes of issuers, such as SRCs and EGCs.\60\ Similar to our
reasons for not exercising our discretion to exempt FPIs, we decline to
exempt SRCs and EGCs from the final amendments. In our view, recovery
of incentive-based compensation that was not earned and should not have
been paid is as appropriate for smaller listed issuers as it is for
larger issuers. We believe shareholders of smaller issuers should
benefit from recovery of erroneously awarded compensation in the same
manner as shareholders of larger issuers. Similarly, recovery
encourages the preparation of reliable financial information, which may
be even more important for smaller issuers and EGCs than for others
because of their susceptibility to an increased likelihood of reporting
an accounting error and to material weakness in internal control over
financial reporting, as studies have found.\61\
---------------------------------------------------------------------------
\60\ In contrast, Section 952 of the Dodd-Frank Act directs the
Commission to take ``into consideration the size of an issuer and
any other relevant factors'' when providing exemption authority.
\61\ See, e.g., Jacquelyn Gillette, Sudarshan Jayaraman, and
Jerold Zimmerman Accounting Restatements: Malfeasance and/or Optimal
Incompetence? (working paper Mar. 2017), available at https://pages.business.illinois.edu/accountancy/wp-content/uploads/sites/12/2017/02/YSS-2017-Gillette.pdf (finding that ``larger and more
profitable firms invest more in accounting resources'', and that
``accounting resources are negatively associated with the likelihood
of a restatement''); see also Preeti Choudhary, Kenneth Merkley and
Katherine Schipper, Immaterial Error Corrections and Financial
Reporting Reliability, 38 Contemp. Acct. Rsch. 2423 (Winter 2021)
(finding that future restatements are less likely for larger firms)
(``Choudhary et al''). See also Jeong-Bon Kim, Jay Junghun Lee, and
Jong Chool Park, Internal Control Weakness and the Asymmetrical
Behavior of Selling, General, and Administrative Costs, (37) J.
Acct. Auditing & Fin 259-292 (2022) (finding that firms with
internal control weaknesses are significantly smaller in terms of
sales revenue, selling, general and administrative costs, and total
assets). See also discussion above and Section IV.A. discussing the
number of restatements for smaller issuers as compared to other
issuers.
---------------------------------------------------------------------------
We recognize, as some commenters asserted, that shareholders of
controlled companies and certain private companies with listed debt may
have a greater degree of control over executive officers than at other
companies. We further recognize that debt holders of debt-only issuers
receive certain protections from the Trust Indenture Act and indenture
covenants governing such debt. Recovery of erroneously awarded
compensation will encourage executive officers to reduce errors
requiring restatements, which could benefit potential future investors
and enhance the efficiency of the market as a whole. Further, while
controlling shareholders generally face fewer difficulties in directing
and incentivizing executive officers, the final amendments will help
minimize any gaps that remain, such as those that could exist for an
issuer's minority shareholders. Although a controlling majority
shareholder may owe state law duties to minority shareholders, we do
not believe that investors' confidence in the accuracy of financial
reporting should depend on their assessment of the likelihood of
successful litigation under state law to vindicate minority shareholder
rights.
We are not granting the exchanges discretion to exempt certain
categories of securities from the listing standards. In reaching these
conclusions, in addition to the plain language of the statute and the
fundamental inequity of permitting executive officers to retain
compensation they did not earn, we
[[Page 73082]]
considered the relative burdens of compliance on different categories
of issuers and types of securities. As discussed more fully in Section
IV, while we recognize that the listing standards could, in certain
respects, impose burdens on particular categories of issuers, there is
also reason to believe that these issuers, their shareholders, and the
markets in general, may derive benefits from the listing standards. The
compensation recovery requirements may reduce the financial benefits to
executive officers when an issuer is required to prepare an accounting
restatement, and thus may increase incentives for reporting accurate
financial results.\62\ Additionally, the recovery requirements may
encourage issuers and their executive officers to devote more resources
to the production of high-quality financial reporting. Shareholders of
listed issuers will, in turn, benefit from improved financial
reporting, and issuers may derive benefits in the form of reduced costs
of capital. As with other categories of listed issuers, we believe that
these benefits justify the costs imposed by the final amendments for
specific categories of issuers, such as EGCs, SRCs, FPIs, controlled
companies, and debt-only issuers.
---------------------------------------------------------------------------
\62\ As discussed more fully in Section IV, academic research
finds that companies with strong compensation recovery provisions
experience improved financial reporting, lower CEO turnover, and
lower CEO compensation. See Michael H.R. Erkens, Ying Gan, and B.
Burcin Yurtoglu, Not all clawbacks are the same: Consequences of
strong versus weak clawback provisions, 66 J. Acct & Econ., 291
(2018). See also Lillian H. Chan et al., The Effects of Firm-
Initiated Clawback Provisions on Earnings Quality and Auditor
Behavior 54 J. Acct. & Econ. 180 (2012) (finding that after the
adoption of clawback provisions, incidence of accounting
restatements declines, firms' earnings response coefficients
increase, and auditors are less likely to report material internal
control weaknesses, charge lower audit fees, and issue audit reports
with a shorter lag); Ed DeHaan, Frank Hodge, and Terry Shevlin, Does
Voluntary Adoption of a Clawback Provision Improve Financial
Reporting Quality?, 30 Contemp. Acct. Rsch. 1027 (2013) (finding
improvements in financial reporting quality following clawback
adoption, including decreases in meet-or-beat behavior and
unexplained audit fees, a decrease in restatements, a significant
increase in earnings response coefficients and a significant
decrease in analyst forecast dispersion).
---------------------------------------------------------------------------
We are adopting, as proposed, the exemptions for the listing of
security futures products cleared by a registered clearing agency or a
clearing agency that is exempt from the registration requirements of
the Exchange Act and for standardized options issued by a registered
clearing agency because the role of a clearing agency as the issuer of
these securities is fundamentally different from that of other listed
issuers.\63\ Whereas in most cases the purchaser of a security is
making an investment decision regarding the issuer of a security, 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, even though the clearing agency is the
issuer of those securities. 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. 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.\64\ Accordingly, pursuant to our authority under
Section 36 of the Exchange Act, we find that it is necessary or
appropriate in the public interest, and consistent with the protection
of investors, to exempt the listing of a security futures product and a
standardized option from the requirements of Rule 10D-1 under the
Exchange Act.\65\
---------------------------------------------------------------------------
\63\ 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'').
\64\ The Commission has previously recognized these fundamental
differences and provided exemptions for security futures products
and standardized options when it adopted the audit committee listing
requirements in 17 CFR 240.10A-3 and the compensation committee
listing requirements in 17 CFR 240.10C-1. See Listing Standards for
Compensation Committees, Release No. 33-9330 (June 20, 2012) [77 FR
38422 (June 27, 2012)].
\65\ See 17 CFR 240.10D-1(c)(1) and (2).
---------------------------------------------------------------------------
Similarly, we are adopting the proposal to exempt the listing of
any security issued by a listed fund on the condition that the fund has
not awarded incentive-based compensation to any current or former
executive officer of the fund in any of the last three fiscal years or,
in the case of a fund that has been listed for less than three fiscal
years, since the initial listing.\66\ We make this conditional
exemption pursuant to our authority under Section 36 of the Exchange
Act, because we find that it is necessary or appropriate in the public
interest, and consistent with the protection of investors. The
conditional exemption would permit listed funds that do not pay
incentive-based compensation to avoid the burden of developing recovery
policies they may never use.\67\ Listed funds that have paid incentive-
based compensation in that time period, however, would be subject to
the rule and rule amendments and be required to implement a
compensation recovery policy like other listed issuers.\68\
---------------------------------------------------------------------------
\66\ See 17 CFR 240.10D-1(c)(4). Listed funds, unlike most other
issuers, are generally externally managed and often have few, if
any, employees that are compensated by the fund (i.e., the issuer).
Instead, listed funds 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. In order to apply the new rules to listed
funds, we are amending Form N-CSR as proposed to redesignate Item 18
as Item 19 and to add a new paragraph (a)(2) to this Item (with
current paragraph (a)(2) redesignated as (a)(3)) to require any
listed fund that would be subject to the requirements of Rule 10D-1
to include as an exhibit to its annual report on Form N-CSR its
policy on recovery of incentive-based compensation. We are also
adding new Item 18 to Form N-CSR as well as amending Item 22 of
Schedule 14A of the Exchange Act to require listed funds that would
be subject to Rule 10D-1 to provide information that would generally
mirror the disclosure requirements of Item 402(w) of Regulation S-K.
\67\ In addition, because the exemption applies to the listing
of securities of registered investment companies, it would not apply
to business development companies, which are a category of closed-
end management investment company that is not registered under the
Investment Company Act.
\68\ One commenter observed that the rule would cover any
incentive-based compensation paid to listed fund chief compliance
officers (``CCOs'') if they are within the rule's definition of an
``executive officer.'' See comment letter from ICI. We agree that if
a listed fund pays an executive officer incentive-based compensation
within the time period specified in the final rule, then the fund
would be required to implement a compensation-recovery policy.
Although the commenter urged the Commission to interpret the
executive officer definition to exclude a listed fund's CCO, we do
not see a basis for this interpretation and the commenter did not
provide one.
---------------------------------------------------------------------------
We are not exempting listed funds unconditionally, as two
commenters suggested. The final rules are designed to reflect the
structure and compensation practice of listed funds by requiring funds
to implement compensation recovery policies only when they in fact
award incentive-based compensation covered by Section 10D. While listed
funds' financial statements may in general be less complex than those
of operating companies, restatements can and do still occur. To the
extent that executive officers of listed funds receive incentive-based
compensation on the basis of a financial reporting measure that is
restated, we
[[Page 73083]]
believe that the policy concerns underlying the rule apply equally to
listed funds, regardless of whether they were specifically mentioned in
the Dodd-Frank Act's legislative history or the treatment of registered
investment companies for purposes of other compensation-related
disclosure requirements.
We also are not exempting externally managed BDCs, as one commenter
suggested. Although BDCs whose advisers receive certain forms of
compensation are subject to certain limitations on their ability to
offer equity compensation such as options, or to establish a profit-
sharing plan, the definition of incentive-based compensation in Section
10D applies to a broader range of incentive-based compensation
arrangements. In addition, BDCs are generally subject to other
disclosure requirements in Regulation S-K, and the final rules treat
all BDCs, whether managed externally or internally, in a consistent
manner.\69\
---------------------------------------------------------------------------
\69\ A commenter suggested that the Commission had previously
exempted externally managed BDCs from pay ratio disclosure
requirements adopted in 2015. See comment letter of Clifford Chance
et al. The rule did not provide an exemption for externally managed
BDCs. Instead, the Commission observed that as a practical matter no
externally managed BDCs would be subject to it. See Pay Ratio
Disclosure, Release No. 33-9877 (Aug. 5, 2015) [80 FR 50103 (Aug.
18, 2015)] at n.90 (``Business development companies will be treated
in the same manner as issuers other than registered investment
companies and therefore will be subject to the pay ratio disclosure
requirement'').
---------------------------------------------------------------------------
As proposed, we are exempting the listing of any security issued by
a UIT because, unlike listed funds, 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, and
they do not file a certified shareholder report. In addition, because
the investment portfolio of a UIT is generally fixed, UITs are not
actively managed. Accordingly, pursuant to our authority under Section
36 of the Exchange Act, we find that it is necessary or appropriate in
the public interest, and consistent with the protection of investors,
to exempt the listing of any security issued by a UIT from the
requirements of Rule 10D-1 under the Exchange Act.\70\
---------------------------------------------------------------------------
\70\ See 17 CFR 240.10D-1(c)(3) and (4).
---------------------------------------------------------------------------
B. Restatements
1. Restatements Triggering Application of Recovery Policy
Sections 10D(a) and 10D(b)(2) require the Commission to adopt rules
directing exchanges and associations to establish listing standards
that require issuers to develop and implement 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 .
. . .'' \71\
---------------------------------------------------------------------------
\71\ See Senate Report at 135.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to require that issuers adopt and comply
with a written policy providing that in the event the issuer is
required to prepare a restatement \72\ to correct an error \73\ that is
material \74\ to previously issued financial statements,\75\ the
obligation to prepare the restatement would trigger application of the
compensation recovery policy. In connection with this proposed trigger,
the Commission proposed to define an ``accounting restatement'' \76\
and specifically noted 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.\77\
---------------------------------------------------------------------------
\72\ 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 Financial Accounting Standards
Board Accounting Standards Codification Topic 250, 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 International
Accounting Standard 8, Accounting Policies, Changes in Accounting
Estimates and Errors (``IAS 8''), paragraph 5.
\73\ 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, paragraph 5.
\74\ The Commission did not propose any additional clarification
about when an error 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 and has received extensive and
comprehensive judicial and regulatory attention. See, e.g., TSC
Industries, Inc. v. Northway, 426 U.S. 438 (1976); Basic v.
Levinson, 485 U.S. 224 (1988).
\75\ When we refer to financial statements, we mean the
statement of financial position (balance sheet), statement of
comprehensive income, statement of cash flows, statement of
stockholders' equity, related schedules, 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 17 CFR 210. 6-10, financial highlights,
and accompanying footnotes, as required by Commission regulations.
\76\ The Commission proposed to define the term 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.''
\77\ See Section II.B.1 of the Proposing Release.
---------------------------------------------------------------------------
After the Commission issued the Proposing Release, some
commentators expressed concerns that some issuers may not be making
appropriate materiality determinations for errors identified \78\ and
may be seeking to avoid recovery under their compensation recovery
policies.\79\ In the Reopening Release, the Commission stated that it
was considering whether to interpret the phrase ``an accounting
restatement due to material noncompliance'' to include all required
restatements made to correct an error in previously issued financial
statements and sought public feedback on such an interpretation. In
particular, the Commission requested comment on whether to provide that
recovery is required with respect to both (1) restatements that correct
errors that are material to previously issued financial statements
(commonly referred to as ``Big R'' restatements), and (2) restatements
that correct errors that are not material to previously issued
financial statements, but would result in a material misstatement if
(a) the errors were left uncorrected in the current
[[Page 73084]]
report or (b) the error correction was recognized in the current period
(commonly referred to as ``little r'' restatements).\80\ A ``little r''
restatement differs from a ``Big R'' restatement primarily in the
reason for the error correction (as noted above), the form and timing
of reporting, and the disclosure required. For example, a ``Big R''
restatement requires the issuer to file an Item 4.02 Form 8-K and to
amend its filings promptly to restate the previously issued financial
statements.\81\ In contrast, a ``little r'' restatement generally does
not trigger an Item 4.02 Form 8-K, and an issuer may make any
corrections ``the next time the registrant files the prior year
financial statements.'' \82\ In connection with the Second Reopening
Release, the Commission provided further opportunity to analyze and
comment upon a memorandum prepared by Commission staff containing
additional analysis and data on compensation recovery policies and
accounting restatements.\83\
---------------------------------------------------------------------------
\78\ See Choudhary et al., supra note 61.
\79\ See, e.g., Jean Eaglesham, Shh! Companies Are Fixing
Accounting Errors Quietly, Wall St. J. (Dec. 5, 2019), available at
https://www.wsj.com/articles/shh-companies-are-fixing-accounting-errors-quietly-11575541981. See also Rachel Thompson, Reporting
Misstatements as Revisions: An Evaluation of Managers' Use of
Materiality Discretion (working paper Sept. 17, 2021) available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3450828
(retrieved from SSRN Elsevier database).
\80\ See Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements
in Current Year Financial Statements (Sept. 13, 2006). Studies cited
and data included in this release on ``little r'' restatement
frequency may define ``little r'' restatements differently than the
definition used herein and are generally based on the total number
of revisions to previously issued financial statements where the
issuer did not file an Item 4.02 Form 8-K.
\81\ An Item 4.02 Form 8-K is required to be filed when an
issuer concludes that any of its previously issued financial
statements should no longer be relied upon because of an error in
such financial statements. It is due within four business days after
the conclusion.
\82\ See supra note 80.
\83\ In the 2022 staff memorandum, the staff refers to ``little
r'' restatements as restatements that correct errors that would only
result in a material misstatement if the errors were left
uncorrected in the current report or the error correction was
recognized in the current period. This reference has the same
meaning as the description of ``little r'' restatements in this
release.
---------------------------------------------------------------------------
b. Comments
We received a range of comments on the proposals regarding
restatements triggering application of the compensation recovery
policy. In response to the Proposing Release, some commenters expressed
support for the proposed use of the concept of a ``material error'' as
the standard for the recovery trigger.\84\ Some commenters suggested
that the materiality standard was vague, or thought examples would be
helpful.\85\ Other commenters recommended that the Commission expressly
provide that a restatement to correct immaterial errors would not
trigger a compensation recovery,\86\ or sought additional guidance for
aggregating immaterial error corrections.\87\ Some commenters
recommended that recovery should not be limited to restatements for
errors that were material to the previously issued financial
restatements,\88\ or recommended revisions to the proposed definition
of ``accounting restatement.'' \89\ Other commenters suggested that
recovery should be triggered when any revision to previously issued
financial statements occurred.\90\ Other commenters, noting a decline
in the number of formal accounting restatements, recommended that the
Commission expand the scope of the rulemaking beyond implementation of
Section 10D to require compensation recovery policies to address
instances of misconduct by executive officers that do not result in a
financial restatement.\91\
---------------------------------------------------------------------------
\84\ See comment letters from Business Roundtable (Sept. 14,
2015) (``BRT 1''); Better Markets 1; Center On Executive
Compensation (Sept. 14, 2015) (``CEC 1''); CFA Institute 1; Ernst &
Young LLP (``EY'') (Sept. 15, 2015); NACD; PricewaterhouseCoopers
LLP (``PWC''); SCG 1; and SBA.
\85\ See comment letters from CalPERS 1; Exxon/Mobil Corporation
(``Exxon'') (suggesting that recovery should only be triggered by a
restatement that ``significantly altered the total mix of
information available''); International Bancshares Corporation
(``IBC'') (suggesting that recovery should only be triggered by a
restatement if there is a substantial likelihood a reasonable
investor would consider the restatement as important in deciding how
to vote); Japanese Bankers; National Association of Manufacturers
(``NAM'') (suggesting ambiguity could result in great variation
among issuers in which restatements should trigger recovery); and
SBA.
\86\ See comment letters from CCMC 1; Chevron Corporation
(``Chevron''); EY; and SCG 1. See also comment letter from PWC
(suggesting that inclusion of the word ``material'' clarifies that
the listing standard would not apply to restatements that reflect
the correction of immaterial errors).
\87\ See comment letters from ABA 1; Chevron; Corporate
Governance Coalition for Investor Value (``Coalition''); Davis Polk
1; FSR; and IBC.
\88\ See comment letters from AFL-CIO (Sept. 14, 2015)
(expressing concern regarding ``revision restatements'' that would
allow an issuer to avoid the application of the proposed
compensation recovery provisions); As You Sow (Sept. 15, 2015) (``As
You Sow 1''); CII 1; CalPERS 1; and SBA. But see comment letter from
ABA 1 (noting ``that the analysis of an error's materiality takes
into account the error's impact on executive compensation'').
\89\ See comment letters from Chevron and SCG 1 (recommending
that the definition include a specific reference to GAAP) and from
ABA 1 (recommending that the definition refer to the applicable
accounting standards). See also comment letter from PWC (noting that
the proposed definition permits the listing standard to be applied
regardless of the accounting framework a listed issuer follows).
\90\ See, e.g., comment letters from As You Sow 1; CII 1; and
CalPERS 1.
\91\ See comment letters from AFL-CIO; AFR 1; Plamen Kovachev
(``Kovachev'') (recommending the rule include ethical misconduct
triggers to more closely align the rule with executives' fiduciary
duties); Rutkowski 1; and UAW Retiree Medical Benefits Trust, et al.
(``UAW, et al.'').
---------------------------------------------------------------------------
In response to the Reopening Release, we received a similar range
of comments relating to the recovery trigger and the meaning of ``an
accounting restatement due to material noncompliance.'' \92\ A number
of commenters supported the standard set forth in the Proposing Release
that would apply recovery policies only when a restatement is required
to correct errors that are material to previously issued financial
statements and triggers disclosure under Item 4.02(a) of Form 8-K.\93\
These commenters further contended that an ``accounting restatement due
to material noncompliance'' should not include ``little r''
restatements.\94\ Other commenters supported interpreting what it means
to be required to prepare an accounting restatement due to material
noncompliance in the manner described in the Reopening Release.\95\
[[Page 73085]]
Some of these commenters noted research suggesting that issuers may be
deeming revisions to be immaterial even though the revisions meet at
least one of the indicators of materiality described in Staff
Accounting Bulletin No. 99.\96\ Some of these commenters additionally
suggested that the increasing prevalence of revisions may stem from
management seeking to avoid restatements that would trigger an Item
4.02 Form 8-K filing or the application of a compensation recovery
policy provision.\97\ Some commenters further recommended expanding the
recovery policy triggers.\98\
---------------------------------------------------------------------------
\92\ One commenter on the Reopening Release suggested ``it would
be easier and more streamlined for issuers to rely on existing
guidance, literature, and definitions concerning accounting errors
rather than define the terms `accounting restatement' and `material
noncompliance.' '' See comment letter in response to the Reopening
Release from ABA 2.
\93\ See, e.g., comment letters in response to the Reopening
Release from Davis Polk 3 (stating that ``immaterial errors should
not trigger clawback policies'' and cautioning against creating a
new materiality standard for disclosure of financial restatements
solely for Rule 10D-1 purposes); Hunton; McGuireWoods, LLP and
Brownstein Hyatt Farber Schreck LLP (``McGuireWoods'') (recommending
that the Commission define ``material error'' as occurring when the
issuer is required, by applicable accounting standards, to issue
restated financial statements to correct one or more errors that are
``material'' to previously issued financial statements); S&C
(contending that immaterial error corrections to the current
period--commonly referred to as out-of-period adjustments--should
not be included because they are not restatements or ``due to
material noncompliance'') (Nov. 16, 2021) (``S&C 2''); and SCG (Nov.
29, 2021) (``SCG 3'').
\94\ See, e.g., comment letters in response to the Reopening
Release from Davis Polk 3 (contending that Proposing Release
facilitates the purpose of the recovery rule in being triggered on
the basis of ``meaningful errors'' and that ``little r''
restatements do not meet this standard and would create costs due to
the uncertainty of the standard); Hunton (suggesting that ``little
r'' restatements are immaterial to investors and should not serve as
a recovery policy trigger); McGuireWoods (suggesting that Section
10D intended that not all restatements should trigger recovery and,
in particular, that immaterial restatements should be excluded from
recovery); and SCG 3. As discussed below, we disagree with how a
number of these commenters characterize ``little r'' restatements.
\95\ See, e.g., comment letters in response to the Reopening
Release from Better Markets (Nov. 22, 2021) (``Better Markets 2'')
(recommending including a definition in the final rule, such as one
defining an accounting restatement as either a revision restatement
or a re-issuance restatement, to avoid unintended, inconsistent
interpretations, and other enforcement challenges that could result
from reliance on guidance); CFA Institute (Nov. 22, 2021) (``CFA
Institute 2'') (suggesting a broad interpretation may serve to
mitigate the perception of misaligned motivations); Council of
Institutional Investors (Nov. 18, 2021) (``CII 3'') (suggesting that
Section 10D was not intended to narrowly limit the required recovery
policy to exclude ``little r'' restatements); International
Corporate Governance Network (``ICGN''); Occupy the SEC
(``Occupy''); Ohio Public Employees Retirement System (Nov. 22,
2021) (``OPERS 2'') (recommending that the Commission clarify ``that
its definition of `accounting restatement' includes all required
restatements made to correct an error in previously issued financial
statements, regardless of whether they are formal restatements or
revisions''); and Public Citizen 2. See also comment letters in
response to the Second Reopening Release from Americans for
Financial Reform (July 6, 2022) (``AFR 2'') (noting studies finding
that ``little r'' restatements have been issued in lieu of ``Big R''
restatements to avoid compensation recovery provisions); and Council
of Institutional Investors (June 24, 2022).
\96\ See, e.g., comment letters in response to the Reopening
Release from CFA Institute 2 (further suggesting that lack of
transparency in the issuer's materiality assessment and the reason
for the method of correction may be contributing factors); and OPERS
2.
\97\ See, e.g., comment letters in response to the Reopening
Release from Better Markets 2; and OPERS 2.
\98\ See, e.g., comment letters in response to the Reopening
Release from New York City Retirement Systems (``NYCRS'')
(recommending recouping compensation from executives responsible for
detrimental conduct causing significant financial or reputational
harm); and New York State Common Retirement Fund (``NYSCRF'')
(recommending recouping compensation awarded to executives during
periods of fraudulent activity, inadequate oversight, misbehavior,
including discrimination and harassment of any kind, or gross
negligence, which impacted or is reasonably expected to impact
financial results or cause reputational harm).
---------------------------------------------------------------------------
A few commenters supported a requirement for an issuer to disclose
its evaluation that errors are immaterial,\99\ while some other
commenters opposed requiring this disclosure.\100\ Another stated that
``involvement of the independent auditors in evaluating management's
materiality analysis and concurring (through the audit opinion) with
management's conclusion, with oversight from the company's audit
committee, provides sufficient protection of investor interests that
material errors do not go uncorrected by a company trying to avoid the
clawback of incentive compensation.'' \101\
---------------------------------------------------------------------------
\99\ See, e.g., comment letters from Better Markets 1; CalPERS
1; and CFA Institute 1. See also comment letter from CFA Institute 1
(noting that because of the inherent estimates, judgements, and
complexity involved, issuers should disclose their evaluations, the
process and assumptions used to determine whether the error(s) in
question were material or immaterial, and why they decided the
matter in this way and suggesting that thorough disclosure provides
investors enough information to understand the material facts and
the reasoning behind such determination, and thereby helps them to
make appropriate decisions about the board's actions); and ICGN.
\100\ See, e.g., comment letters from BRT 1 (suggesting it is a
tenet of the Federal securities laws that disclosure of immaterial
information is not required); EY; NACD; and SCG 1.
\101\ See comment letter from EY.
---------------------------------------------------------------------------
c. Final Amendments
After considering comments received on the Proposing Release and
reopening releases, in a change from the proposal, we are adopting
rules to require listed issuers to adopt and comply with a written
compensation recovery policy that will be triggered in the event the
issuer is required to prepare an accounting restatement that corrects
an error in previously issued financial statements that is material to
the previously issued financial statements, or that would result in a
material misstatement if the error were corrected in the current period
or left uncorrected in the current period.\102\ While the proposed
rules focused on restatements for errors that are material to the
previously issued financial statements, after further consideration and
input from commenters, the final rules reflect a broader construction
of the phrase ``an accounting restatement due to the material
noncompliance of the issuer with any financial reporting requirement
under the securities laws'' based upon the fact that both types of
restatements are caused by material misstatements that either already
exist or would exist in the current period.
---------------------------------------------------------------------------
\102\ See 17 CFR 240.10D-1(b)(1) (``Rule 10D-1(b)(1)'').
---------------------------------------------------------------------------
In our view, the statutory language of Section 10D--``an accounting
restatement due to the material noncompliance of the issuer with any
financial reporting requirement under the securities laws''--can
appropriately be read to encompass both ``Big R'' and ``little r''
restatements. First, as a threshold matter, we disagree with those
commenters who stated that ``little r'' restatements are not accounting
restatements. We note that both are considered ``accounting
restatements'' under U.S. GAAP and IFRS \103\ because both result in
revisions of previously issued financial statements for a correction of
an error in those financial statements. In contrast, as noted by one
commenter, sometimes the correction of an error is recorded instead in
the current period financial statements--commonly referred to as an
out-of-period adjustment--when the error is immaterial to the
previously issued financial statements, and the correction of the error
is also immaterial to the current period.\104\ We agree with that
commenter that an out-of-period adjustment should not trigger a
compensation recovery analysis under the final rules, because it is not
an ``accounting restatement.'' \105\
---------------------------------------------------------------------------
\103\ See supra note 72.
\104\ See comment letter from S&C 2.
\105\ See supra note 93. In response to commenters who requested
clarification about the statement in the Proposing Release 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,'' we do not think this
is necessary. See supra note 87. Staff guidance on materiality is
already available which specifically addresses the aggregation of
misstatements that individually do not cause the financial
statements taken as a whole to be materially misstated. See infra
note 108. Furthermore, the scope of the final amendments includes
``little r'' restatements, which are sometimes required due to the
cumulative effects of an error over multiple reporting periods. See
more detailed discussion below.
---------------------------------------------------------------------------
Second, both types of restatements address material noncompliance
of the issuer with financial reporting requirements. In the case of a
``Big R'' restatement, the material noncompliance results from an error
that was material to previously issued financial statements. In the
case of a ``little r'' restatement, the material noncompliance results
from an error that is material to the current period financial
statements if left uncorrected or if the correction were recorded only
in the current period.\106\ Due to the materiality of the impact the
error would have on the current period, the previously issued financial
statements must be revised to correct it even
[[Page 73086]]
though the error may not have been material to those financial
statements. We note that the plain language of Section 10D does not
limit the concept of ``an accounting restatement due to material
noncompliance'' to effects on previously issued financial statements,
and thus the final rules require compensation recovery analysis for
both ``Big R'' and ``little r'' restatements.
---------------------------------------------------------------------------
\106\ We note that certain errors may compound over time. While
the initial error amount may not have been material to previously
issued financial statements, it may become material due to its
cumulative effect over multiple reporting periods. A material
adjustment to the current period that relates to an error from
previously issued financial statements would cause the current
period financial statements to be materially misstated. An example
of such error is an improper expense accrual (such as an overstated
liability) that has built up over five years at $20 per year. Upon
identification of the error in year five, the issuer evaluated the
misstatement as being immaterial to the financial statements in
years one through four. To correct the overstated liability in year
five a $100 credit to the statement of comprehensive income would be
necessary; however, $80 of it would relate to the previously issued
financial statements for years one through four. During the
preparation of its annual financial statements for year five, the
issuer determines that, although a $20 annual misstatement of
expense would not be material, the adjustment to correct the $80
cumulative error from previously issued financial statements would
be material to comprehensive income for year five. Accordingly, the
issuer must correct the financial statements for years one through
four.
---------------------------------------------------------------------------
We also disagree with those commenters who asserted that including
``little r'' restatements would make it difficult to comply with the
rule. Issuers are already required to perform a materiality analysis on
each error that is identified in order to determine how to account for
and report the correction of that error. Thus, issuers will have
already performed the analysis necessary to identify these additional
accounting restatements. Furthermore, the final rules reduce
uncertainty regarding their scope by expressly identifying the types of
restatements that are required to be included within an issuer's
recovery policy.
In addition to being clear and consistent with applicable
accounting literature, guidance, and the plain language of Section 10D,
this construction of the statutory language addresses concerns that
issuers could manipulate materiality and restatement determinations to
avoid application of the compensation recovery policy.\107\ In this
regard, we note that Commission staff has provided guidance to assist
issuers in making materiality determinations. The staff guidance
emphasizes that an issuer's materiality evaluation of an identified
unadjusted error should consider the effects of the identified
unadjusted error on the applicable financial statements and related
footnotes, and evaluate quantitative and qualitative factors.\108\
Registrants, auditors, and audit committees should already be aware of
the need to assess carefully whether an error is material by applying a
well-reasoned, holistic, objective approach from a reasonable
investor's perspective based on the total mix of information. Further,
whether the misstatement has the effect of increasing management's
compensation, for example, by satisfying requirements for the award of
bonuses or other forms of incentive compensation, is a qualitative
factor that should be considered when making a materiality
determination.
---------------------------------------------------------------------------
\107\ We note evidence supporting the materiality manipulation
concern. See, e.g., Brian Hogan and Gregory A. Jonas, The
association between executive pay structure and the transparency of
restatement disclosures, Acct. Horizons (Sept. 2016) (finding that
CFO pay structure is correlated with the transparency of restatement
disclosure (``Big R'' vs. ``little r'')). See also Thompson, supra
note 69 (finding that issuers with compensation recovery provisions
are more likely to report misstatements as ``little r'' restatements
instead of ``Big R'' restatements).
\108\ See Staff Accounting Bulletin No. 99, Materiality (Aug.
12, 1999) and Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements
in Current Year Financial Statements (Sept. 13, 2006). (This
guidance and any other staff statement cited in this release is not
a rule, regulation, or statement of the Commission and the
Commission has neither approved nor disapproved its content. This
guidance, like all staff statements, has no legal force or effect:
it does not alter or amend applicable law, and it creates no new or
additional obligations for any person.) We note that Commission
staff have observed that some materiality analyses appear to be
biased toward supporting an outcome that an error is not material to
previously issued financial statements. See id. Relatedly, it has
been reported that, while the total number of accounting
restatements by issuers declined each year from 2013 to 2020, the
percentage of ``little r'' restatements increased to approximately
76% of restatements in 2020. See Audit Analytics, 2020 Financial
Restatements: A Twenty-Year Review (November 2021).
---------------------------------------------------------------------------
Requiring recovery analysis for both ``Big R'' and ``little r''
accounting restatements does not eliminate the risk that an issuer
could avoid a recovery obligation by manipulating its materiality
analysis of an error.\109\ While this is an inherent risk, we note the
involvement of an independent auditor in evaluating management's
materiality analyses, with the oversight of the audit committee,
protects investor interests by helping ensure that material errors do
not go uncorrected by an issuer seeking to avoid the recovery of
erroneously awarded compensation. Furthermore, we note the potential
serious consequences, including but not limited to Commission
enforcement action and private litigation, of mischaracterizing
material accounting errors as immaterial.
---------------------------------------------------------------------------
\109\ This could occur if an issuer were to inappropriately
conclude that an identified error was not material to its previously
issued financial statements or the current period.
---------------------------------------------------------------------------
For similar reasons, we are not adopting a requirement for an
issuer to disclose the materiality analysis of an error when the error
is determined to be immaterial, as recommended by some commenters.
Inclusion of ``little r'' restatements in the scope of restatements
triggering recovery, the involvement of independent auditors and
oversight of audit committees, and the serious potential consequences
of deliberate mischaracterizations of accounting errors, should
mitigate the risk that some errors will be incorrectly determined to be
immaterial. Further, many assessments of materiality are complex and
highly sensitive to particular facts and circumstances. Requiring
issuers to disclose sufficient information to make these assessments
meaningful to investors would likely entail lengthy disclosures that
may be of limited use for investors. Instead, we are adopting a
disclosure requirement, discussed in Section II.D., for issuers to
clearly identify on the cover page of their annual reports when the
financial statement periods presented contain restatements, which
should provide additional transparency regarding such restatements.
In a change from the proposal, Rule 10D-1 will not provide separate
definitions of ``accounting restatement'' or ``material noncompliance''
as proposed. Existing accounting standards and guidance already set out
the meaning of those terms.\110\ This rule is not intended to affect
that guidance. While we acknowledge that a number of commenters
supported the proposed definitions of ``accounting restatement'' and
``material noncompliance,'' in light of the modifications discussed
above, we agree with the commenter that suggested that it will be
easier for issuers to look to existing guidance, literature, and
definitions when assessing accounting errors \111\ and that such an
approach will help ensure that those standards are consistently applied
both across different issuers and over time.
---------------------------------------------------------------------------
\110\ Rule 10D-1 clarifies the meaning of an ``accounting
restatement due to the material noncompliance of the issuer with any
financial reporting requirement under the securities laws.''
\111\ See comment letter in response to the Reopening Release
from ABA 2.
---------------------------------------------------------------------------
As indicated in the Proposing Release, we understand that under
current accounting standards the following types of changes to an
issuer's financial statements do not represent error corrections, and
therefore would likewise not trigger application of the issuer's
compensation recovery policy under the listing standards:
Retrospective application of a change in accounting
principle; \112\
---------------------------------------------------------------------------
\112\ 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.
---------------------------------------------------------------------------
Retrospective revision to reportable segment information
due to a change in the structure of an issuer's internal organization;
\113\
---------------------------------------------------------------------------
\113\ 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.
---------------------------------------------------------------------------
[[Page 73087]]
Retrospective reclassification due to a discontinued
operation; \114\
---------------------------------------------------------------------------
\114\ See ASC Topic 205-20. IFRS 5 has similar guidance.
---------------------------------------------------------------------------
Retrospective application of a change in reporting entity,
such as from a reorganization of entities under common control; \115\
---------------------------------------------------------------------------
\115\ See ASC Topic 250-10-45-21. IFRS does not have specific
guidance addressing this reporting matter.
---------------------------------------------------------------------------
Retrospective adjustment to provisional amounts in
connection with a prior business combination (IFRS filers only); \116\
and
---------------------------------------------------------------------------
\116\ See IFRS 3, paragraph 45.
---------------------------------------------------------------------------
Retrospective revision for stock splits, reverse stock
splits, stock dividends or other changes in capital structure.
2. Date the Issuer Is Required To Prepare an Accounting Restatement
Section 10D(b)(2) requires recovery of erroneously awarded
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 an issuer is ``required to prepare an accounting
restatement'' for purposes of this provision.
a. Proposed Amendments
The Commission proposed 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.
A note to the proposed rule indicated 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 would be predicated on if or when a Form 8-K was filed.
In the Reopening Release, the Commission solicited further comment as
to whether to remove the ``reasonably should have concluded'' language
in light of concerns that the language adds uncertainty to the
determination.
b. Comments
We received a range of comments on the proposed specification of
the date the issuer is required to prepare an accounting restatement
(referred to in this release as the ``trigger date''). Some commenters
supported including ``reasonably should have concluded'' as an
objective standard that provides certainty and prevents manipulation or
the potential for evasion,\117\ while others expressed concern that use
of ``reasonably should have concluded'' could introduce elements of
uncertainty and subjectivity into the determination.\118\ Some
commenters recommended a bright-line standard involving a single date,
such as the date of the Item 4.02(a) Form 8-K filing.\119\ Other
commenters recommended including as a trigger the filing of an Item
4.02(b) Form 8-K disclosing that independent accountants have advised
the issuer that the financial statements can no longer be relied
upon.\120\ Some commenters, however, did not believe that receipt of
such a notification from the auditor should be conclusive.\121\
---------------------------------------------------------------------------
\117\ See comment letters from Better Markets 1; and Compensia.
Some commenters specifically supported using the earlier to occur of
the alternative dates, as proposed. See, e.g., letters from CalPERS
1; CII 1; and CFA Institute 1.
\118\ See, e.g., comment letters from ABA 1; BRT 1; CEC 1;
Exxon; and SCG 1. Some of these commenters further suggested that
the language could invite disputes or lead to litigation. See, e.g.,
comment letters from Exxon; and SCG 1.
\119\ See, e.g., comment letters from Davis Polk 1; Mercer; and
NACD. See also comment letters from Exxon (recommending the actual
issuance of a restatement); and Public Citizen 1 (recommending the
date the erroneous financial statement is filed).
\120\ See comment letters from CFA Institute 1; and EY.
\121\ See comment letters from ABA 1; and SCG 1.
---------------------------------------------------------------------------
Some commenters expressed the view that existing legal requirements
provide sufficient deterrents against intentionally delaying issuance
of a restatement.\122\ Other commenters expressed concerns about the
potential for delay,\123\ and one suggested the proposed ``reasonably
should have concluded'' language would discourage issuers from
improperly delaying filing a restatement to avoid recovery.\124\
---------------------------------------------------------------------------
\122\ See, e.g., comment letters from ABA 1 (noting that other
existing laws, including the certification requirements and anti-
fraud provisions of the Exchange Act as well as applicable corporate
law, provide the appropriate incentives to make timely financial
reporting determinations in connection with Commission filings); and
Exxon (noting Commission and private litigation liabilities likely
to accrue while a material error in an issuer's financial reporting
remains uncorrected, the personal certification requirements
applicable to the principal executive and financial officers, and
the risk that an issuer's independent auditors will refuse to give
an opinion on financial statements containing an uncorrected
material error).
\123\ See comment letters from Public Citizen 1; and CFA
Institute 1 (noting that considerable time can pass between the time
an error is detected and the time a court or regulator requires the
issuer to take action).
\124\ See comment letter from CII 1.
---------------------------------------------------------------------------
In response to the Reopening Release, a number of commenters
expressed support for the inclusion of ``reasonably should have
concluded'' language in the proposed rule because in their view it
would create a more objective standard and appropriately limit board
discretion.\125\ In contrast, other commenters supported using the date
the issuer's board of directors (or 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 that the
issuer's previously issued financial statements contain a material
error. Some of these commenters expressed concern about uncertainty or
ambiguity associated with the ``reasonably should have concluded''
determination.\126\
---------------------------------------------------------------------------
\125\ See, e.g., comment letters in response to the Reopening
Release from Better Markets 2 (suggesting the ``reasonably should
have concluded'' language imposes an enforceable obligation on the
issuer and reduces the likelihood of litigation by inducing issuers
to act prudently to avoid the risk); CFA Institute 2 (suggesting the
language would mitigate concerns about internal investigations
taking longer than necessary, unreasonable delays in reaching a
conclusion, or misalignment of executives' incentives impacting the
timeliness or accuracy of the financial reporting); and ICGN. See
also comment letters in response to the Reopening Release from
Eileen Morrell; Public Citizen 2; Occupy; and OPERS 2 (supporting
the use of the ``reasonably should have concluded'' language); and
comment letter in response to the Second Reopening Release from AFR
2 (suggesting that the ``reasonably should have concluded'' language
discourages issuers from delaying actions necessary to fix erroneous
financial statements).
\126\ See, e.g., comment letters in response to the Reopening
Release from ABA 2 (suggesting the ``reasonably should have
concluded'' language would add subjectivity by using a triggering
event that differs from Form 8-K and would be open to second-
guessing and litigation); CEC (Nov. 17, 2021) (``CEC 2'')
(suggesting the language creates excessive uncertainty and excessive
legal risk based on the board's view of when the look back period
should commence versus the view of an impacted shareholder or an
executive who disputes that timing); Davis Polk 3; and McGuireWoods
(suggesting the standard would be ambiguous and overly broad and
noting that Item 4.02 of Form 8-K relies on when the board concludes
a restatement is required). See also comment letter in response to
the Reopening Release from SCG 1 (noting that knowingly, recklessly,
or negligently misreporting false or misleading financial
information already subjects the issuer to liability).
---------------------------------------------------------------------------
Some commenters on the proposal additionally sought guidance as to
the types of facts that would support a finding that the issuer
reasonably should have concluded that its previously issued financial
statements contain a material error.\127\ Some
[[Page 73088]]
commenters also sought clarification regarding when a regulator or
other legally authorized body directs an issuer to restate its
previously issued financial statements to correct a material
error.\128\
---------------------------------------------------------------------------
\127\ See comment letters from CEC 1; Compensia; and SCG 1
(seeking clarification that a restatement by an issuer's peer group
member does not trigger recovery when an issuer's incentive-based
compensation is based on performance relative to the peer group).
\128\ See comment letter from EY (suggesting that it may be
unclear whether a request for a restatement from a regulator would
be a trigger, given the lack of finality of the determination). See
also comment letters from CEC 1 (recommending that the date not be
established until a court order is final and non-appealable); and
SCG 1 (recommending that the date of the initial court or agency
restatement order should be designated as the starting point of the
three-year look-back period, but only after the order is final and
non-appealable).
---------------------------------------------------------------------------
c. Final Amendments
After considering the comments, we are adopting the rules
substantially \129\ as proposed to provide that under the listing
standards the date on which an issuer is required to prepare an
accounting restatement is the earlier to occur of:
---------------------------------------------------------------------------
\129\ In a nonsubstantive change from the proposal, we have
incorporated the standard for the date the issuer is required to
prepare an accounting restatement into 17 CFR 240.10D-1(a)(1)(ii)
rather than separately defining the term ``date on which an issuer
is required to prepare an accounting restatement'' in paragraph (c)
as proposed.
---------------------------------------------------------------------------
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 is
required to prepare an accounting restatement due to the material
noncompliance of the issuer with any financial reporting requirement
under the securities laws as described in Rule 10D-1(b)(1); or
The date a court, regulator or other legally authorized
body directs the issuer to prepare an accounting restatement.\130\
---------------------------------------------------------------------------
\130\ See 17 CFR 240.10D-1(b)(1)(ii) (``Rule 10D-1(b)(1)(ii)'').
---------------------------------------------------------------------------
We believe the final rule provides reasonable certainty for
issuers, shareholders, and exchanges while minimizing incentives for
issuers to delay their restatement conclusions. While we acknowledge
some commenters' assertion that a bright-line or single-date standard
might be easier to apply, we continue to have concerns that such an
approach would not address the potential for delay of a restatement
determination in order to manipulate the recovery date.
As noted in the Proposing Release,\131\ using the date the
erroneous financial statements were filed as the triggering date would
be inconsistent with the three-year look-back period because if the
date of filing of the erroneous financial statements were used,
recovery would not apply to any incentive-based compensation received
after that date, even when the amount was affected by the erroneous
financial statements. As a result, we disagree with the suggestion that
the look-back period should be triggered by the date the issuer files
the accounting restatement. The issuer will necessarily determine that
it is ``required to prepare'' a restatement on or before the day it
files the restatement. We have not adopted this suggestion because it
would allow an issuer to delay the recovery period, and potentially
reduce the amount of compensation subject to recovery, by delaying the
filing of a restatement it had already determined it was required to
prepare.
---------------------------------------------------------------------------
\131\ See Proposing Release at Section II.B.2 (``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.'').
---------------------------------------------------------------------------
Rather, we agree with the commenters that indicated that the timing
standard we are adopting is sufficiently certain and appropriately
limits board discretion. The standard promotes compliance with the rule
by making evasion of the application of a recovery policy more
difficult.\132\ The ``reasonably should have concluded'' concept
reduces the incentive for an issuer to delay the investigation of a
known error and the decision that a restatement is necessary, because
the delayed decision date would not determine the beginning of the
recovery period. We recognize that, as some commenters indicated,
establishing the trigger date as the date that the issuer's board
concludes, or reasonably should have concluded, that the issuer is
required to prepare an accounting restatement creates some risk that
the board's conclusions will be subject to litigation. We believe this
risk is acceptable in light of the benefit of deterring issuers from
manipulating the timing of their conclusions to avoid or delay a
recovery obligation. In order to trigger application of the recovery
policy, an issuer merely needs to have concluded that it is required to
prepare an accounting restatement, which may occur before the precise
amount of the error has been determined.\133\ We further note that
applying a reasonableness standard to the determination of the three-
year look-back supports an exchange's ability to enforce the recovery
provision by providing the exchange a standard by which to review an
issuer's conclusion.
---------------------------------------------------------------------------
\132\ Rule 10D-1(b)(1)(ii) is being established specifically for
purposes of determining the relevant recovery period under Rule 10D-
1. The ``reasonably should have concluded'' language applies only
with respect to the determination of the three-year look-back timing
for purposes of compensation recovery. It does not apply with
respect to a conclusion under applicable accounting rules and
standards as to whether there is an error that requires a
restatement.
\133\ We disagree with commenters that asserted that the
reasonableness standard increases uncertainty or ambiguity. While we
acknowledge that the standard is not a fixed date in time, it is
intended to allow an exchange to assess, based on the facts
available to the issuer, the point at which a reasonable person
would have concluded that an accounting restatement is required.
Contrary to a subjective determination, this standard provides for
an objective assessment based on the facts available as to the
determination of the timing of the lookback.
---------------------------------------------------------------------------
To the extent that an issuer is required to file an Item 4.02(a)
Form 8-K, the conclusion that it is required to prepare an accounting
restatement is expected to coincide with the occurrence of the event
disclosed in the Form 8-K.\134\ In addition, in applying a
reasonableness standard to the determination of a three-year look-back
period, while not dispositive, one factor that an issuer would have to
consider carefully would be any notice that it may receive from its
independent auditor that previously issued financial statements contain
a material error.\135\
---------------------------------------------------------------------------
\134\ In a modification from the proposal, we are no longer
including a note indicating that the date generally is expected to
coincide with the occurrence of the event described in Item 4.02(a)
of Exchange Act Form 8-K because we are expanding the circumstances
that would trigger the analysis to include ``little r'' restatements
which generally do not require reporting on a Form 8-K.
\135\ We are not, however, adopting the suggestion of some
commenters that the filing of an Item 4.02(b) Form 8-K disclosing
that independent accountants have advised the issuer that the
financial statements can no longer be relied upon be included as a
trigger. See supra note 120. As noted by another commenter, such a
date may not be conclusive. See comment letter from ABA 1. However,
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, at the latest, when the listed issuer determines to
restate its financial statements, even if it subsequently neglects
to file an Item 4.02(a) Form 8-K to report that decision.
---------------------------------------------------------------------------
While we anticipate that most issuers will make their determination
regarding the three-year look-back trigger based on the standard in 17
CFR 240.10D-1(b)(1)(ii)(A), some issuers may not conclude they are
required to prepare an accounting restatement and instead may choose to
contest whether an accounting restatement is required. While we expect
these occurrences to be rare, 17 CFR 240.10D-1(b)(1)(ii)(B) (``Rule
10D-
[[Page 73089]]
1(b)(1)(ii)(B)'') clarifies that in these circumstances, the trigger
date will be no later than the date a court, regulator, or other
legally authorized body directs the issuer to prepare an accounting
restatement. In the event that such date is different than the date an
issuer reasonably should have concluded that an accounting restatement
is required, Rule 10D-1(b)(1)(ii) mandates that the trigger date be the
earlier date. In response to questions raised by a commenter, we are
clarifying that for purposes of Rule 10D-1(b)(1)(ii)(B), the date of
the initial court order or agency action would be the trigger date for
the three-year look-back period, but that the determination and
application of the recovery policy would occur only after the order is
final and non-appealable.
Incorporating the triggering events into the rule rather than
leaving the determination solely to the issuer will 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, is triggered for purposes of the listing standards. In this
regard, we note that the rule also states that an issuer's obligation
to recover erroneously awarded compensation is not dependent on if or
when the restated financial statements are filed with the
Commission.\136\
---------------------------------------------------------------------------
\136\ See 17 CFR 240.10D-1(b)(1)(i)(B) (``Rule 10D-
1(b)(1)(i)(B)'').
---------------------------------------------------------------------------
C. Application of Recovery Policy
1. Executive Officers Subject to Recovery Policy
Section 10D identifies the class of persons and the time frame
during which that class of persons is subject to recovery of
erroneously awarded incentive-based compensation. Specifically, 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 erroneously awarded compensation from ``any
current or former executive officer of the issuer who received
incentive-based compensation'' during the three-year look back
period.\137\
---------------------------------------------------------------------------
\137\ Section 10D does not define ``executive officer'' for
purposes of the recovery policy. 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.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to include in the listing standards a
definition of ``executive officer'' modeled on the definition of
``officer'' in 17 CFR 240.16a-1(f) (``Rule 16a-1(f)''). For purposes of
Section 10D, the proposed definition of ``executive officer'' included
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. The proposed definition expressly included the principal
financial officer and the principal accounting officer (or if there is
no such accounting officer, the controller), reflecting the view that
their responsibility for financial information justifies their
inclusion in the definition of ``executive officer'' for this purpose.
As proposed, 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.\138\
---------------------------------------------------------------------------
\138\ The proposed definition also contained 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 17 CFR 229.401(b)
are presumed to be executive officers for purposes of the proposed
rule.
---------------------------------------------------------------------------
The Commission additionally proposed that the rules 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. 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.\139\
---------------------------------------------------------------------------
\139\ 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.
---------------------------------------------------------------------------
b. Comments
Commenters provided varying recommendations on the appropriate
definition of ``executive officer.'' Some commenters expressly
supported the proposed definition,\140\ and one recommended expanding
the definition.\141\ Other commenters suggested that the proposed
definition was too broad.\142\ Some of these commenters contended that
Section 10D does not require the breadth of the proposed
definition,\143\ and some further recommended various other limits on
covered executive officers.\144\ In contrast, some commenters noted
that a narrower definition would exclude individuals with a significant
executive role at an issuer and could be contrary to the interests of
investors.\145\
---------------------------------------------------------------------------
\140\ See, e.g., comment letters from AFL-CIO; AFR 1; As You Sow
1; Better Markets 1; CEC 1; CFA Institute 1; CII 1; OPERS (Sept. 14,
2015) (``OPERS 1'') (supporting the focus on policy-making
functions); Public Citizen 1; Rutkowski 1; and UAW, et al.
\141\ See comment letter from Better Markets 1 (recommending
including the principal legal officer, the chief compliance officer,
and the chief information officer). But see comment letter from CEC
1 (suggesting that expanding the pool of executives beyond Section
16 officers would go beyond Congress' intended purpose).
\142\ See, e.g., comment letters from ABA 1; American Vanguard
Corporation (``American Vanguard''); CCMC 1; Chevron; Coalition;
Compensia; Duane; FedEx Corporation (Sept. 14, 2015) (``FedEx 1'');
Fried; Hay Group, Inc. (``Hay Group''); IBC; Japanese Bankers;
Kovachev; NAM; Pay Governance LLC (``Pay Governance''); S&C 1; SCG
1; Steven Hall & Partners (``SH&P''); and WorldatWork (``WAW''). See
also comment letters in response to the Reopening Release
recommending limiting the term to executives who had a meaningful
role or responsibility over the issuer's financial reporting from
ABA 2; CCMC 2; McGuireWoods; and SCG (Nov. 3, 2021) (``SCG 2'').
\143\ See, e.g., comment letters from CCMC 1; Chevron;
Compensia; NAM; and SCG 1.
\144\ Some commenters recommended limiting the definition to the
issuer's named executive officers as defined in 17 CFR
229.402(a)(3). See, e.g., comment letter from Duane; FedEx 1; Fried;
Hay Group; and NACD. Other commenters recommended limiting the
definition to only the principal executive officer, principal
financial officer, principal accounting officer (or if there is no
such accounting officer, the controller), and, in addition, any
officer in charge of a principal business unit, division, or
function or who performs a policy-making function and whom the board
of directors or compensation committee determines to have had an
important role in contributing to the events leading to a financial
restatement. See, e.g., comment letters from ABA 1; Chevron; and SCG
1. Still other commenters recommended various forms of scienter
requirements. See, e.g., comment letters from American Vanguard;
CCMC 1; Coalition; Compensia; and SH&P.
\145\ See, e.g., comment letters from AFL-CIO; AFR 1; and
Rutkowski 1.
---------------------------------------------------------------------------
We received limited comment specific to our proposal to base the
definition on the Rule 16a-1(f) definition of ``officer,'' instead of
the 17 CFR 240.3b-7 (``Rule 3b-7'') definition of ``executive
officer.'' \146\ A few commenters suggested that including all Section
16 officers, without providing the compensation committee discretion in
enforcing recovery, may affect issuers' practices in identifying their
executive officers.\147\
---------------------------------------------------------------------------
\146\ See comment letters from Keith Paul Bishop (``Bishop'')
(recommending use of the Rule 3b-7 definition) and CalPERS 1
(supporting use of the Rule 3b-7 definition as an alternative to the
proposal).
\147\ See comment letters from ABA 1 (suggesting that some
issuers may have an incentive to reevaluate the identification of
their ``corporate insiders'' to see whether they should reduce the
number of individuals subject to those rules--particularly where the
individual has little or no responsibility for accounting and
finance matters); and Pearl Meyer (suggesting the definition may
lead some issuers to redefine duties of executive officers in order
to limit those subject to recovery). See also Compensia.
---------------------------------------------------------------------------
[[Page 73090]]
Several commenters recommended limiting recovery only to incentive-
based compensation earned during the portion of the look-back period
when the individual was an executive officer of the issuer.\148\ Some
questioned whether recovery for periods when the individual was serving
in non-executive capacities would be consistent with the statute.\149\
Others questioned the fairness of applying recovery to periods when an
officer was not serving in an executive capacity.\150\ Some commenters
further expressed concern that this aspect of the proposal would
discourage employees from serving as executive officers, with a
detrimental impact on corporate governance and the issuer's ability to
provide for smooth transitions.\151\ In contrast, one commenter
expressly supported the proposal.\152\
---------------------------------------------------------------------------
\148\ See, e.g., comment letters from ABA 1; CCMC 1; CEC 1;
Chevron; Compensia; Davis Polk 1; Duane; Ensco, PLC (``Ensco'');
Exxon; FSR; FedEx 1; IBC; Mercer; NACD; and S&C 1. See also comment
letters in response to the Reopening Release from Davis Polk 3; and
McGuireWoods. One commenter additionally suggested granting the
board discretion to recover only for the portion of the look-back
period when the person was an executive officer. See comment letter
from Ensco.
\149\ See comment letters from Exxon; and FSR.
\150\ See comment letters from FSR; and SH&P.
\151\ See comment letters from Davis Polk 1; IBC; and S&C 1.
\152\ See comment letter from CalPERS 1.
---------------------------------------------------------------------------
c. Final Amendments
After considering the comments, we are adopting the rules defining
executive officers subject to recovery substantially as proposed, with
modifications in response to commenters.\153\ Section 10D uses the term
``executive officer'' to identify the persons who are to be subject to
the rules without reference to a specific scope or defined term. As
described above, while Congress did not intend to cover rank-and-file
employees, it also did not limit the scope of recovery to those
officers who may be ``at fault'' for accounting errors that led to a
restatement, nor to those who are directly responsible for the
preparation of the financial statements.
---------------------------------------------------------------------------
\153\ See 17 CFR 240.10D-1(b)(1)(i) (``Rule 10D-1(b)(1)(i)'')
and the definition of ``executive officer'' in 17 CFR 240.10D-1(d)
(``Rule 10D-1(d)'').
---------------------------------------------------------------------------
In developing the definition of ``executive officer'' for purposes
of Rule 10D-1, we considered the statutory purpose of the rule. First,
Section 10D seeks to recover erroneously awarded incentive-based
compensation, reducing a potential form of unjust enrichment, in which
executive officers would gain from accounting errors at the expense of
shareholders. The statute thus protects shareholders from bearing the
economic burden of erroneously awarded compensation derived from
material noncompliance with financial reporting requirements. The
statute also helps to maintain investor confidence in markets and
improve liquidity by incentivizing executive officers to provide more
accurate financial reporting. While some commenters recommended that we
use our discretion to apply Section 10D to a limited set of executive
officers, such as named executive officers, executive officers who had
a role in preparing the financial statements, or executive officers who
had a role in the accounting error leading to the restatement, we are
not persuaded that such limitations would be consistent with Congress'
goals. Further, Congress' use of the unqualified term ``executive
officer'' in Section 10D, compared to its application of qualifiers to
that term elsewhere in the Dodd-Frank Act, suggests that it did not
intend to limit the group of executive officers subject to recovery.''
\154\
---------------------------------------------------------------------------
\154\ We note, for example, that Section 952 of the Dodd-Frank
Act uses the term ``named executive officer'' and Section 953
directly refers to 17 CFR 229.402, which makes extensive use of the
term ``named executive officer''.
---------------------------------------------------------------------------
We also acknowledge commenters who recommended that we base the
definition on Rule 3b-7.\155\ The term ``executive officer'' as defined
in 17 CFR 240.3b-7 and the term we are adopting are similar. However,
we determined to establish a definition of ``executive officer'' in
Rule 10D-1 in order to expressly include officers with an important
role in financial reporting. This includes an issuer's president,
principal financial officer, and principal accounting officer (or if
there is no such accounting officer, the controller), which we note is
consistent with the term ``officer'' as defined in Rule 16a-1(f).
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 essential that
officers with an important role in financial reporting be subject to
the recovery policy, which is expected to further incentivize high-
quality financial reporting.
---------------------------------------------------------------------------
\155\ See supra note 146.
---------------------------------------------------------------------------
At the same time, because Congress broadly intended Section 10D to
ensure that erroneously awarded compensation be returned to the issuer,
we do not agree with commenters who suggested that the scope of the
rule should be limited to only officers with a direct role in financial
reporting. Further, including officers with policy-making functions or
important roles in the preparation of financial statements in the
definition of ``executive officer'' for purposes of Rule 10D-1 will
ensure that the recovery policy requirements have the additional
benefits of providing executive officers with an increased incentive to
reduce the likelihood of inadvertent misreporting and of reducing the
financial benefits to executive officers from failures to accurately
account for the issuer's results. Because officers with policy making
functions or important roles in the preparation of financial statements
play an important managerial role and help set the tone at the top,
ensuring that the required recovery policy will apply to any such
officers may enhance these benefits. Further, requiring the issuer to
establish a direct connection between an executive officer and a
material error would add significant time, uncertainty, and litigation
risk to recovery determinations, which in turn would increase costs to
the issuer and its shareholders.
Further, the definition of ``executive officer'' we are adopting,
like the Rule 16a-1(f) definition of ``officer,'' 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. Identification of an executive officer for
purposes of this section would include, at a minimum, executive
officers identified pursuant to 17 CFR 229.401(b).\156\ With respect to
commenters who indicated that issuers may have an incentive to
mischaracterize an officer determination, we remind issuers that such a
determination must be an objective determination without regard to
whether that officer is subject to a recovery policy.
---------------------------------------------------------------------------
\156\ See Rule 10D-1(d), modeled on the Note to Rule 16a-1(f).
---------------------------------------------------------------------------
We also concluded that applying additional scienter or
responsibility requirements as suggested by some commenters would run
counter to the intent of the statute. Section 10D does not require the
issuer to establish scienter before it may recover erroneously awarded
incentive-based compensation, nor does the statute limit recovery to
executive officers who were directly involved with the accounting
error. This suggests that Congress intended that the recovery policy be
[[Page 73091]]
implemented without regard to the fault of the executive officers for
the accounting errors. In this regard, we believe Section 10D was
established not to punish wrongdoing, but to require executive officers
to return monies that rightfully belong to the issuer and its
shareholders.
The statute specifically requires recovery from any current or
former executive officers of the issuer who received incentive-based
compensation in excess of what would have been paid to the executive
officer under the accounting restatement. Section 10D(b)(2) expressly
states that the recovery policy must apply to ``any current or former
executive officer of the issuer.'' We believe recovery from former
executive officers is appropriate because otherwise, such individuals
would be in a position to improperly benefit from material errors that
occurred during their tenure as executive officers at the issuer.\157\
---------------------------------------------------------------------------
\157\ The final amendments do not distinguish between former
executive officers that leave a company, retire, or transition to an
employee role (including after serving as an executive officer in an
interim capacity) during the recovery period. We disagree with
commenters who suggest that an individual who serves as an executive
officer and then transitions to an employee role should not be
subject to recovery of incentive based compensation received while
serving as an employee. Section 10D-1 specifically applies to
``former executive officers'' and does not distinguish among types
of former executive officers. Moreover, any former executive officer
who is now an employee who receives incentive-based compensation
that would be affected by the recovery policy is receiving
compensation that, had the issuer's financial statements not been in
error, the individual would not have received. Similarly, while we
acknowledge commenters' concerns regarding the application of the
statute and the rules to interim executive officers, the recovery
policy would only apply if such interim (and former interim)
executive officers received erroneously awarded compensation as a
result of errors in the financial statements. Like retired
executives, such individuals would be in a position to benefit from
erroneously awarded compensation as a result of such errors. The
potential for such benefit would weaken the individual's incentives
to ensure accurate financial statements while they were serving as
an executive.
---------------------------------------------------------------------------
We agree, however, with commenters who suggested that requiring
recovery from individuals for incentive-based compensation received
prior to the period when they became an executive officer may not serve
the goals of the statute.\158\ Therefore, in a change from the
proposal, the final rule will only require recovery of incentive-based
compensation received by a person (i) after beginning service as an
executive officer and (ii) if that person served as an executive
officer at any time during the recovery period.\159\ Recovery of
compensation received while an individual was serving in a non-
executive capacity prior to becoming an executive officer will not be
required.\160\
---------------------------------------------------------------------------
\158\ See supra note 150.
\159\ See 17 CFR 240.10D-1(b)(1)(i)(A) and (B). The rule further
provides that the recovery policy applies to incentive-based
compensation received while the issuer has a class of securities
listed on an exchange and during the three completed fiscal years
immediately preceding the date that the issuer is required to
prepare an accounting restatement. See 17 CFR 240.10D-1(b)(1)(i)(C)
and (D).
\160\ Id. Note that an award of incentive-based compensation
granted to an individual before the individual becomes an executive
officer will be subject to the recovery policy, so long as the
incentive-based compensation was received by the individual at any
time during the performance period after beginning service as an
executive officer.
---------------------------------------------------------------------------
We further note that the recovery requirement also does not apply
to an individual who is an executive officer at the time recovery is
required if that individual was not an executive officer at any time
during the period for which the incentive-based compensation is subject
to recovery. Nevertheless, nothing in the rule would limit an issuer's
compensation recovery policy from requiring recovery more broadly.
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.
i. Proposed Amendments
The Commission proposed to define ``incentive-based compensation''
in a principles-based manner as ``any compensation that is granted,
earned or vested based wholly or in part upon the attainment of any
financial reporting measure.'' The proposed definition further provided
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, any measures derived
wholly or in part from such financial information, and stock price and
total shareholder return (``TSR''). 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.
ii. Comments
We received a range of comments relating to the proposed definition
of ``incentive-based compensation.'' Some commenters endorsed the
proposed principles-based approach to defining ``incentive-based
compensation.\161\ Other commenters recommended that the definition
leverage existing executive compensation disclosure requirements and
look to the existing definition of ``incentive plan.'' \162\ We also
received a range of comments relating to the types of awards that
should be covered. Some commenters recommended that the Commission
expand the definition to include subjective awards as covered
incentive-based compensation,\163\ while others objected to recovering
compensation based on qualitative or discretionary standards.\164\
Similarly, a number of commenters expressed concern about excluding, or
recommended including, time- or service-based awards.\165\ Other
[[Page 73092]]
commenters supported excluding time- or service-based awards \166\ and
awards based on attaining nonfinancial measures.\167\ Some of these
commenters requested specific confirmation that time-based equity
awards are not considered incentive-based compensation for purposes of
the rule.\168\ Some commenters supported having the rule also apply to
deferred compensation as proposed; \169\ however, several other
commenters expressed concern that application to deferred compensation
plans and pension plans could violate the Internal Revenue Code or
Employee Retirement Income Security Act (``ERISA'').\170\
---------------------------------------------------------------------------
\161\ See, e.g., comment letters from Better Markets 1; CalPERS
1; CFA Institute 1; and OPERS 1. Commenters generally did not see
the need for anti-evasion provisions. See, e.g., comment letters
from Better Markets 1; CalPERS 1; and NACD. But see comment letter
from OPERS 1.
\162\ See, e.g., comment letters from ABA 1 (recommending
including only awards already reported in an issuer's executive
compensation disclosure and reported in the equity incentive plan
and non-equity incentive plan awards columns of the Grants of Plan-
Based Awards Table pursuant to 17 CFR 229.402(d) that are granted,
earned or vested based wholly or in part upon attainment of a
financial reporting measure); and Kovachev (recommending reference
to the 17 CFR 229.402(a)(6)(ii) definition of ``incentive plan,''
excluding compensation determined by metrics such as market share or
customer satisfaction).
\163\ See, e.g., comment letters from Better Markets 1
(recommending a presumption that all incentive-based compensation is
based in whole or in part on financial reporting measures); and
Public Citizen 1 (recommending similar levels of recovery of all
incentive-based compensation). See also comment letter from CFA
Institute 1 (recommending board discretion to recover compensation
based on satisfying subjective standards to the extent the
subjective standards are satisfied in whole or in part by meeting a
financial reporting measure performance goal) and comment letter in
response to the Reopening Release form ICGN (recommending including
ESG-related metrics).
\164\ See, e.g., comment letters from FSR; Kovachev (contending
that including discretionary bonuses would be beyond the scope of
the statute); and NACD. See also comment letter from ABA 1 (noting
that subjective awards do not lend themselves to formulaic re-
creation).
\165\ See, e.g., comment letters from AFL-CIO (recommending that
for stock options awarded as compensation the board make reasonable
estimates of the effect on stock price); and Pay Governance
(suggesting that excluding service-based equity awards could create
an incentive to grant more such awards, thus shifting away from pay-
for-performance).
\166\ See, e.g., comment letters from ABA 1; CEC 1; Chevron;
Compensia; Davis Polk 1; FedEx 1; Japanese Bankers; Kovachev; and
SCG 1.
\167\ See comment letter from FedEx 1. See also Kovachev
(recommending defining covered equity awards by referencing
compensation reported in the Estimated Future Payouts Under Equity
Incentive Plan Awards column of the Grants of Plan-Based Awards
table provided pursuant to 17 CFR 229.402(c)).
\168\ See, e.g., comment letters from Chevron; Compensia; and
SCG 1. These commenters were concerned that the stock price metric
included in the proposed definition could be read to include an
equity award for which value is determined based on stock price but
vests solely upon completion of a specified employment period or
passage of time.
\169\ See comment letters from AFR 1; and Rutkowski 1.
\170\ See, e.g., comment letters from ABA 1; Exxon; FSR; IBC;
Mercer; SCG 1; Sutherland Asbill & Brennan LLP (``Sutherland''); and
WAW. But see comment letter from ABA 1 (noting that the forfeiture
of excess incentive-based compensation deferred into a holdback plan
as a recovery mechanism would be permissible and would not result in
an accelerated payment under Section 409A of the Internal Revenue
Code). See discussion relating to the exemption for tax-qualified
retirement plans in Section II.B.3.b.iii.
---------------------------------------------------------------------------
We received a number of comments on the proposed inclusion of TSR/
stock price metrics. Some commenters expressly supported inclusion of
these metrics,\171\ some commenters expressed qualifications or
reservations but did not object to their inclusion,\172\ and other
commenters expressly opposed inclusion of stock price/TSR metrics.\173\
Commenters opposed to inclusion of these metrics noted the costs,
uncertainty, and subjectivity of calculating recoverable amounts,\174\
questioned the proposed definition of ``incentive-based compensation,''
\175\ expressed concern over the potential for litigation from
shareholders or executive officers challenging the amount
determined,\176\ questioned the statutory authority to cover the
metrics,\177\ and suggested that the metrics' inclusion could
discourage the use of TSR as a performance measure.\178\ Another
commenter recommended providing a safe harbor for determining the
amount subject to recovery if stock price and TSR metrics are
included.\179\
---------------------------------------------------------------------------
\171\ See, e.g., comment letters from AFR 1; Better Markets 1
(suggesting that these metrics fall within the ambit of the
statutory formulation, which broadly encompasses all compensation
``based on financial information required to be reported under the
securities laws'' and provides for recovery of excessive
compensation ``based on'' erroneous data and that because stock
price and TSR are widely used in calculating executive compensation
their exclusion would substantially undermine the attainment of the
objectives underlying Section 10D); CalPERS 1; and Rutkowski 1
(suggesting that inclusion is appropriate because stock price is
based on investor expectation of cash flows, which are in turn
deeply informed by accounting metrics).
\172\ See, e.g., comment letters from CFA Institute 1 (noting
that establishing a link between financial errors and a change in
stock price would be easier in cases of fraud that are meant to
directly affect stock price); Compensia (expressing concern
regarding how to calculate the amounts subject to recovery); and
OPERS 1.
\173\ See, e.g., comment letters from ABA 1; BRT 1; Davis Polk
1; FSR; FedEx 1; Fried; IBC; Japanese Bankers; Mercer; Meridian
Compensation Partners LLC (``Meridian''); NACD; Pearl Meyer; and
SH&P. See also comment letters in response to the Reopening Release
from Cravath, McGuireWoods; and Hunton.
\174\ See, e.g., comment letters from Davis Polk 1; FedEx 1;
Fried; FSR; IBC (suggesting that analyses by third-party advisors
are expensive, highly speculative, and imprecise); Mercer (citing
the study of restatements by the Center for Audit Quality considered
in the Proposing Release to show that restatements at over 4,000
companies caused only an average 1.5% decline in stock price and a
median decline of 0.01%. The average impact of restatements as a
result of a material error was slightly higher (-2.3%), but the
median was also near zero%); and SH&P. Some of these commenters
suggested that the subjectivity of calculating the amounts for stock
price/TSR metrics would be incompatible with the no-fault standard
of the proposed rule. See, e.g., comment letters from Davis Polk 1;
FedEx 1; and SH&P (further recommending that due to the
subjectivity, recovery should be at the discretion of the board).
See also comment letters in response to the Reopening Release from
Cravath; Hunton; and McGuireWoods (suggesting that calculating the
amounts would be difficult and would require additional economic
analysis by issuers).
\175\ See, e.g., comment letter from ABA 1 (recommending that
the present disclosure requirements under Item 402 of Regulation S-K
adequately define the types of compensation that should be
considered ``incentive-based compensation'' for purposes of Section
10D: that is non-equity incentive plan awards as reported in columns
(c) through (e) of the Grants of Plan-Based Awards table pursuant to
17 CFR 229.402(d)(2)(iii) and equity incentive plan awards as
reported in columns (f) through (h) of that table pursuant to 17 CFR
229.402(d)(2)(iv)).
\176\ See comment letters from Davis Polk 1; and FSR.
\177\ See comment letters from ABA 1; Meridian (suggesting that
implicit in the determination of excess incentive-based compensation
is that the reach of Section 10D is limited to incentive-based
compensation that is linked to the achievement of specific financial
metrics); and NACD. See also comment letters in response to the
Reopening Release from ABA 1 (suggesting it is inconsistent with the
statutory mandate to include either an issuer's stock price or its
TSR in such definition as each measure reflects many factors beyond
the issuer's reported financial information, the sole criterion set
forth in Section 10D); and McGuireWoods (suggesting the term is
limited to financial reporting measures used in preparing the
issuer's financial statements that are accounting-based metrics).
\178\ See, e.g., comment letter from FSR (suggesting that
avoiding the use of TSR could be problematic in light of proposed
``pay-versus-performance'' rules requiring issuers to disclose the
relationship between company performance as reflected by TSR and the
compensation paid).
\179\ See comment letter in response to the Reopening Release
from McGuireWoods.
---------------------------------------------------------------------------
iii. Final Amendments
After considering the statutory language of Section 10D, the views
of commenters, and the administrability of any mandatory recovery
policy that encompasses incentive-based compensation, we are adopting
substantially as proposed the defined term ``incentive-based
compensation.'' \180\ Specifically, for purposes of Rule 10D-1, we are
defining ``incentive-based compensation'' to be ``any compensation that
is granted, earned, or vested based wholly or in part upon the
attainment of any financial reporting measure.'' \181\ We determined to
define the term in a principles-based manner so that the rule will
capture new forms of compensation that are developed and new measures
of performance upon which compensation may be based. As noted above,
any incentive-based compensation recovered under the final rules is
compensation that an executive officer would not have been entitled to
receive had the financial statements been accurately presented. A
number of the alternatives recommended by commenters would omit
incentive-based compensation received outside of an incentive plan.
Allowing executive officers to retain such incentive-based pay when it
was erroneously awarded based on material accounting errors would
undermine the statutory purpose of Section 10D to recover these amounts
for the benefit of issuers and their shareholders. Absent recovery of
such compensation, executive officers would still be in a position to
benefit from
[[Page 73093]]
accounting errors, undermining their incentives to ensure reliable
financial reporting. Further, gaps in the forms of incentive-based pay
that would be subject to recovery might encourage issuers to shift
compensation towards omitted categories, further undermining the
purpose of the rule.
---------------------------------------------------------------------------
\180\ See Rule 10D-1(d). The definition applies only to recovery
of incentive-based compensation under proposed Rule 10D-1, and does
not apply to the recovery of incentive-based compensation pursuant
to 15 U.S.C. 7243 (``Sarbanes-Oxley Act Section 304'').
\181\ ``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% of
the target amount is earned if a certain revenue level is achieved,
and 40% 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.
---------------------------------------------------------------------------
Consistent with the proposal, we are defining ``financial reporting
measures'' to be measures that are determined and presented in
accordance with the accounting principles used in preparing the
issuer's financial statements, and any measures derived wholly or in
part from such measures.\182\ This includes ``non-GAAP financial
measures'' for purposes of Exchange Act Regulation G and 17 CFR 229.10
as well other measures, metrics and ratios that are not non-GAAP
measures, like same store sales.\183\ Financial reporting measures may
or may not be included in a filing with the Commission, and may be
presented outside the financial statements, such as in Management's
Discussion and Analysis of Financial Conditions and Results of
Operations \184\ or the performance graph.\185\
---------------------------------------------------------------------------
\182\ See Rule 10D-1(d).
\183\ See Conditions for Use of Non-GAAP Measures, Release No.
33-8176 (Jan. 22, 2003) [68 FR 4820 (Jan. 20, 2003)] and Commission
Guidance on Management's Discussion and Analysis of Financial
Condition and Results of Operations, Release No. 33-10751 (Jan. 30,
2020) [85 FR 10571 (Feb. 25, 2020)].
\184\ 17 CFR 229.303. See also Item 5, Form 20-F. Examples of
such measures could be accounts receivable turnover, Earnings before
interest, taxes, depreciation and amortization, or sales per square
foot.
\185\ 17 CFR 229.201(e).
---------------------------------------------------------------------------
In order to provide guidance to issuers, we reiterate the examples
of financial reporting measures provided in the Proposing Release,
including, but not limited to, the following accounting-based measures
and measures derived from:
Revenues;
Net income;
Operating income;
Profitability of one or more reportable segments; \186\
---------------------------------------------------------------------------
\186\ As disclosed in a financial statement footnote. See ASC
Topic 280.
---------------------------------------------------------------------------
Financial ratios (e.g., accounts receivable turnover and
inventory turnover rates);
Net assets or net asset value per share (e.g., for
registered investment companies and business development companies that
are subject to the rule);
Earnings before interest, taxes, depreciation and
amortization;
Funds from operations and adjusted funds from operations;
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, the definition of ``financial reporting measures''
also includes stock price and TSR, as proposed.\187\ As the Commission
noted in the Proposing Release, 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.'' We note that Congress' direction to include
compensation that is ``based on'' financial information and to recover
compensation ``based on'' the erroneous accounting data suggests
Congress' intent to provide an expansive reading of those terms. The
final rule therefore encompasses incentive-based compensation tied to
measures such as stock price and TSR because improper accounting
affects such measures and in turn results in excess compensation.\188\
---------------------------------------------------------------------------
\187\ In a nonsubstantive modification from the proposal, we
have broken out the inclusion of stock price and TSR in a separate
clause of the definition. By including a separate clause in the
definition, instead of using the conjunctive ``and,'' the
modification makes clear that stock price and TSR are financial
reporting measures.
\188\ One commenter recommended using the definition of
``incentive plan award'' in 17 CFR 229.402(a)(6)(iii) of Regulation
S-K, which includes ``any other performance measure.'' See comment
letter from ABA 1. Using the existing definition of ``incentive plan
award'' to define ``incentive-based compensation'' would apply the
recovery to a different scope of incentive compensation. The Rule
10D-1 definition does 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.
---------------------------------------------------------------------------
Although the phrase ``financial information required to be reported
under the securities laws'' might be interpreted as applying only to
accounting-based metrics, in consideration of the statutory purpose
described above, we have determined that it is appropriate to interpret
the term to include performance measures including stock price and TSR
that are affected by accounting-related information and that are
subject to our disclosure requirements. Stock price and TSR are
frequently used incentive-based performance metrics for executive
compensation, such that excluding them could lead issuers to alter
their executive compensation arrangements in ways that would avoid
application of the mandatory recovery policy, undermining the
objectives of the rule, as well as impacting efficient incentive
alignment. While some commenters recommended that we narrow the scope
of the definition, we agree with other commenters that supported a
broader reading of the definition.\189\
---------------------------------------------------------------------------
\189\ As one commenter noted, stock price is at least in part
based on investor expectation of cash flows, which is intrinsically
tied to a company's financial statement disclosures. See supra note
171.
---------------------------------------------------------------------------
We disagree with the contention put forth by some commenters that
Section 10D is limited to incentive-based compensation that is linked
to the achievement of specific financial metrics. Section 10D requires
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.'' The use of the term ``based on''
is expansive and the statute does not explicitly delineate the types of
financial information that should be considered. Section 10D(b)
separately requires the issuer to recover from any current or former
executive officer of the issuer who received ``incentive-based
compensation . . . based on the erroneous data.'' As we have previously
noted, if an executive officer erroneously receives incentive-based
compensation based on stock price or TSR that was inaccurate as a
result of an accounting misstatement, that compensation is based on
such erroneous data.\190\ Being mindful of the statutory language and
purpose of Section 10D, we do not see a basis for allowing that
executive officer to retain such compensation, given that it was
erroneously awarded. Absent recovery of such compensation, certain
executive officers would be in a position to benefit from accounting
errors, undermining their incentives to ensure reliable financial
reporting. We therefore believe that inclusion of incentive-based
[[Page 73094]]
compensation based on stock price and TSR is necessary and appropriate
for the implementation of Section 10D. Adopting a narrower definition
of ``incentive-based compensation'' or ``financial reporting measures''
would result in the failure to recover from executive officers
incentive-based compensation that was erroneously awarded to them, and
therefore would be less effective in achieving the goals of the
statute.
---------------------------------------------------------------------------
\190\ We note that Rule 10D-1 applies only to erroneously
awarded incentive-based compensation based on stock price or TSR
that was inaccurate as a result of the issuer's accounting
restatement. For example, if the issuer is using TSR where the
performance measure is linked to a peer group (such as relative
TSR), only an accounting restatement by the issuer, not accounting
restatements by other issuers in the peer group, would result in
application of the rule and potential recovery.
---------------------------------------------------------------------------
We recognize, as some commenters noted, concerns relating to costs,
uncertainty, and subjectivity of calculating amounts of recoverable
erroneously awarded compensation with respect to the calculation of
stock price and TSR. These commenters highlighted that, once an issuer
concludes that its compensation is incentive-based compensation for the
purposes of this rule, issuers may need to engage in complex analyses
that require technical expertise and specialized knowledge and may
involve substantial exercise of judgment in order to determine the
stock price impact of the error that led to a restatement. Due to the
presence of confounding factors, it may be difficult to establish the
relationship between an accounting restatement and the stock price.
While we recognize these challenges, we believe the additional
costs associated with these factors are justified in order to better
achieve the objectives of the statute, as outlined above. 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 erroneously awarded compensation to be recovered
following an accounting error. In an accommodation to address concerns
relating to costs, uncertainty, and subjectivity of calculating these
amounts, Rule 10D-1 permits issuers to use reasonable estimates when
determining the impact of a restatement on stock price and TSR.\191\
Allowing the use of 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.\192\ Further, since ``little r''
restatements are less likely to be associated with significant stock
price reactions, we expect that recovery of incentive-based
compensation as a result of ``little r'' restatements that is tied to
TSR would be relatively small and infrequent, which should further
mitigate these costs.\193\
---------------------------------------------------------------------------
\191\ See 17 CFR 240.10D-1(b)(1)(iii)(A) (``Rule 10D-
1(b)(1)(iii)(A)''). In addition, 17 CFR 240.10D-1(b)(1)(iii)(B)
(``Rule 10D-1(b)(1)(iii)(B)'') requires the issuer to maintain
documentation of the determination of that reasonable estimate and
provide such documentation to the exchange or association as
proposed. In a modification from the proposal, 17 CFR
229.402(w)(1)(i)(C) additionally requires disclosure of the
estimates that were used in determining the erroneously awarded
compensation attributable to an accounting restatement and an
explanation of the methodology used to estimate the effect on stock
price or TSR, if the financial reporting measure related to a stock
price or TSR metric, to better explain how the issuer established
its estimates. See Section II.D.3.
\192\ We acknowledge that implementation of a safe harbor could
further mitigate potential concerns about the difficulties and costs
of calculating recovery amounts. As discussed in more detail in
Section II.B.3.a.iii, we believe that permitting reasonable
estimates will sufficiently mitigate these potential difficulties.
\193\ See discussion infra at note 400.
---------------------------------------------------------------------------
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 and as proposed, the definition of ``incentive-based
compensation'' in the final rule includes options and other similar
equity awards whose grant or vesting is based wholly or in part upon
the attainment of financial reporting measures.
Specific examples of ``incentive-based compensation'' include, but
are not limited to:
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;
Other cash awards based on satisfaction of a financial
reporting measure performance goal;
Restricted stock, restricted stock units, performance
share units, 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 is not ``incentive-based
compensation'' for this purpose include, but are not limited to:
Salaries; \194\
---------------------------------------------------------------------------
\194\ 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 performance goal, such a salary increase
is subject to recovery as a non-equity incentive plan award for
purposes of Rule 10D-1.
---------------------------------------------------------------------------
Bonuses paid solely at the discretion of the compensation
committee or board that are not paid from a ``bonus pool'' that is
determined by 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 nonfinancial reporting measures.\195\
---------------------------------------------------------------------------
\195\ This statement responds to commenters' questions and
concerns regarding the treatment of time-based and service-based
equity awards.
---------------------------------------------------------------------------
b. When Compensation is ``Received'' and Time Period Covered
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 erroneously awarded 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 or specify when an executive officer should be deemed to have
received incentive-based compensation for the recovery policy required
under the applicable listing standards.
i. Proposed Amendments
The Commission proposed that incentive-based compensation would be
deemed ``received'' for purposes of triggering a recovery policy in the
fiscal period 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. As proposed, 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.
[[Page 73095]]
The Commission further proposed that 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. Where an
issuer has changed its fiscal year end during the three-year look-back
period, the Commission proposed 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).
ii. Comments
We received limited comment regarding clarification of when
compensation is received and establishing the time period to be covered
by the listing standard. Some commenters supported the proposed
definition of when compensation is deemed ``received.'' \196\ In
contrast, one commenter suggested that the proposed definition was
overly broad.\197\
---------------------------------------------------------------------------
\196\ See comment letters from ABA 1 (noting the proposal is
consistent with Item 402 reporting requirements and how most issuers
view the receipt of incentive-based compensation); Better Markets 1;
CFA Institute 1; and CEC 1 (suggesting the time gap between when the
award's financial metric is achieved and the date the executive
obtains control over the award may allow an issuer to seek recovery
by cancelling the affected portion of the award). However, two of
these commenters were split on the proposal to limit recovery only
to the extent that compensation was received while the issuer has a
class of securities listed on an exchange, with one in favor (ABA 1)
and one opposed (Better Markets 1).
\197\ See comment letter from NACD (noting that just because a
reward is granted, earned, or vests does not mean that it is
actually received).
---------------------------------------------------------------------------
One commenter expressly supported the three-year period as a
reasonable period of time,\198\ another recommended issuer discretion
to select the appropriate time period,\199\ and a third noted that
accounting restatements may take place a considerable time after
erroneous payments were made, and recommended that the look-back period
should be extended to at least five years.\200\ In addition, while one
commenter expressly supported the proposed use of fiscal years as
consistent with the statutory language and minimizing the potential for
confusion,\201\ another suggested that existing issuer recovery
policies do not use the term ``fiscal year.'' \202\
---------------------------------------------------------------------------
\198\ See comment letter from CFA Institute 1.
\199\ See comment letter from NACD.
\200\ See comment letter from As You Sow 1.
\201\ See comment letter from CEC 1.
\202\ See comment letter from Bishop.
---------------------------------------------------------------------------
iii. Final Amendments
After considering the views of commenters, we are adopting the
rules relating to when compensation is ``received'' and the time period
covered substantially as proposed.\203\ Incentive-based compensation
will be deemed received for purposes of the recovery policy under
Section 10D in the fiscal period \204\ 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.\205\ Under the rules, incentive-based compensation is 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.\206\ Further, the time period covered for the recovery
policy will be the three completed fiscal years immediately preceding
the date the issuer is required to prepare an accounting
restatement.\207\
---------------------------------------------------------------------------
\203\ See Rule 10D-1(b)(1)(i). In a nonsubstantive modification
from the proposal, we are no longer including ``(f)or purposes of
Section 10D'' in the definition of ``received'' in Rule 10D-1(d) as
the introductory portion of Rule 10D-1(d) makes clear that the
definitions are for purposes of the section. We additionally
simplified the language in Rule 10D-1(b)(1)(i)(B) to clarify the
meaning of transition period for purposes of the rule without
defining the term.
\204\ Including a transition period for a change in fiscal year,
if applicable.
\205\ See Rule 10D-1(d).
\206\ See 17 CFR 240.10D-1(b)(1)(i)(A). After considering
comments, we continue to believe that the statute calls for recovery
limited to compensation that is received while the issuer has a
class of securities listed on an exchange or an association. We note
that an award of incentive-based compensation granted to an
executive officer before the issuer lists a class of securities will
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 is not required to be subject to the recovery policy.
\207\ Including a transition period for a change in fiscal year,
if applicable. See Rule 10D-1(b)(1)(i)(B).
---------------------------------------------------------------------------
The date of receipt of the compensation depends upon the terms of
the award. For example,
If the grant of an award is based, either wholly or in
part, on satisfaction of a financial reporting measure performance
goal, the award would be deemed received in the fiscal period when that
measure was satisfied;
If an equity award vests only upon satisfaction of a
financial reporting measure performance condition, the award would be
deemed received in the fiscal period when it vests; \208\
---------------------------------------------------------------------------
\208\ See infra notes 210 and 211.
---------------------------------------------------------------------------
A non-equity incentive plan award would be deemed received
in the fiscal year that the executive officer 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; \209\
and
---------------------------------------------------------------------------
\209\ 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 17 CFR
229.402(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.''
---------------------------------------------------------------------------
A cash award earned upon satisfaction of a financial
reporting measure performance goal would be deemed received in the
fiscal period when that measure is satisfied.
We further note that a particular award may be subject to multiple
conditions and that an executive officer need not satisfy all
conditions to an award for the incentive-based compensation to be
deemed received for purposes of triggering the recovery policy. 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,'' we believe that the executive officer
``receives'' the compensation for purposes of a 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.\210\ Ministerial acts or other conditions
necessary to effect issuance or payment, such as calculating the amount
earned or
[[Page 73096]]
obtaining the board of directors' approval of payment, do not affect
the determination of the date received.\211\
---------------------------------------------------------------------------
\210\ We disagree with the commenter that suggested the proposed
definition was overly broad. We believe this definition is
appropriate for the recovery policy to capture the appropriate
amounts of compensation subject to recovery. For example, an issuer
could grant an executive officer restricted stock units in which the
number of units earned is determined at the end of the three-year
incentive-based performance period (2020-2022), but the award is
subject to service-based vesting for two more years (2023-2024).
Although the executive officer does not have a non-forfeitable
interest in the units before expiration of the subsequent two-year
service-based vesting period, the number of shares in which the
units ultimately will be paid will be established at the end of the
three-year performance period which is when the relevant financial
reporting measure performance goal is attained. If the issuer's
board of directors concludes in 2023 that the issuer will restate
previously issued financial statements for 2020 through 2022 (the
three-year performance period), the recovery policy should apply to
reduce the number of units ultimately payable in stock, even though
the executive officer has not yet satisfied the two-year service-
based vesting condition to payment. To the extent that an executive
officer fails to then meet the service vesting period and never
actually receives the compensation, the compensation forgone as a
result of the failure to meet the vesting period would be the
reduced compensation as a result of the recovery policy.
\211\ For example, as stated above, an equity award granted upon
attainment of a financial reporting measure would be deemed received
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. The fiscal year in which an incentive-
based equity award is deemed received 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].
---------------------------------------------------------------------------
The three-year look-back period for the recovery policy will
comprise the three completed fiscal years immediately preceding the
date the issuer is required to prepare an accounting restatement for a
given reporting period.\212\ We recognize that some commenters
recommended different lengths of time for the look-back period;
however, the final rules are consistent with the statute, which
explicitly contemplates a three-year look-back.\213\ Basing the look-
back period on fiscal years, rather than a preceding 36-month period,
is consistent with the statutory language and issuers' general practice
of making compensation decisions and awards on a fiscal year
basis.\214\ As an example, if a calendar year issuer concludes in
November 2024 that a restatement of previously issued financial
statements is required and files the restated financial statements in
January 2025, the recovery policy would apply to compensation received
in 2021, 2022, and 2023. 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. Moreover, an issuer will 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.\215\ In situations where an issuer has changed
its fiscal year end during the three-year look-back period, 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).\216\
---------------------------------------------------------------------------
\212\ See Rule 10D-1(b)(1)(i)(B).
\213\ See discussion in Section II.B.2 regarding the date an
issuer is required to prepare an accounting restatement for purposes
of Rule 10D-1.
\214\ While we recognize, as one commenter noted, that some
recovery policies may not use fiscal years, we have determined to
use that term because the term is well understood and consistent
with the statutory language.
\215\ See Rule 10D-1(b)(1)(i)(B).
\216\ Id. 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. 17 CFR 240.13a-10 and 17 CFR
240.15d-10. For example, if in late 2021, an issuer changes its
fiscal closing date from June 30 to Dec. 31, it would subsequently
report on the transition period from July 1, 2021 to Dec. 31, 2021.
If the issuer's board of directors concludes in May 2023 that it is
required to restate previously issued financial statements, the
look-back period would consist of the year ended June 30, 2020, the
year ended June 30, 2021, the period from July 1, 2021 to Dec. 31,
2021, and the year ended Dec. 31, 2022. However, consistent with 17
CFR 210.3-06(a), a transition period of nine to 12 months would be
considered a full year in applying the three-year look-back period
requirement.
---------------------------------------------------------------------------
3. Recovery Process
a. Calculation of Erroneously Awarded 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.''
i. Proposed Amendments
The Commission proposed to define the amount of incentive-based
compensation that must be subject to the issuer's recovery policy
(``erroneously awarded compensation'') 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.'' \217\ For incentive-
based compensation that is based on stock price or TSR, where the
amount of erroneously awarded compensation is not subject to
mathematical recalculation directly from the information in an
accounting restatement, the Commission proposed that the erroneously
awarded compensation amount may be determined based on a reasonable
estimate of the effect of the accounting restatement on the applicable
measure and that the issuer shall maintain documentation of that
reasonable estimate and provide it to the exchange. The Commission
further proposed that the erroneously awarded compensation would be
calculated on a pre-tax basis.\218\
---------------------------------------------------------------------------
\217\ See Proposed Rule 10D-1(b)(1)(iii).
\218\ Id. (providing that the erroneously awarded compensation
must be computed without regard to any taxes paid by the executive
officer). Under the proposal, the erroneously awarded compensation
would be determined based on the full amount of incentive-based
compensation received by the executive officer, rather than the
amount remaining after the officer satisfies the officer's personal
income tax obligation on it.
---------------------------------------------------------------------------
Additionally, in the Proposing Release, the Commission provided
guidance relating to the amount to be recovered when discretion was
exercised in the original grant and stated that Rule 10D-1 would not
permit issuers' boards of directors to pursue differential recovery
among executive officers, including in ``pool plans,'' \219\ where the
board may have exercised discretion as to individual grants in
allocating the bonus pool.
---------------------------------------------------------------------------
\219\ ``Pool plans'' are 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 executive
officers are based on discretion.
---------------------------------------------------------------------------
ii. Comments
We received varying comments on how excess compensation subject to
recovery should be determined. Some commenters expressed concern
regarding issuers' ability to determine the amount of erroneously
awarded compensation.\220\ Other commenters recommended that the
Commission provide additional guidance regarding calculating
recoverable amounts for specific forms of compensation, such as stock
options, profits from the sale of securities, and awards where
discretion to reduce the award had been used in determining the size of
the original award.\221\ A few commenters also expressed concern about
duplicative recovery.\222\
---------------------------------------------------------------------------
\220\ See comment letters from Coalition; Osler, Hoskin &
Harcourt (``Osler''); and TELUS. Two of these commenters asserted
that calculation of the amount would require the exercise of
judgement and estimation. See comment letters from Osler; and TELUS.
\221\ See comment letters from ABA 1; Compensia; IBC; Japanese
Bankers; Kovachev; and Mercer.
\222\ See comment letters from CCMC 1; Coalition; and FSR
(noting that the proposal would credit recovery under Sarbanes-Oxley
Act Section 304 and recommending extending the relief to recovery of
compensation under other compensation recovery policies).
---------------------------------------------------------------------------
We received limited comment regarding the amount to be recovered
when discretion was exercised in the original grant. One commenter
recommended that recovery should not apply to a pool plan that does not
have a minimum financial performance requirement,\223\ and another
commenter supported allowing discretion as to the
[[Page 73097]]
amount recoverable if discretion was used to determine the original
award amount.\224\ A few commenters recommended board discretion on
various other aspects of recovery.\225\
---------------------------------------------------------------------------
\223\ See comment letter from NACD.
\224\ See comment letter from ABA 1. See also comment letter
from SH&P (supporting revisiting the use of discretion applied in
granting the original award based on the new information from the
restatement).
\225\ See comment letters from Compensia (recommending
discretion over whether to settle a recovery obligation for less
than the full amount); and Technical Compensation Advisors, Inc.
(``TCA'') (recommending discretion over which executives to recover
from, the amount to recover from each, and the timing of repayment).
---------------------------------------------------------------------------
One commenter expressly supported the proposal to require issuers
to maintain documentation of their determination of the reasonable
estimate, but said it should be provided to the exchange upon the
exchange's request rather than in all circumstances.\226\ Another
commenter similarly recommended that issuers be required to provide
documentation of the estimate to the exchange only upon request,
subject to confidentiality assurances.\227\ Some commenters, however,
opposed the idea that issuers should be required to provide the
information.\228\
---------------------------------------------------------------------------
\226\ See comment letter from Compensia.
\227\ See comment letter from ABA 1.
\228\ See comment letters from Osler; and TELUS.
---------------------------------------------------------------------------
Some commenters expressed concern regarding the proposed
requirement that an issuer establish a reasonable estimate of the
effect of the accounting restatement on the applicable measure as it
relates to stock price and TSR.\229\ Other commenters recommended that
the Commission provide additional guidance, or a safe harbor, for
calculating ``reasonable estimates.'' \230\ In contrast, one commenter
expressed support for the proposed requirement and recommended
disclosure of the results for each executive officer.\231\
---------------------------------------------------------------------------
\229\ See comment letters from NAM; and SH&P. These commenters
noted the numerous factors beyond the financial statements that
affect the movement of an issuer's stock price.
\230\ See, e.g., comment letters from CEC 1 (recommending that
any estimate made in good faith be deemed per se reasonable);
Chevron; Compensia; Hay Group; Pay Governance; Pearl Meyer; TCA; and
WAW. Two of these commenters suggested that issuers may need to
engage a valuation expert in some circumstances in order to
establish a reasonable estimate. See comment letters from Chevron;
and Compensia. Others noted the litigation risk and recommended the
Commission provide examples, potential methodologies, or a safe
harbor. See comment letters from Chevron; Pearl Meyer; and TCA. See
also comment letter from EY (suggesting that some restatements, such
as those relating to measurement and recognition of financial assets
and liabilities, may have limited impact on stock price or TSR, such
that an issuer may reasonably conclude that share price would not
have been affected).
\231\ See comment letter from Public Citizen 1.
---------------------------------------------------------------------------
Some commenters expressed concern regarding recovery on a pre-tax
basis and recommended that amounts should be recovered after
taxes.\232\ Other commenters expressed concern over the effect that tax
law could have on the recovery.\233\
---------------------------------------------------------------------------
\232\ See, e.g., comment letters from ABA 1; CEC 1; Davis Polk
1; Duane; FedEx 1; Japanese Bankers; and NACD. Two of these
commenters expressed concern that pre-tax recovery could be
considered punitive. See comment letters from ABA 1; and FedEx 1.
See also comment letters from ABA 2; Davis Polk 3; and McGuireWoods
on the Reopening Release suggesting that recovery of compensation be
made on an after-tax basis in order to avoid undue hardship for and
an inequitable over-collection from executive officers.
\233\ See, e.g., comment letters from Bishop (suggesting that
Federal tax law does not permit executives to amend their income tax
returns for earlier years which could result in the recovery being
considered a financial penalty); Canadian Bankers Association
(suggesting that the Canadian Income Tax Act does not provide for
executive officers to recover any taxes paid); and Freshfields
(suggesting that different outcomes for different individuals in
different foreign jurisdictions with divergent recovery rules and
tax rates could result in unfair tax impacts).
---------------------------------------------------------------------------
iii. Final Amendments
After considering the views of commenters, we are adopting
substantially as proposed that the erroneously awarded compensation
under an issuer's recovery policy is ``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,'' computed without regard to taxes paid.\234\
The final rules also provide that, for incentive-based compensation
based on TSR or stock price, where the amount of erroneously awarded
compensation is not subject to mathematical recalculation directly from
the information in an accounting restatement, the amount must be based
on a reasonable estimate of the effect of the accounting restatement on
the applicable measure and the issuer must maintain documentation of
the determination of that reasonable estimate and provide it to the
exchange. While we recognize some commenters' concerns and requests for
additional, specific guidance, including with respect to the
calculation of the recoverable amount for specific forms of incentive-
based compensation, we believe that the guidance we are providing in
this release coupled with the requirement in the final rule to use
reasonable estimates of the effect of the accounting restatement
provides appropriate direction and flexibility for issuers and
exchanges to implement the rule.
---------------------------------------------------------------------------
\234\ See 17 CFR 240.10D-1(b)(1)(iii) (``Rule 10D-
1(b)(1)(iii)'').
---------------------------------------------------------------------------
Applying this definition, after an accounting restatement, the
issuer must first recalculate the applicable financial reporting
measure and the amount of incentive-based compensation based thereon.
The issuer must then determine whether, based on that financial
reporting measure as calculated by 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.\235\ Where incentive-based compensation is
based only in part on the achievement of a financial reporting measure
performance goal, the issuer would first need to determine the portion
of the original incentive-based compensation based on or derived from
the financial reporting measure that was restated.\236\ 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.\237\
---------------------------------------------------------------------------
\235\ 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 amount of recoverable erroneously awarded
compensation would be $200 (i.e., $2,000-$1,800).
\236\ We address bonus pool plans in Section II.B.3.c.
\237\ 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 amount of
erroneously awarded compensation that would be recoverable 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 (i.e., $4,000-($1,800 +
$1,000)).
---------------------------------------------------------------------------
For incentive-based compensation that is based on stock price or
TSR, where the amount of erroneously awarded compensation is not
subject to mathematical recalculation directly from the information in
an accounting restatement, the amount of erroneously awarded
compensation may be
[[Page 73098]]
determined based on a reasonable estimate of the effect of the
accounting restatement on the applicable measure.\238\ 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, and under the final rules, issuers will have flexibility
to determine the method that is most appropriate based on their facts
and circumstances. While we recognize some commenters' concerns and
request for additional guidance or a safe harbor, we believe that the
requirement to use reasonable estimates of the effect of the accounting
restatement provides useful flexibility for issuers to implement the
rule, and that additional guidance or a safe harbor may unnecessarily
limit issuers' methods to determine a reasonable estimate, or
inadvertently create a de facto standard. While providing this
flexibility, we note that the issuer would be required to maintain
documentation of the determination of that reasonable estimate and
provide such documentation to the relevant exchange.\239\
---------------------------------------------------------------------------
\238\ See Rule 10D-1(b)(1)(iii)(A).
\239\ See Rule 10D-1(b)(1)(iii)(B). We disagree with commenters
that recommended that the documentation of the determination be
provided to the exchanges only upon request. Requiring the
documentation in all cases will provide exchanges ready access to
the necessary documentation to evaluate when they seek to determine
whether estimates were reasonable. Requiring such documentation only
upon request would put the onus of seeking documentation on the
exchanges, adding an additional burden to enforcing the requirements
that could lead to some issuers conducting a less robust--or even
no--analysis in the belief that their analysis is unlikely to be
reviewed or questioned.
---------------------------------------------------------------------------
The final rules provide that erroneously awarded compensation must
be calculated without respect to tax liabilities that may have been
incurred or paid by the executive \240\ to ensure that the issuer
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 permits the issuer to avoid the burden and
administrative costs associated with calculating erroneously awarded
compensation based on the particular tax circumstances of individual
executive officers, which may vary significantly based on factors
independent of the incentive-based compensation and outside of the
issuer's control. While we acknowledge the views of the commenters who
opposed a pre-tax basis for recovery, we are adopting such an approach
because it better effectuates the statutory intent of Section 10D in
that it seeks to ensure recovery for the benefit of shareholders of the
full amount of erroneously awarded compensation paid to the
executive.\241\
---------------------------------------------------------------------------
\240\ Rule 10D-1(b)(1)(iii) provides that the erroneously
awarded compensation must be computed without regard to any taxes
paid by the executive officer.
\241\ See Senate Report supra note 5.
---------------------------------------------------------------------------
The ability of executive officers to recoup, to the extent
authorized by applicable tax laws and regulations, taxes previously
paid on recovered compensation, would mitigate fairness concerns raised
by commenters.\242\ We note, however, that the extent to which a tax
system allows current adjustments for tax paid in prior periods under
assumptions that later prove incorrect is a matter of tax policy
outside the scope of this rulemaking. Limiting recovery to after-tax
amounts would in effect require shareholders to provide the tax relief
that the tax authorities in the executive officer's jurisdiction chose
not to offer. In any event, we believe any resulting tax burden should
be borne by executive officers, not the issuer and its shareholders. In
light of these considerations, coupled with the administrative
difficulty for issuers to implement recovery on an after-tax basis, we
believe the approach reflected in the final rules better meets the goal
of recovery of the full amount of erroneously awarded compensation paid
to the executive.
---------------------------------------------------------------------------
\242\ We are aware that in some instances executive officers may
be able to reduce their current-period taxes to reflect earlier tax
payments made on compensation that is subsequently recovered.
---------------------------------------------------------------------------
We intend for the definition of erroneously awarded compensation to
apply in a principles-based manner and as a result issuers may adopt
more extensive recovery policies, so long as those policies at a
minimum satisfy the requirements of the rule. While the definition is
principles-based, we believe some guidance will be helpful for issuers,
consistent with the proposal and input from commenters.
For cash awards, the erroneously awarded compensation is
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.\243\
---------------------------------------------------------------------------
\243\ Similarly, for nonqualified deferred compensation, the
executive officer's account balance or distributions would be
reduced by the erroneously awarded compensation contributed to the
nonqualified deferred compensation plan and the interest or other
earnings accrued thereon under the nonqualified deferred
compensation plan.
---------------------------------------------------------------------------
For cash awards paid from bonus pools, the erroneously
awarded compensation is the pro rata portion of any deficiency that
results from the aggregate bonus pool that is reduced based on applying
the restated financial reporting measure.\244\
---------------------------------------------------------------------------
\244\ Boards also may not 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. For example, 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, each bonus would need to
be ratably reduced to recover the excess amount for each
individual's bonus.
---------------------------------------------------------------------------
For equity awards, if the shares, options, or SARs are
still held at the time of recovery, the erroneously awarded
compensation is the number of such securities received in excess of the
number that should have been received applying the restated financial
reporting measure (or the value of that excess number). If the options
or SARs have been exercised, but the underlying shares have not been
sold, the erroneously awarded compensation is the number of shares
underlying the excess options or SARs (or the value thereof).
While we acknowledge that many commenters sought additional
guidance, we decline to offer more specific guidance regarding the
determination of erroneously awarded compensation with respect to
additional forms of incentive-based compensation, as the determination
will depend on the particular facts and circumstances applicable to
that issuer and the executive officer's particular compensation
arrangement. Issuers and their boards will be in the best position to
make these determinations. A principles-based application of the rules
provides useful flexibility for issuers and boards, and avoids the risk
that more detailed guidance may inadvertently establish de facto
standards. In that regard, boards of directors should consider the
statute's goal to return erroneously awarded compensation to the issuer
and its shareholders, and their fiduciary duties to those shareholders,
in making such determinations. We additionally note that, as described
in Section II.D., the issuer is required to disclose the amount of
erroneously awarded compensation attributable to an accounting
restatement, including an analysis of how the erroneously awarded
compensation was calculated.
In response to commenters who raised concerns that the rule may
result in duplicative recovery, we note that Rule 10D-1 is not intended
to alter or otherwise affect the interpretation of
[[Page 73099]]
other recovery provisions, such as Sarbanes-Oxley Act Section 304, or
the determination by the Commission or the courts of when reimbursement
is required under Section 304. To the extent that the application of
Rule 10D-1 would provide for recovery of incentive-based compensation
that the issuer recovers pursuant to Section 304 or other recovery
obligations, it would be appropriate for the amount the executive
officer has already reimbursed the issuer to be credited to the
required recovery under the issuer's Rule 10D-1 recovery policy.\245\
We note, however, that recovery under Rule 10D-1 would not preclude
recovery under Sarbanes-Oxley Act Section 304, to the extent any
applicable amounts have not been reimbursed to the issuer.
---------------------------------------------------------------------------
\245\ Similarly, to the extent that the erroneously awarded
compensation is recovered under a foreign recovery regime, the
recovery would meet the obligations of Rule 10D-1.
---------------------------------------------------------------------------
b. Board Discretion Regarding Whether To Seek Recovery
Section 10D requires the Commission, by rule, to direct the
exchanges and associations to adopt listing standards that require
issuers to adopt and comply with recovery policies. Specifically, under
the statute, the Commission's rules shall require each issuer to
develop a policy providing 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.
i. Proposed Amendments
The Commission proposed 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 where
certain conditions are met, including that (i) the direct expense paid
to a third party to assist in enforcing the policy would exceed the
amount to be recovered, and (ii) in certain circumstances where the
recovery would violate home country law that was in effect prior to the
date of publication of the Proposing Release in the Federal Register.
As proposed, before concluding that it would be impracticable to
recover any amount of erroneously awarded compensation based on direct
expenses paid to a third party, the issuer would first need to make a
reasonable attempt to recover that incentive-based compensation,
document its attempts to recover, and provide that documentation to the
exchange. 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 exchange, that recovery would result in
such a violation. In addition, to minimize any incentive countries may
have to change their laws in response to this provision, as proposed,
the relevant home country law must have been adopted prior to the date
of publication in the Federal Register of proposed Rule 10D-1, which
was July 14, 2015. In either case, 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, or in the absence of a compensation committee, by a majority
of the independent directors serving on the board.
ii. Comments
We received mixed comments regarding the board's discretion over
whether to pursue recovery and the scope of any such discretion. Some
commenters expressly supported the proposal to provide limited board
discretion over whether to pursue recovery, including the proposed
conditions.\246\ A few commenters specifically supported the proposal
to require that the individuals exercising discretion should be
independent directors.\247\ Other commenters expressed concern that the
proposed level of discretion was excessive.\248\
---------------------------------------------------------------------------
\246\ See comment letters from CII 1; OPERS 1; and UAW, et al.
\247\ See comment letters from ABA 1; and NACD.
\248\ See, e.g., comment letters from AFL-CIO (suggesting that
the statutory language that the issuer ``will recover'' indicates
that the board should have no discretion); As You Sow 1
(recommending limiting consideration of costs to direct costs and
expressing concern that issuers may be incentivized to inflate costs
to avoid recovery); Better Markets 1; CalPERS 1 (recommending that
erroneously awarded compensation be recovered even where the costs
of recovery are greater than the amount recovered); and Public
Citizen 1. See also comment letter from Fried (suggesting that
boards may use discretion to decide not to recover and that
requiring boards to recover excess pay, even if it is costly to do
so, may reduce both executives' resistance to returning erroneously
awarded pay and the likelihood of the need for recovery).
---------------------------------------------------------------------------
In contrast, other commenters expressed concern regarding the
limited scope of proposed board discretion \249\ and the requirement to
first make a ``reasonable attempt'' at recovery before exercising
discretion.\250\ Some of these recommended a de minimis threshold for
pursuing recovery,\251\ or specifically objected to limiting cost
considerations to direct costs.\252\ Some commenters further
recommended that directors should have discretion to determine whether
to recover awards based on metrics that cannot be accurately
recalculated, including stock price and TSR.\253\ Other commenters
further contended that directors' state law fiduciary duties justify
allowing boards to exercise greater discretion, noting the board's
business judgment, or expressing concern that the proposal's restricted
discretion would diminish board authority.\254\ Some commenters
[[Page 73100]]
recommended that the Commission could balance greater board discretion
with a requirement to publicly disclose the determination not to
recover, the reasons why, and the amount at issue.\255\ Commenters also
identified other specific factors that boards should be permitted to
take into account in deciding whether to recover, such as the
probability of recovery or likelihood of success; \256\ the
circumstances giving rise to the accounting restatement; \257\ the
potential costs of determining and defending the recovery
determination; \258\ the potential effects on the issuer; \259\ the
potential effect on executive officers; \260\ and the long-term impact
on the issuer.\261\
---------------------------------------------------------------------------
\249\ See, e.g., comment letters from ABA 1 (characterizing the
limited scope of board discretion as ``the single biggest impediment
to the effective implementation of Section 10D''); BRT 1; Bishop;
Compensation Advisory Partners LLC (``CAP''); CCMC 1; CEC 1; CFA
Institute 1; Chevron; Coalition; Compensia; Davis Polk 1; Duane;
Ensco; Exxon; FedEx 1; FSR; Hay Group; IBC; Kovachev; Mercer; NACD;
Pearl Meyer; S&C 1; SCG 1; TCA; TELUS; and WAW. See also comment
letters in response to the Reopening Release from ABA 2; CEC 2;
Davis Polk 3; ICGN; McGuireWoods; and Hunton.
\250\ See, e.g., comment letters from ABA 1 (noting the
subjective nature of the determination and the resulting compliance
burden, and recommending against the requirement); CEC 1; Chevron;
Compensia (suggesting the requirement is an unreasonable and
impractical burden); Exxon; IBC; Hay Group; SCG 1; and TELUS. Some
of these commenters sought guidance as to what constitutes a
reasonable attempt at recovery and requested the Commission provide
examples or a safe harbor. See comment letters from CEC 1
(recommending the Commission permit the board to make a preliminary
determination of the success of the reasonable attempt); Chevron;
and Hay Group.
\251\ See, e.g., comment letters from ABA 1 (recommending a
$10,000 threshold per executive); Chevron; Compensia; Duane
(recommending a $50,000 threshold per executive); FSR; and Mercer
(recommending a $10,000 threshold per executive).
\252\ See, e.g., comment letters from ABA 1 (recommending that
the board be permitted to consider the expense of determining
whether excess compensation resulted from the restatement along with
the recovery costs); CEC 1 (recommending that the Commission permit
consideration of specific indirect costs, such as opportunity costs
resulting from diverting internal staff, management and board
resources); Compensia; Duane; SCG 1; and TELUS (recommending that
the board be permitted to consider the costs of determining what the
recoverable amount would be rather than incur those costs before
making its determination). See also comment letter in response to
the Reopening Release from ABA 2 (recommending the impracticability
analysis be based on direct costs, whether or not paid to a third
party, as well as any indirect costs that it can reasonably allocate
to the recovery process).
\253\ See, e.g., comment letters from Davis Polk 1; and SH&P.
\254\ See, e.g., comment letters from BRT 1 (suggesting that
directors have fiduciary duties, which would serve to blunt any
potential adverse impact to Section 10D); Bishop; CCMC 1; Compensia
(citing board's fiduciary duties and noting that shareholders could
vote against directors or sue for breach of fiduciary duty);
Kovachev (suggesting that under state corporate law directors, not
shareholders or the Federal government, are responsible for
determining executive compensation); Pearl Meyer; SCG 1 (suggesting
that deciding whether excess compensation should be recovered is not
unlike other decisions the compensation committee regularly makes);
and WAW. See also comment letters in response to the Reopening
Release from CEC 2 (suggesting that without sufficient discretion
the rule could force a board to carry out a recovery in a manner at
odds with its fiduciary duties and result in shareholder harm); and
Hunton (noting discretion is consistent with the board's fiduciary
or other legal duties under state law).
\255\ See comment letters from CFA Institute 1; S&C 1; and TCA.
\256\ See comment letters from BRT 1; and Bishop.
\257\ See, e.g., comment letters from BRT 1 (suggesting taking
into account the scope of misconduct or responsibility for the
errors); CFA Institute 1 (suggesting taking into account the
severity of the error behind the original financial reporting
decision); and Davis Polk 1 (suggesting taking into account
culpability).
\258\ See comment letters from Bishop; and Davis Polk 1. See
also comment letters from Ensco; and Pearl Meyer (recommending
consideration be given where executives are subject to pre-existing
legally binding contracts).
\259\ See, e.g., comment letters from Bishop; BRT 1; Davis Polk
1; NACD; and S&C 1 (expressing concern over negative publicity or
reputational harm to the issuer). See also comment letter from Davis
Polk 1 (noting that recovery could be considered an admission
against interest by the issuer resulting in higher litigation risk).
\260\ See comment letters from Davis Polk 1 (recommending
permitting consideration of severe financial hardship, death or
serious illness of the executive); and S&C 1 (recommending
permitting consideration of the effect on recruiting and retaining
executives).
\261\ See comment letters from BRT 1; and S&C 1.
---------------------------------------------------------------------------
Commenters addressing the impracticability conclusion based on
violations of home country law expressed concern with the proposed
limitations,\262\ with some suggesting that limiting the
impracticability exclusion to home country law in effect as of the
proposal's Federal Register publication could intrude into the public
policy determinations of other nations \263\ and create a disincentive
for foreign firms to list in the U.S.\264\ Some commenters also
expressed concern over the proposed requirement for a legal
opinion.\265\ However, no commenters identified any foreign laws that
would prohibit recovery under the proposed rules.
---------------------------------------------------------------------------
\262\ See, e.g., comment letters from ABA 1; Bishop; CCMC 1;
Coalition; Duane; Exxon; FSR; Kaye Scholer; Mercer; Osler; SAP; S&C
1; TELUS; and UBS. Some commenters recommended that an exemption
based on home country law should also cover any other countries
whose laws otherwise apply to the executive officer, such as the
local law of the jurisdiction where the executive officer is
employed, as that local law would govern the employee/employer
relationship. See, e.g., comment letters from ABA 1; CCMC 1;
Coalition; Davis Polk 1; Exxon; FSR; Kaye Scholer; Osler; SAP; S&C
1; TELUS; and UBS. See also comment letter in response to the
Reopening Release from Hunton.
\263\ See comment letters from S&C 1; and TELUS.
\264\ See comment letters from CCMC 1; and Coalition. See also
comment letters in response to the Reopening Release from Cravath;
and CCMC 2 (suggesting that the rules may penalize foreign firms for
changes in law made after adoption of the rules).
\265\ See, e.g., comment letters from Bishop; CEC 1 (noting
legal uncertainty in some jurisdictions); CCMC 1; Coalition;
Freshfields; SAP; S&C 1 (noting absence of a prohibition does not
mean the compensation recovery provision would be enforced); and
TELUS (noting enforceability of compensation recovery arrangements
is a developing area of jurisprudence).
---------------------------------------------------------------------------
Several commenters expressed concern that the proposal did not
address potential impediments to recovery under state law and
questioned whether the listing standards adopted pursuant to this rule
would preempt state laws governing compensation.\266\ A number of these
commenters suggested that the Commission provide an exception to
recovery or allow boards discretion not to pursue recovery where such
actions may cause the issuer to violate state law.\267\
---------------------------------------------------------------------------
\266\ See comment letters from ABA 1; American Vanguard; Bishop;
Coalition; Compensia; Cooley; Exxon; FSR; Mercer; NACD; Pearl Meyer;
and SCG 1.
\267\ See comment letters from Compensia; Cooley; FSR; Pearl
Meyer; and SCG 1.
---------------------------------------------------------------------------
Additionally, some commenters expressed concern regarding recovery
of amounts deferred under tax-qualified retirement plans, stating that
such actions may violate ERISA anti-alienation rules, which could
result in loss of tax-qualified status for the plan.\268\
---------------------------------------------------------------------------
\268\ See, e.g., comment letters from ABA 1; IBC; and Sutherland
(noting that violating the Internal Revenue Code could result in
loss of tax-qualified status for the plan, causing adverse
consequences to all participants). See also comment letter from the
Reopening Release from McGuireWoods.
---------------------------------------------------------------------------
iii. Final Amendments
After considering the views of commenters, we are adopting
substantially as proposed rules to require 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.
We read the Section 10D recovery mandate to require recovery regardless
of ``fault'' or responsibility for the error or resulting restatement.
The language of this provision signals that the issuer should pursue
recovery in most instances.
As we have previously noted, the intent of Section 10D is to
require executive officers to return monies that rightfully belong to
the issuer and its shareholders. In keeping with this intent and our
understanding that the statute contemplates recovery in most instances,
we have determined to establish very limited circumstances that would
allow executive officers, or permit boards of directors to allow
executive officers, to retain incentive-based compensation that they
were erroneously awarded.
Some commenters sought to justify allowing boards to exercise
greater discretion or permitting issuers to not seek to recover
erroneously awarded compensation by citing to state law fiduciary
duties and a board's business judgment.\269\ Commenters also suggested
that the Commission could balance greater board discretion with
additional disclosure or suggested that boards should be permitted to
take into account the probability of recovery or likelihood of success,
the circumstances giving rise to the accounting restatement, the
potential costs of determining and defending the recovery
determination, the potential effects on the issuer, the potential
effect on executive officers, and the long-term impact on the issuer.
We have considered the potential costs of not affording such
discretion, such as the possibility that in some instances recovery
would be required even if the total costs for the issuer exceed the
expected recovery amount. Notwithstanding these possible costs, other
than the limited exceptions noted below, we do not believe that
additional discretion to forgo recovery of erroneously awarded
compensation would be appropriate. In enacting Section 10D, Congress
determined that listed companies in the U.S. should ``develop and
implement'' a policy providing that they ``will recover'' erroneously
awarded compensation within three years of an accounting restatement.
Congress chose to impose a federally mandated policy with specific
parameters and requirements. Its decision to adopt such a mandate
implies that Congress concluded that issuers likely would not
voluntarily pursue recovery to the extent mandated by Section 10D.
Allowing issuers broad discretion to decide whether to enforce such
policies would therefore tend to undermine Congress' intent, as issuers
that have previously failed to adopt
[[Page 73101]]
recovery policies that Congress concluded would protect shareholders
may also tend to exercise their discretion to recover in ways that
similarly fail to protect shareholders. Thus, to the extent that
commenters' suggestions would further permit executive officers to
retain monies that they should not have been awarded pursuant to their
compensation agreements, such exceptions or limitations could undermine
the objectives of the statute.
---------------------------------------------------------------------------
\269\ See supra note 254.
---------------------------------------------------------------------------
The exceptions we adopt below will limit the instances in which an
issuer would be obliged to pursue a money-losing recovery. Providing
for such narrow exceptions is consistent with the overall structure of
the statutory recovery mandate, which is unqualified and applies on a
no-fault basis to erroneously awarded compensation. We are concerned
that affording broader discretion could undermine the effectiveness of
the rule, as issuers and their boards may face short-term incentives or
other impediments to pursuing recovery even where recovery would be in
the interest of shareholders, the long-term interest of the issuer, or
the market as a whole. In addition, providing boards with broad
discretion to waive recovery could also reduce the reliability of
financial reporting, as executive officers may expect that they would
be enriched by some errors if the board had broad discretion.
After considering the views of commenters, we are adopting
impracticability exceptions, as proposed, where (1) the direct cost of
recovery would exceed the amount of recovery, and (2) the recovery
would violate home country law and additional conditions are met.\270\
We are additionally adopting an exception, as discussed further below,
that addresses commenters' concerns about the implications of
recovering amounts from tax-qualified retirement plans.
---------------------------------------------------------------------------
\270\ See 17 CFR 240.10D-1(b)(1)(iv)(A) (``Rule 10D-
1(b)(1)(iv)(A)'') and 17 CFR 240.10D-1(b)(1)(iv)(B) (``Rule 10D-
1(b)(1)(iv)(B)'').
---------------------------------------------------------------------------
We do not believe that inconsistency between the rules and existing
compensation contracts, in itself, should be a basis for finding
recovery to be impracticable. Such an approach could effectively
exclude a significant number of existing compensation contracts from
the scope of the rule, undermining its effectiveness. We note that
issuers have been on notice of the statutory mandate for several years
and will have additional time between adoption of these rules and
exchange listing standards implementing the rules to amend any
contracts to accommodate recovery. While a number of commenters
suggested that recovery should be limited to executive officers who
bear responsibility for the error; as discussed in Section II.C.1.c,
under our reading of the statute, the extent to which an individual
executive officer may be responsible for the financial statement errors
requiring the restatement is irrelevant to whether they are subject to
the requirement or the issuer should seek recovery.\271\ We also note
that a number of commenters recommended a de minimis threshold for
pursuing recovery. However, absent satisfaction of the conditions to
demonstrate that recovery is impracticable due to costs, we believe a
de minimis exception may risk being both over and under-inclusive,
given the variation in issuer sizes and executive compensation
structures. We therefore decline to adopt such an approach.
---------------------------------------------------------------------------
\271\ We note that this standard similarly applies in Sarbanes-
Oxley Act Section 304.
---------------------------------------------------------------------------
In determining whether recovery would be impracticable due to
costs, the only permissible criteria under the rule are whether the
direct costs paid to a third party to assist in enforcing recovery
would exceed the erroneously awarded compensation amounts.\272\ Only
direct costs paid to a third party, such as reasonable legal expenses
and consulting fees, may be considered for this purpose.\273\ We
disagree with those commenters that recommended permitting issuers to
include indirect costs. Indirect costs relating to concerns such as
reputation or the effect on hiring new executive officers are not
readily quantifiable and, as one commenter noted, are susceptible to
exaggeration,\274\ in addition to other confounding factors. We
therefore do not believe such costs should be taken into account when
determining whether recovery is impracticable.
---------------------------------------------------------------------------
\272\ See Rule 10D-1(b)(1)(iv)(A).
\273\ We note that the challenges of using incentive-based
compensation tied to stock price and TSR to determine the amount of
compensation to be recovered are not a sufficient basis for
determining that recovery is impracticable. Nonetheless, the amount
spent on a consultant or other third-party service provider could be
considered in determining whether the impracticability exception
applies, once the recoverable amount is determined.
\274\ See comment letter from As You Sow 1.
---------------------------------------------------------------------------
The final rules also require the issuer to make a reasonable
attempt to recover incentive-based compensation before concluding that
it would be impracticable to do so. The issuer must document its
attempts to recover and provide that documentation to the
exchange.\275\ We remain concerned that, without a requirement to
attempt recovery, an issuer could simply assert impracticability
without doing the work necessary to establish that the costs exceed the
recovery amounts. We believe that requiring an attempt to recover is
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.
---------------------------------------------------------------------------
\275\ See Rule 10D-1(b)(1)(iv)(A). New Item 402(w) of Regulation
S-K also requires the issuer to disclose why it determined not to
pursue recovery.
---------------------------------------------------------------------------
In providing this narrow cost exception, we note that Section 10D
provides that, to meet the applicable listing standard, the issuer
``will recover,'' without exceptions, erroneously awarded compensation
resulting from material misstatements of financial reporting items. The
plain text does not provide for issuer discretion. We believe that
Congress' broad mandate to recover signals that an exception from
recovery of an executive officer's erroneously awarded compensation, if
any, that the Commission exercises its authority to grant should be
carefully considered and tailored. In exercising our authority to
provide an exception, we have determined that issuers should not be
afforded broad discretion to determine whether to recover compensation.
We are therefore adopting as proposed a narrow exception relating to
impracticability due to costs.
We also believe it is appropriate to adopt substantially as
proposed a narrow exception that allows an issuer to conclude that
recovery is impracticable because it would violate the home country law
of the issuer.\276\ 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
November 28, 2022, the date of publication in the Federal Register of
Rule 10D-1.\277\ Before concluding that it would be impracticable to
recover because doing so would violate home country law in effect as of
the date of publication of Rule 10D-1 in the Federal Register, the
issuer would first need to obtain an opinion of home country counsel,
acceptable to the applicable exchange, that recovery would result in
such a violation.\278\
---------------------------------------------------------------------------
\276\ See Rule 10D-1(b)(1)(iv)(B).
\277\ As discussed further below, in a modification from the
Proposing Release, the relevant home country law must have been
adopted prior to the date of publication in the Federal Register of
Rule 10D-1 rather than July 14, 2015, which was the date of
publication of the proposed rule.
\278\ See Rule 10D-1(b)(1)(iv)(B). The issuer must provide such
opinion to the exchange. We recognize the concerns of some
commenters regarding the requirement for a legal opinion. We note,
however, that requiring an issuer to obtain a legal opinion provides
additional substantiation to the issuer's claim that recovery would
result in such a violation and reduces the burden on exchanges, who
might otherwise have to make a determination of whether the
exception is available to the issuer, by permitting them to use and
rely on the opinion.
---------------------------------------------------------------------------
[[Page 73102]]
We recognize some commenters' concerns that the erroneously awarded
compensation rules could intrude into the public policy determinations
of other nations or create a disincentive for foreign firms to list in
the U.S. However, the recovery mandate of Section 10D signals that the
issuer should generally pursue recovery when it is determined there is
erroneously awarded compensation subject to the rule. Issuers that
choose to list on U.S. exchanges have chosen to be subject to the rules
of those exchanges and the laws of the United States. Such issuers may
choose to list on U.S. exchanges in order to signal the greater
reliability of their financial reporting, and making executive officers
subject to recovery may further strengthen this signal, so that the
adopted approach in fact may incentivize, rather than discourage,
listings by foreign firms. Given the clear mandate from the statute
that executive officers not be permitted to retain erroneously awarded
compensation, we have determined that any exception relating to
impracticability due to conflict with home country law should be
narrow.
We are not expanding the exception, as suggested by some
commenters, to cover the domicile of the executive officer or any other
country whose laws may apply to the executive officer or to encompass
foreign laws that may be enacted in the future.\279\ As compared to the
jurisdiction of incorporation, it may be easier for an executive
officer to shift domicile or work location and thereby avoid
application of the rule. To the extent that the laws of jurisdictions
other than the issuer's place of incorporation would present obstacles
to recovery, we think those obstacles are more appropriately addressed
by the discretion we are providing not to pursue recovery in situations
in which the direct costs of recovering the erroneously awarded
compensation would exceed the amount to be recovered.
---------------------------------------------------------------------------
\279\ See supra note 262.
---------------------------------------------------------------------------
Similarly we do not believe it is appropriate for the exception to
apply without a time limitation. Doing so could incentivize
jurisdictions to enact statutes that prohibit or restrict recovery in
an effort to attract issuers that may be seeking to avoid enforcement
of a compensation recovery policy. Although we are not aware that any
such laws have been adopted since publication of the proposed rule, and
mindful of the length of time that has passed since 2015, in a
modification from the proposal, the relevant home country law must have
been adopted prior to the date of publication in the Federal Register
of Rule 10D-1 rather than July 14, 2015, which was the date of
publication of the proposed rule. This change will avoid any undue
disruption for foreign issuers who may have entered the U.S. markets
and listed on an exchange not anticipating a potential conflict with
the final amendments and would now face an immediate decision about
whether to maintain their U.S. listing. Going forward, however, we
believe it is appropriate and consistent with the purposes of Section
10D to require foreign issuers that avail themselves of the benefits of
U.S. listing to comply with the mandatory recovery policy in the same
manner as domestic issuers.
We also decline to provide an exception or additional board
discretion not to pursue recovery due to potential state law conflicts.
As a threshold matter, a number of commenters asserted that it is
unclear whether the mandated recovery would be in violation of any
state laws. We are not aware of any state law that currently would
clearly prohibit recovery, and commenters did not identify any.\280\ We
recognize that executive officers seeking to oppose recovery could
assert a number of defenses, including objections based on state law,
and issuers may need to address such matters as part of the recovery
process. Nevertheless, for the reasons discussed above, we believe
issuers should have discretion not to pursue recovery only in the
limited circumstances outlined in the final rule.
---------------------------------------------------------------------------
\280\ As an example of a potentially conflicting state law, one
commenter cited California Labor Code Section 221, which provides
that it is ``unlawful for any employer to collect or receive from an
employee any part of wages theretofore paid by said employer to said
employee.'' See comment letter from Bishop. California Labor Code
Section 224, however, also provides that Section 221 ``shall in no
way make it unlawful for an employer to withhold or divert any
portion of an employee's wages when the employer is required or
empowered so to do by state or Federal law.''
---------------------------------------------------------------------------
In any event, we believe that state law will not pose a significant
obstacle to recovery because issuers should have strong arguments that
state laws that conflict with Section 10D are preempted. With respect
to preemption, as a general matter, listing standards adopted by
national securities exchanges and associations at the direction of
Congress and the Commission can preempt state laws in certain
circumstances.\281\ In such a case, a court may consider whether a
state law that prevents or interferes with the recovery required under
this rule ``stands as an obstacle'' to accomplishing the objectives of
Federal law.\282\ As discussed above, this rule will advance the
objectives of Section 10D by ensuring recovery from all listed issuers
for the benefit of shareholders of erroneously awarded compensation
that would not have been paid had the issuer's financial statements not
been in error. The recovery requirement would serve the interest of
fairness to shareholders and improve the overall quality and
reliability of financial reporting, which further benefits shareholders
and the capital markets as a whole. Accordingly, issuers should be able
to assert that state laws that would prevent or impede recovery are
preempted, although the outcomes for any particular state law would
depend on the details of that provision.
---------------------------------------------------------------------------
\281\ See Credit Suisse First Bos. Corp. v. Grunwald, 400 F.3d
1119, 1128 (9th Cir. 2005).
\282\ See id. See also Geier v. Am. Honda Motor Co., 529 U.S.
861, 873 (2000) (quoting Hines v. Davidowitz, 312 U.S. 52, 67
(1941)). Some commenters argue that because Section 10D is addressed
to exchanges and associations, state law would not be preempted
because it is technically possible for an issuer to comply with both
state and Federal law. This describes one type of implied
preemption--``conflict preemption.'' Id. at 873-74. But a different
type of implied preemption--``obstacle preemption''--may arise where
a state law stands as an obstacle to Federal law. See, e.g., AT&T
Mobility LLC v. Concepcion, 563 U.S. 333, 342-43, 352 (2011)
(finding no conflict but ruling that state law was preempted as an
obstacle to a Federal scheme); and Williamson v. Mazda Motors of
Am., 562 U.S. 323, 330 (2011).
---------------------------------------------------------------------------
In exercising our discretion to provide an exception for tax-
qualified retirement plans described in 26 U.S.C. 401(a), we have
determined that a narrow exception is appropriate. Under 26 U.S.C.
401(a)(13), a plan will not be tax-qualified unless it provides that
the plan's benefits may not be assigned or alienated, subject to
certain limited exceptions that are not applicable here. Commenters
noted that this statutory anti-alienation rule would preclude a tax-
qualified plan from complying with a request for recovery. Commenters
also expressed concerns that requiring recovery of amounts deferred
under tax-qualified retirement plans may cause plans to violate the
anti-alienation rule and other plan qualification requirements under
the Internal Revenue Code. In recognition of those concerns, the final
rule will permit issuers to forgo recovery from tax-qualified
retirement plans.\283\ Without
[[Page 73103]]
this exception, such plans may fail statutory requirements for tax
exemption, resulting in potentially adverse tax consequences for all
plan participants. Thus, the change would avoid serious potential tax
consequences for rank-and-file employees by providing a narrow
exemption from recovery for a limited amount of incentive-based
compensation.\284\ Erroneously awarded incentive-based compensation
contributed to plans limited only to executive officers, SERPs, or
other nonqualified plans and benefits therefrom, would still be subject
to recovery.
---------------------------------------------------------------------------
\283\ See Rule 10D-1(b)(iv)(C). One of these commenters noted
that tax-qualified retirement plans are required to be non-
discriminatory in application and, thus, are not incentive-based
compensation and are not subject to various ``incentive plan''
disclosure under Item 402. See comment letter from ABA 1. See also
comment letter from Sutherland (also noting that tax-qualified
retirement plans are not considered incentive-based compensation in
the normal sense of that term). This commenter suggested that the
Commission not interpret ``incentive-based compensation'' to include
either tax-qualified or non-qualified plans, further suggesting that
all such compensation is provided for retirement, rather than as a
performance incentive. Because amounts contributed to qualified
plans may be affected by incentive-based awards, such as in the case
where the benefit formula for a plan includes amounts awarded as an
annual bonus, we disagree with this commenter's characterization of
such compensation as categorically lacking a performance incentive.
\284\ We anticipate the effect will be modest. We believe that
incentive-based compensation will typically have only small and
indirect effects on amounts added to tax-qualified retirement plans.
26 U.S.C. 401(a)(17) precludes a tax-qualified retirement plan from
basing contributions or benefits on compensation in excess of an
annual limit ($305,000 in 2022). The compensation of many covered
executive officers will exceed this limit regardless of any
incentive-based compensation they may have been erroneously awarded.
In addition, 26 U.S.C. 415 provides a series of limits on benefits
under qualified defined benefit plans and on contributions and other
additions under qualified defined contribution plans. For example,
under these limitations, in 2022, annual additions with respect to a
participant in a defined contribution plan may not exceed $61,000
and a participant's annual benefit under a defined benefit plan may
not exceed $245,000.
---------------------------------------------------------------------------
In order to mitigate potential conflicts of interest, any
determination that recovery would be impracticable in any of these
three circumstances must be made by the issuer's committee of
independent directors that is responsible for executive compensation
decisions. In the absence of a compensation committee, the
determination must be made by a majority of the independent directors
serving on the board. Such a determination, as with all determinations
under Rule 10D-1, is subject to review by the listing exchange.
We acknowledge that there are circumstances in which pursuing
recovery of erroneously awarded compensation may not be in the interest
of shareholders. We have determined that limited board discretion to
determine when it would be impracticable to recover is necessary or
appropriate in the public interest and consistent with the protection
of investors. Permitting board discretion in these circumstances will
save issuers the expense of pursuing recovery in circumstances where
recovery would violate anti-alienation rules applicable to tax-
qualified retirement plans, or home country law, or where the direct
costs of recovery could exceed or be disproportionate to the
erroneously awarded compensation amounts. Balancing these concerns, the
standard we are adopting appropriately permits boards of directors to
evaluate whether to pursue recovery of erroneously awarded
compensation, but only in these limited circumstances.
c. Board Discretion Regarding the Means 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.
i. Proposed Amendments
In the Proposing Release, in addition to addressing board
discretion regarding whether to recover excess incentive-based
compensation, the Commission addressed whether boards may exercise
discretion in effecting the means of recovery. The Proposing Release
recognized that the appropriate means of recovery may vary by issuer
and by type of compensation arrangement, and that consequently issuers
should be able to exercise discretion in how to accomplish recovery.
Regardless of the means of recovery utilized, the Proposing Release
indicated that issuers should recover excess incentive-based
compensation reasonably promptly, as undue delay would constitute
noncompliance with an issuer's recovery policy.
ii. Comments
We received various comments on the Proposing Release relating to
whether boards may exercise discretion regarding the means of recovery.
Commenters generally supported allowing board discretion regarding
the means of recovery.\285\ Some commenters noted the concept of
fungibility of assets, which would permit issuers to more readily
recover erroneously awarded compensation.\286\ Based on this concept of
fungibility, commenters recommended permitting issuers various means of
recovery, such as through canceling unrelated unvested compensation
awards,\287\ offsets against nonqualified deferred compensation and
unpaid incentive compensation,\288\ future compensation
obligations,\289\ or dividends on company stock owed to an executive
officer.\290\ Some commenters also recommended including in the final
rule specific instructions on how to compute the excess amount of
specific forms of incentive-based compensation and sought discretion to
recover the cash value of excess shares subject to recovery.\291\
---------------------------------------------------------------------------
\285\ See comment letters from ABA 1; Bishop; CEC 1; Compensia;
Exxon; and FSR. See also comment letters in response to the
Reopening Release from CEC 2; McGuireWoods (recommending flexibility
for boards to enter into settlement and repayment terms); and
Hunton.
\286\ See comment letters from AFL-CIO; and Exxon.
\287\ See comment letters from ABA 1; CEC 1; and WAW.
\288\ See comment letters from Exxon; and WAW.
\289\ See comment letters from Duane; and WAW.
\290\ See comment letter from Exxon.
\291\ See, e.g., comment letters from ABA 1 (recommending that,
for equity awards, recovery should first be sought from shares that
remain held, and that for the equity awards where the shares were
sold prior to recovery that the recovery be for the fair market
value on the date the erroneously awarded compensation amount is
determined, or if the shares were gifted, the fair market value on
the date of the gift); Duane (noting potential restrictions on an
executive's ability to liquidate securities and issuers' stock
retention requirements, and recommending recovery of stock awards
either in cash or in kind over reasonable periods of time); Exxon
(recommending cash value should be calculated at the time the shares
are ``received'' within the meaning of the rule to avoid
incentivizing executives to sell shares immediately on vesting); and
FSR (recommending basing the cash amount on the shares' value on the
date the issuer is required to prepare a restatement to address
manipulation concerns).
---------------------------------------------------------------------------
Commenters also recommended that the final rules permit, or that
the Commission provide guidance or other confirmation relating to the
use of, nonqualified deferred compensation plans, holdback policies, or
otherwise deferring payment of incentive-based compensation to
facilitate potential future recovery.\292\ Other commenters highlighted
potential benefits to such set-offs.\293\ Some commenters additionally
recommended that netting overpayments with incentive-based compensation
underpayments resulting from restating financial statements for
[[Page 73104]]
different periods be permitted under the rules.\294\
---------------------------------------------------------------------------
\292\ See, e.g., comment letters from ABA 1; AFL-CIO; Compensia;
and NACD.
\293\ See, e.g., comment letters from Exxon (enhancing the
ability to recover promptly); CEC 1 (ease of recovery and ability to
recover the full pre-tax amount of excess compensation); and WAW
(reduced cost of recovery and risk of litigation with executives).
\294\ See, e.g., comment letters from ABA 1; Bishop; CEC 1
(recommending disclosure to inform shareholders of recovery by
netting); Compensia; Mercer (suggesting that without netting
executives would be penalized and that making the executive whole
could distort the pay for performance relationship); NACD; SCG 1;
and SH&P. Two of these commenters suggested that this approach would
be fair and consistent with the ``no-fault'' standard of the
proposed rule. See comment letters from NACD; and SH&P.
---------------------------------------------------------------------------
We also received varied comments regarding the timing requirements
for recovery ranging from recommendations to require ``immediate
recovery,'' \295\ input regarding the meaning of the ``reasonably
promptly'' guidance,\296\ and recommendations opposing time
limits.\297\ Some commenters recommended allowing deferred
repayments,\298\ with one noting that immediate recovery could result
in significant economic hardship to an executive officer and that a
deferred payment plan could increase the likelihood of collecting and
avoid potential litigation costs.\299\
---------------------------------------------------------------------------
\295\ See comment letter from CalPERS 1.
\296\ See comment letter from Better Markets 1 (further
recommending requiring an explanation of the timing to discourage a
protracted recovery process).
\297\ See, e.g., comment letters from Bishop (noting that
issuers will face circumstances beyond their control, such as
litigation by executives); CFA Institute 1 (recommending that the
listing exchange determine whether an issuer is complying with its
recovery policy); and NACD.
\298\ See, e.g., comment letters ABA 1 (noting that there may be
circumstances where the executive is otherwise unable to repay the
excess amount); Bishop; Davis Polk 1; Ensco; and SCG 1 (recommending
that the rule permit discretion where the board determines
enforcement could affect the issuer's defense in a securities class
action). One of these commenters sought clarification that repayment
plans would not constitute prohibited personal loans under Exchange
Act Section 13(k). See comment letter from Bishop. See also comment
letters in response to the Reopening Release from ABA 2
(recommending discretion to permit a deferred payment plan);
McGuireWoods (recommending flexibility for boards to enter into
settlement and repayment terms); and Hunton.
\299\ See comment letter from Davis Polk 1.
---------------------------------------------------------------------------
iii. Final Amendments
After considering the views of commenters, we continue to believe
that the adopted rules should provide boards discretion, subject to
certain reasonable restrictions, regarding the means of recovery and
are providing the following guidance to assist boards in exercising
that discretion.\300\ Rule 10D-1 does not limit the amount of
compensation the board is required to recover; however, the rule does
not permit boards to settle for less than the full recovery amount
unless they satisfy the conditions that demonstrate recovery is
impracticable.\301\
---------------------------------------------------------------------------
\300\ See Rule 10D-1(b)(1)(iii). For a discussion of how to
determine the amounts, see supra note 235.
\301\ In that circumstance, the same conditions would apply as
for a determination to forgo recovery. See Section II.C.3.b.
---------------------------------------------------------------------------
We recognize that the appropriate means of recovery may vary by
issuer and by type of compensation arrangement. We agree with
commenters that many different means of recovery may be appropriate in
different circumstances. Consequently, the final amendments permit
issuers to exercise discretion in how to accomplish recovery.
Nevertheless, in exercising this discretion, issuers should act in a
manner that effectuates the purpose of the statute: to prevent current
or former executive officers from retaining compensation that they
received and to which they were not entitled under the issuer's
restated financial results.
Regardless of the means of recovery used, issuers should recover
erroneously awarded compensation reasonably promptly, because delays in
recovering excess payments allow executive officers to capture the time
value of money with respect to funds they did not earn, which should
instead belong to shareholders. Consistent with the discussion of the
timing in which the issuer must seek recovery in the Proposing Release,
the final rule clarifies that the issuer must pursue recovery
``reasonably promptly.'' \302\ The rule does not, however, adopt a
definition of ``reasonably promptly.'' We recognize that what is
reasonable may depend on the additional cost incident to recovery
efforts. We expect that issuers and their directors and officers, in
the exercise of their fiduciary duty to safeguard the assets of the
issuer (including the time value of any potentially recoverable
compensation), will pursue the most appropriate balance of cost and
speed in determining the appropriate means to seek recovery.
Furthermore, the rules do not prevent an issuer from securing recovery
through means that are appropriate based on the particular facts and
circumstances of each executive officer that owes a recoverable
amount.\303\
---------------------------------------------------------------------------
\302\ See Rule 10D-1(b)(1).
\303\ We note that unpaid amounts will be subject to disclosure
pursuant to 17 CFR 229.402(w)(1)(ii) and (iii).
---------------------------------------------------------------------------
For example, an issuer may be acting reasonably promptly in
establishing a deferred payment plan that allows the executive officer
to repay owed erroneous compensation as soon as possible without
unreasonable economic hardship to the executive officer, depending on
the particular facts and circumstances.\304\ The final rules also do
not prohibit an issuer from establishing compensation practices that
account for the possibility of the need for future recovery; while we
acknowledge the many suggestions by commenters in this regard, we
decline to offer specific guidance on which methods may be appropriate,
as it will depend on the particular facts and circumstances applicable
to that issuer. Finally, we note that the final rules do not restrict
exchanges from adopting more prescriptive approaches to the timing and
method of recovery under their rules in compliance with Section 19(b)
of the Exchange Act, including after they have observed issuer
performance and use any resulting data to assess the need for further
guidelines to ensure prompt and effective recovery.
---------------------------------------------------------------------------
\304\ In response to the commenter who asked for clarification
regarding whether a deferred repayment plan would be a prohibited
personal loan under 15 U.S.C. 78m(k), as a general matter, we would
not view such arrangements that are narrowly tailored to the
compensation being recovered and in order to facilitate full payment
as promptly as is reasonable under the circumstances as being a
prohibited personal loan.
---------------------------------------------------------------------------
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.
1. Proposed Amendments
The Commission proposed to require that issuers disclose their
recovery policies as an element of the listing standards, so that
exchanges could commence de-listing proceedings for issuers that fail
to make the required disclosure, as well as those that fail to adopt
recovery policies or those that fail to comply with the terms of their
policy.
In addition, the Commission proposed amendments to its rules and
relevant forms to require disclosure about, and the filing of, the
issuer's recovery policy. Specifically, the Commission proposed:
Amending Item 601(b) of Regulation S-K to require that an
issuer file its recovery policy as an exhibit to its annual report on
Form 10-K;
Adding Item 402(w) of Regulation S-K to require issuers to
disclose certain information about how they have
[[Page 73105]]
applied their recovery policies, including the date of and amount of
erroneously awarded compensation attributable to the accounting
restatement, any estimates that were used in determining the amount,
the amount that remains to be collected, and the names of, and amounts
owed by, executive officers where amounts due are owed or forgone;
Amending the Summary Compensation Table requirements of
Item 402 of Regulation S-K to disclose the effect of any recovered
amount;
Amending rules to require the new compensation recovery
disclosure pursuant to proposed Item 402(w) of Regulation S-K be
structured using machine-readable eXtensible Business Reporting
Language (``XBRL''); \305\ and
---------------------------------------------------------------------------
\305\ The proposed structuring would be limited to block text
tagging of the disclosures, rather than any additional detail tags
for specific data points included within the compensation recovery
disclosures. See Proposing Release at Section II.D.1.
---------------------------------------------------------------------------
Amending forms applicable to FPIs and listed funds to
require the same information called for by proposed Item 402(w) of
Regulation S-K.
In the Reopening Release, the Commission requested comment on
whether additional disclosures would benefit investors, such as
disclosure of how issuers calculated the erroneously awarded
compensation, including their analysis of the amount of the executive
officer's compensation that is recoverable under the rule, and, for
incentive-based compensation based on stock price or TSR, disclosure
regarding the determination and methodology that an issuer used to
estimate the effect of stock price or TSR on erroneously awarded
compensation. The Reopening Release also sought comment on whether to
add check boxes to the Form 10-K cover page that indicate separately
(a) whether the previously issued financial statements in the filing
include an error correction, and (b) whether any such corrections are
restatements that triggered a compensation recovery analysis during the
fiscal year. The Commission additionally requested comment on whether
any specific data points that are included within the new compensation
recovery disclosure should be detail tagged using Inline XBRL.
2. Comments
While commenters generally supported some level of disclosure about
an issuer's recovery policy, comments were mixed regarding the specific
disclosures that should be required. Some commenters generally
supported the proposed disclosure requirements, with several commenters
stating that required disclosure under the Federal securities laws
would promote consistency.\306\ One commenter specifically supported
the use of a listing standard requirement to disclose the issuer's
recovery policy,\307\ and others supported the proposed structure of
the disclosure requirements as they would facilitate exchanges' ability
to commence delisting proceedings for issuers that fail to make the
required disclosure.\308\ A few commenters recommended requiring the
issuer's recovery policy be posted on the issuer's website rather than
requiring it to be filed, as proposed.\309\
---------------------------------------------------------------------------
\306\ See, e.g., comment letters from ABA 1; Better Markets 1;
and CFA Institute 1.
\307\ See comment letter from Compensia.
\308\ See comment letters from ABA 1; and Better Markets 1.
\309\ See, e.g., comment letters from ABA 1 (recommending
following the compensation committee charter disclosure model which
relies on website disclosure and noting that many issuers disclose
their existing recovery policies on the corporate website and
investors are familiar with accessing corporate governance policies
there); and NACD.
---------------------------------------------------------------------------
We received a range of comments on the specific proposed disclosure
requirements.\310\ Some commenters supported proposed Item 402(w),\311\
noting its relevance to say-on-pay and director election voting
decisions,\312\ and the insight the disclosure would provide into board
decision-making.\313\ Some commenters further supported requiring the
additional disclosure requirements on which we requested comment in the
Reopening Release.\314\ Another commenter suggested that the disclosure
would elicit a sufficient amount of detailed information about how a
listed issuer has enforced its compensation recovery policy.\315\ Some
commenters recommended expanding certain disclosure requirements.\316\
Another commenter recommended further clarification of the
requirements.\317\
---------------------------------------------------------------------------
\310\ We received limited comment regarding the proposal to
adjust Summary Compensation Table disclosure, with one commenter
expressly supporting the proposal (see comment letter from ABA 1)
and another recommending that amounts recovered for periods earlier
than the three years presented should be reported in a footnote (see
comment letter from Mercer). One commenter questioned whether
reducing amounts reported in the Summary Compensation Table Stock
Awards and Option Awards columns would be inconsistent with
reporting other modifications under ASC Topic 718 and whether a
delay in grant date determination for share-based awards under ASC
Topic 718 could result from a recovery policy consistent with Rule
10-D-1. See comment letter from TCA. That commenter expressed
concern that such a delay would have a substantial and material
impact on the disclosure timing for those awards in the Summary
Compensation Table and Grants of Plan-Based Awards Table. We note
that, assuming the conditions for establishing a grant date under
ASC Topic 718 are otherwise met, having such a recovery policy
should not affect the issuer's determination.
\311\ See, e.g., comment letters from As You Sow 1; Better
Markets 1; CII 1; CalPERS 1; and OPERS 1.
\312\ See, e.g., comment letters from CalPERS 1; and CII 1
(noting its usefulness to institutional investors).
\313\ See comment letter from OPERS 1.
\314\ See, e.g., comment letters on the Reopening Release from
Better Markets 2 (supporting disclosure of how issuers calculate the
recoverable amount, especially with regards to compensation based on
stock price or TSR); CFA Institute 2; CII 3 (noting that such
disclosures could be particularly helpful in assessing the company's
executive compensation policies and practices for purposes of
shareholder voting); ICGN; Public Citizen 2; and Occupy. See also
comment letter from the Second Reopening Release from AFR 2
(supporting disclosure of how issuers calculate the recoverable
amount). But see comment letter on the Reopening Release from ABA 2
(generally supporting disclosure, but suggesting inclusion of stock
price and TSR would lead to complex disclosures regarding
determination and methodology).
\315\ See comment letter from ABA 1 (supporting tracking any
amount of incentive-based compensation subject to recovery through
the duration of the recovery obligation until that amount either is
recovered or the issuer concludes that recovery would be
impracticable).
\316\ See, e.g., comment letters from Better Markets 1; and
Public Citizen 1. These commenters recommended requiring
identification of each executive officer from whom recovery is
sought or obtained, the respective amounts, how the amounts were
determined, and the status of the recovery effort. See also comment
letters on the Reopening Release from CFA Institute 2; and ICGN
(supporting disclosure of the timing, and materiality
determination); and comment letter from ABA 1 (recommending
requiring the issuer to identify the incentive-based compensation
arrangements that were subject to recovery, to provide context for
the amount of excess incentive-based compensation resulting from the
restatement).
\317\ See comment letter from ABA 1 (recommending guidance as to
when a restatement is considered completed for purposes of
triggering the disclosure requirement and clarification that
disclosure would be required where the issuer's calculation results
in no erroneously awarded compensation and where no such
compensation is recovered because the board determines recovery
would be impracticable).
---------------------------------------------------------------------------
In contrast, some commenters recommended reducing or omitting
certain of the proposed disclosure requirements.\318\ A number of
commenters expressed concern or objected to identifying specific
executive officers from whom recovery has not yet been made or where
[[Page 73106]]
recovery was not pursued,\319\ others raised concerns that the
disclosure could violate data privacy laws of foreign
jurisdictions,\320\ and two others suggested that this disclosure would
invite second-guessing the board's decisions.\321\ Several of these
commenters offered various alternative approaches to the disclosure
requirement.\322\
---------------------------------------------------------------------------
\318\ See, e.g., comment letters from BRT 1; CAP; Compensia;
Exxon; Japanese Bankers; Mercer; NACD; Pay Governance; S&C 1; and
UBS. A few commenters objected to the inclusion of the disclosure in
Item 402. See comment letter from Pay Governance (suggesting more
disclosure in the proxy statement would be administratively
burdensome); and comment letters from NACD; and Public Citizen 1
(recommending disclosure on Form 8-K). See also comment letters on
the Reopening Release from Davis Polk 3 (suggesting that disclosure
of the methodology for calculating the recoverable amounts would be
burdensome, lack comparability, and involve litigation risk);
McGuireWoods; and SCG 2 (suggesting that the disclosure could be
confusing and would add legal, audit, compensation consulting, and
other expenses).
\319\ See, e.g., comment letters from BRT 1 (recommending board
discretion to omit individuals' names given the range of potential
factors including, security or safety concerns, the likelihood of
ongoing confidential legal negotiations, or the potential personal
impact of disclosure); CAP (expressing reputational concerns);
Mercer (recommending against the disclosure and suggesting that
exchanges could require individualized information in an issuer's
submission to the exchange if critical to their compliance
analysis); S&C 1 (suggesting that the specific identity of an
executive will in most cases not be material to the evaluation of
the boards' determination not to pursue recovery); and UBS
(suggesting that naming individuals from whom the issuer determines
not to recover is irrelevant and provides no benefit to
shareholders). See also comment letter on the Reopening Release from
McGuireWoods (recommending that compensation recovery disclosure
regarding non-named executive officers be generalized).
\320\ See, e.g., comment letters from Exxon (expressing concern
that identifying the status of specific individuals in certain
European Union and other jurisdictions could violate local data
privacy laws); Japanese Bankers (expressing concern that the
proposed disclosure may violate local personal information
protection acts and noting that under Japanese law the scope of
separate disclosure for financial reporting purposes is limited to
certain highly compensated executives); and UBS (suggesting data
privacy laws or regulations in various foreign jurisdictions could
affect a listed issuer's ability to disclose personal information).
\321\ See comment letters from ABA 1 (further noting the
requirement could subject executives to embarrassing disclosure as
to why they are unable to pay); and Compensia.
\322\ See, e.g., comment letters from CAP (recommending
identifying only named executive officers); BRT 1 (recommending
providing board discretion over whether to identify executive
officers); and Japanese Bankers (recommending disclosure on forgone
recovery only for those executive officers responsible for preparing
and disclosing financial statements). See also comment letters from
ABA 1; and Mercer (recommending aggregate disclosure of amounts
forgone and outstanding together with the number of executives from
whom recovery was not pursued and amounts outstanding).
---------------------------------------------------------------------------
In response to the request for comment in the Reopening Release
some commenters supported adding check boxes to the cover page of Form
10-K.\323\ Other commenters believed the check boxes would not provide
useful information to investors and were not consistent with the
Commission's modernization and simplification efforts.\324\
---------------------------------------------------------------------------
\323\ See, e.g., comment letters on the Reopening Release from
CFA Institute 2; CII 3; ICGN (also supporting Form 8-K disclosure);
and Occupy. See also comment letter on the Second Reopening Release
from AFR 2.
\324\ See, e.g., comment letters on the Reopening Release from
Davis Polk 3; McGuireWoods (stating that information regarding
restatements and recovery of compensation are sufficiently covered
by other disclosure rules such that this check box would provide
little additional informational value to investors); and SCG 2.
---------------------------------------------------------------------------
We similarly received varied comments on our proposal to require
the disclosure be tagged using XBRL. Some commenters expressed support
for the proposed implementation of XBRL data tagging.\325\ Other
commenters opposed the data tagging requirement,\326\ while some
recommended making tagging optional,\327\ or exempting SRCs and EGCs in
view of the burden.\328\ In response to the request for comment in the
Reopening Release regarding compensation recovery disclosure being
separately detail tagged using Inline XBRL, some commenters supported
Inline XBRL requirements for the compensation recovery information,
suggesting that such requirements would lead to more timely and less
costly analysis of the new disclosures.\329\ In contrast, some other
commenters expressed concern or opposed the Inline XBRL requirements
discussed in the Reopening Release, citing compliance costs and lack of
comparability across filers as specific concerns.\330\
---------------------------------------------------------------------------
\325\ See, e.g., comment letters from CII 1; CalPERS 1; and
OPERS 1 (contending that tagging would lower investors' costs to
collect the data and permit the information to be analyzed more
efficiently).
\326\ See, e.g., comment letters from CCMC 1; Davis Polk 1; FSR;
FedEx 1; Hay Group; Mercer (recommending a comprehensive approach to
tagging the proxy statement); and Pearl Meyer. Many of these
commenters expressed concern regarding the cost of implementation
versus the perceived benefits, such as the utility of the
information to investors. See, e.g., comment letters from CCMC 1;
Davis Polk 1 (expressing concern about the comparability of the
data); FSR; FedEx 1; and Pearl Meyer.
\327\ See comment letter from Hay Group.
\328\ See comment letters from ABA 1; and Hay Group.
\329\ See, e.g., comment letters on the Reopening Release from
CFA Institute 2; CII 3; and XBRL US (Aug. 30, 2021) (recommending
that the disclosure be tagged using Inline XBRL and be incorporated
into the definitive proxy or information statement).
\330\ See, e.g., comment letters on the Reopening Release from
ABA 2; Davis Polk 3; and McGuireWoods. These commenters suggested
that varying recovery processes may necessitate custom tagging,
which would undermine comparability issues and thus limit the
benefits of tagging.
---------------------------------------------------------------------------
3. Final Amendments
After considering the views of commenters, we are adopting
substantially as proposed rules to require that listed issuers disclose
their recovery policies as an element of the listing standards and to
require disclosure about, and the filing of, the issuer's recovery
policy, in Commission filings. After considering comments to the
Reopening Release, and in a change from the proposal, the final rules
will additionally require: disclosure relating to an issuer's
compensation recovery policy and recovery; tagging of the additional
information in Inline XBRL; and additional check box disclosure on the
cover of the Forms 10-K, 20-F, and 40-F.
We believe Sections 10D(a) and (b) are intended to require listed
issuers to adopt, comply with, and provide disclosure about their
compensation recovery policies. Accordingly, Rule 10D-1 requires the
listing standards adopted by exchanges to include that listed issuers
disclose their recovery policies.\331\ As noted above, as a result of
implementing the disclosure requirement as an element of the listing
standards, we would expect exchanges to commence delisting proceedings
for issuers that fail to make the required disclosure. 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 permits 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.
---------------------------------------------------------------------------
\331\ See 17 CFR 240.10D-1(b)(2).
---------------------------------------------------------------------------
The 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. To provide consistent disclosure across exchanges, Rule 10D-1
provides that the required disclosure about the issuer's recovery
policy must be filed in accordance with the disclosure requirements of
the Federal securities laws. \332\ Amended Item 601(b) of Regulation S-
K requires that an issuer file its recovery policy as an exhibit to its
annual report on Form 10-K.\333\ Structuring the provision in this
[[Page 73107]]
manner provides that, in addition to making the disclosure a condition
to listing, it is also subject to Commission oversight to the same
extent as other disclosure required in Commission filings.
---------------------------------------------------------------------------
\332\ Id.
\333\ 17 CFR 229.601(b)(97). In a modification from the
proposal, we are designating the exhibit containing the compensation
recovery policy as Item 601(b)(97) rather than Item 601(b)(96) as
was proposed because Item 601(b)(96) is currently in use. In
addition, we are moving the definition of the affected registrant to
the operative text rather than defining ``listed registrant'' for
purposes of Item 601(b)(97). Corresponding filing requirements will
apply to listed FPIs and registered management investment companies
subject to Rule 10D-1. We are correspondingly amending the Form 20-F
Instructions as to Exhibits to add new Instruction 97 and Form 40-F
to add new paragraph 19(a) to General Instruction B. Form N-CSR is
also being amended to renumber Item 18 (Exhibits) as Item 19 and add
new paragraph (a)(2) to that item (and redesignating current
paragraph (a)(2) as paragraph (a)(3)) for those registered
management investment companies that are subject to the requirements
of Rule 10D-1.
---------------------------------------------------------------------------
In connection with our implementation of Section 10D(b)(1), we are
also using our discretionary authority to amend Item 402 of Regulation
S-K, Form 40-F, and Form 20-F to require listed issuers to disclose how
they have applied their recovery policies.\334\ In addition to new Item
402(w), we are adding substantially as proposed a new instruction to
the Summary Compensation Table to require that any amounts recovered
pursuant to a listed issuer's compensation recovery policy reduce the
amount reported in the applicable column, as well as the ``total''
column'' for the fiscal year in which the amount recovered initially
was reported and be identified by footnote.\335\
---------------------------------------------------------------------------
\334\ See new Item 402(w) of Regulation S-K, Item 6.F. of Form
20-F, and Instruction 19 of Form 40-F.
\335\ See Instruction 5 to 17 CFR 229.402(c), and Instruction 5
to 17 CFR 229.402(n). The language from the proposal has been
revised for clarity but the revisions do not affect the substance of
the instructions.
---------------------------------------------------------------------------
As adopted,\336\ 17 CFR 229.402(w)(1) (``Item 402(w)(1)'') \337\
applies if at any time during or after its last completed fiscal year
the issuer was required to prepare an accounting restatement that
required recovery of erroneously awarded compensation pursuant to the
listed issuer's compensation recovery policy required by the listing
standards adopted pursuant to Rule 10D-1, or there was an outstanding
balance as of the end of the last completed fiscal year of erroneously
awarded compensation to be recovered from the application of that
policy to a prior restatement.\338\
---------------------------------------------------------------------------
\336\ In a nonsubstantive modification from the proposed rules
and in order to streamline the rule, we have removed the separate
definitions of certain terms and incorporated the substance of the
definition into the text of the rule.
\337\ All domestic listed issuers are subject to Item 402(w)
disclosure and are required to provide the disclosure along with the
issuer's other Item 402 disclosure as part of an issuer's annual
reporting obligation. See Item 11. Executive Compensation of Form
10-K.
\338\ See Item 402(w)(1). The revised language of Item 402(w)(1)
more clearly delineates when the disclosure is required and also
addresses the commenter who asked for clarification of when a
restatement is considered ``completed.'' This is because the trigger
for disclosure is now when the issuer determines that it is required
to prepare the restatement, which is the same event that triggers
the issuer to comply with its compensation recovery policy pursuant
to Rule 10D-1.
---------------------------------------------------------------------------
In these circumstances, an issuer will be required to provide the
following information in its Item 402 disclosure:
The date on which the listed issuer was required to
prepare an accounting restatement and the aggregate dollar amount of
erroneously awarded compensation attributable to such accounting
restatement (including an analysis of how the recoverable amount was
calculated) \339\ or, if the amount has not yet been determined, an
explanation of the reasons and disclosure of the amount and related
disclosures in the next filing that is subject to Item 402 of
Regulation S-K; \340\
---------------------------------------------------------------------------
\339\ In a modification from the proposal, 17 CFR
229.402(w)(1)(i)(B) will require an analysis of how the amount of
erroneously awarded compensation was calculated. We believe that
investors will benefit from disclosure of the analysis of how the
amount was calculated and agree with commenters that suggested such
disclosures could be particularly helpful in assessing the issuer's
executive compensation policies and practices for purposes of
shareholder voting.
\340\ See 17 CFR 229.402(w)(1)(i)(A), (B), and (E). In another
modification from the proposal, proposed Instruction 4 to Item
402(w) has been incorporated into the rule as 17 CFR
229.402(w)(1)(i)(E) (``Item 402(w)(1)(i)(E)'') and provides as
proposed that if the aggregate dollar amount of erroneously awarded
compensation has not yet been determined, the listed issuer must
disclose this fact and explain the reasons. Item 402(w)(1)(i)(E)
also now includes a requirement, when the amount has not yet been
determined, to disclose the amount and related disclosures in the
next filing that is subject to Item 402 of Regulation S-K. This
modification was necessary, because otherwise the issuer would not
be required to disclose the determined amount in a subsequent year
unless the amount is still outstanding at the end of the year.
---------------------------------------------------------------------------
The aggregate dollar amount of erroneously awarded
compensation that remains outstanding at the end of its last completed
fiscal year; \341\
---------------------------------------------------------------------------
\341\ See 17 CFR 229.402(w)(1)(i)(D). To the extent that a
company determines recovery is impracticable in reliance on the
exceptions in 17 CFR 240.10D-1(b)(1)(iv), the balance would no
longer be outstanding and disclosure under this section would no
longer be provided.
---------------------------------------------------------------------------
If the financial reporting measure related to a stock
price or TSR metric, the estimates used to determine the amount of
erroneously awarded compensation attributable to such accounting
restatement and an explanation of the methodology used for such
estimates; \342\
---------------------------------------------------------------------------
\342\ See 17 CFR 229.402(w)(1)(i)(C).
---------------------------------------------------------------------------
If recovery would be impracticable pursuant to 17 CFR
240.10D-1(b)(1)(iv) (``Rule 10D-1(b)(1)(iv)''), for each current and
former named executive officer and for all other current and former
executive officers as a group, disclose the amount of recovery forgone
and a brief description of the reason the listed registrant decided in
each case not to pursue recovery; \343\ and
---------------------------------------------------------------------------
\343\ See 17 CFR 229.402(w)(1)(ii).
---------------------------------------------------------------------------
For each current and former named executive officer,
disclose the amount of erroneously awarded compensation still owed that
had been outstanding for 180 days or longer since the date the issuer
determined the amount owed.\344\
---------------------------------------------------------------------------
\344\ In response to commenters' concerns regarding the privacy
of executive officers, in a modification from the Proposing Release
the final amendments limit these detailed disclosures to current and
former named executive officers. We are requiring the more detailed
disclosure for current and former named executive officers for the
same reasons as those discussed at note 343 supra. See 17 CFR
229.402(w)(1)(iii). More general information about amounts remaining
outstanding is required by 17 CFR 229.402(w)(1)(i)(D).
---------------------------------------------------------------------------
We continue to believe that disclosure regarding the use of the
impracticability exception in Rule 10D-1(b)(1)(iv) will provide
information to shareholders and exchanges that will help them monitor
the implementation of an issuer's recovery policy. Any brief
description of the reason an issuer determined not to pursue recovery
should include the element of Rule 10D-1(b)(1)(iv) that caused the
impracticability, and should provide additional context relating to
that element, such as:
A brief explanation of the types of direct expenses paid
to a third party to assist in enforcing the recovery policy, if the
issuer is relying on Rule 10D-1(b)(1)(iv)(A);
Identification of the provision of foreign law the
recovery policy would violate if the issuer is relying on Rule 10D-
1(b)(1)(iv)(B); or
A brief explanation of how the recovery policy would cause
an otherwise tax-qualified retirement plan to fail to meet the
requirements of 26 U.S.C. 401(a)(13) or 26 U.S.C. 411(a), if the issuer
is relying on Rule 10D-1(b)(1)(iv)(C).
Upon further consideration and in response to commenters concerns
regarding the privacy of executive officers,\345\ in a modification
from the Proposing Release the final amendments require specific
disclosure regarding use of the impracticability exception with respect
only to the current and former named executive officers. The final
amendments require more generalized disclosure regarding use of the
impracticability exception with respect to other current and former
executive officers as a group. Aggregated disclosure of recovery from
the group of officers other than named executive officers is consistent
with the registrant's reporting obligations for executive compensation
purposes, and will help investors to monitor the registrant's
implementation of its recovery obligation. However, we believe that
more detailed information
[[Page 73108]]
for the named executive officers is appropriate, as it will be relevant
to investors' understanding of current and prior compensation
disclosures.
---------------------------------------------------------------------------
\345\ See notes 319 through 322.
---------------------------------------------------------------------------
We are also adopting the amendment to Item 404(a) providing that an
issuer that complies with its Item 402(w) disclosure requirements need
not disclose any incentive-based compensation recovery pursuant to Item
404(a).\346\
---------------------------------------------------------------------------
\346\ Item 404(a) requires a description of certain transaction
between the issuer and a related person. To avoid duplicative
disclosure, we are amending Instruction 5.a.iii to Item 404(a) of
Regulation S-K largely as proposed. We are clarifying the
description of affected compensation in the instruction to indicate
that it applies to erroneously awarded compensation computed as
provided in 17 CFR 240.10D-1(b)(1)(iii) and the applicable listing
standards for the registrant's securities. See also Instruction 1 to
Item 22(b)(20) of Schedule 14A for registered management investment
companies (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)). See also Item 7.B to Form 20-F for
FPIs (disclosure need not be provided pursuant to this Item if the
transaction involves the recovery of erroneously awarded
compensation that is disclosed pursuant to Item 6.F).
---------------------------------------------------------------------------
The requirements elicit disclosure regarding an issuer's activity
to recover erroneously awarded compensation during its last completed
fiscal year. In a nonsubstantive modification from the proposal, we are
adopting the substance of Instruction 5 to Item 402(w) as new 17 CFR
229.402(w)(3), which limits the disclosure requirement to proxy or
information statements that call for Item 402 disclosure and the
issuer's annual report on Form 10-K and provides that the information
required by 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. As this information is similar to other executive
compensation information required by Item 402 and is likely to serve a
similar purpose for investors in evaluating the issuer and making
voting decisions, we believe that the information is most relevant to
shareholders in an issuer's proxy or information statements that call
for Item 402 disclosure and the issuer's annual report on Form 10-K.
As proposed, the disclosure will be required as a separate item
rather than as an amendment to the CD&A requirement because the
requirements apply to any current or former executive officer, not just
``named executive officers'' and CD&A requirements do not apply to
SRCs, EGCs, and FPIs,\347\ all of which are subject to the new
requirements.\348\
---------------------------------------------------------------------------
\347\ SRCs and EGCs are not required to provide CD&A in
accordance with the scaled disclosure requirements contained in Item
402 of Regulation S-K. See 17 CFR 229.402(l) and Section 102(c) of
the JOBS Act. FPIs 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, FPIs 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 17 CFR
229.402(a)(1) of Regulation S-K.
\348\ We note that a listed issuer required to provide CD&A
could choose to include the Item 402(w) disclosure in its CD&A
discussion of its recovery policies and decisions pursuant to 17 CFR
229.402(b)(2)(viii) of Regulation S-K, which could benefit investors
by disclosing all compensation recovery information together in the
filing.
---------------------------------------------------------------------------
With respect to registered management investment companies subject
to Rule 10D-1, the final rules will require information mirroring the
Item 402(w) disclosure to be included in annual reports on Form N-CSR
and in proxy statements and information statements relating to the
election of directors.\349\ Similarly for listed FPIs, the same
information called for by Item 402(w) will be required in their annual
reports filed with the Commission pursuant to Section 13(a) or Section
15(d) of the Exchange Act, such as on Form 20-F or, if the issuer
elects to use the registration and reporting forms that U.S. issuers
use, on Form 10-K.\350\ MJDS filers will be required to provide this
information in annual reports on Form 40-F.\351\
---------------------------------------------------------------------------
\349\ See Item 18 of Form N-CSR; Item 22(b)(20) of Schedule 14A.
We are also amending General Instruction D to Form N-CSR to permit
registered management investment companies subject to Rule 10D-1 to
answer the information required by Item 18 by incorporating by
reference from the company's definitive proxy statement or
definitive information statement. In addition, we are amending 17
CFR 270.30a-2 to reflect the new item numbers in Form N-CSR. We are
also cross-referencing Item 18 of Form N-CSR in Item 22(b)(20) of
Schedule 14A rather than restating the requirements of Form N-CSR in
Schedule 14A.
\350\ Because securities registered by these listed issuers are
exempt from Section 14(a) of the Exchange Act, these issuers are not
required to disclose any proxy or consent solicitation materials
with respect to their securities under that provision. See Item 6.F
of Form 20-F.
\351\ See Paragraph (19) of General Instruction B of Form 40-F.
---------------------------------------------------------------------------
In addition, we are amending the cover page of Form 10-K, Form 20-
F, and Form 40-F to add check boxes that indicate separately (a)
whether the financial statements of the registrant included in the
filing reflect correction of an error to previously issued financial
statements, and (b) whether any of those error corrections are
restatements that required a recovery analysis of incentive-based
compensation received by any of the registrant's executive officers
during the relevant recovery period pursuant to Sec. 240.10D-
1(b).\352\ Comments in response to the Reopening Release generally
supported the addition of check boxes to the cover page of Form 10-
K.\353\ Particularly as it relates to ``little r'' restatements which
typically are not disclosed or reported as prominently as ``Big R''
restatements, the check boxes provide greater transparency around such
restatements and easier identification for investors of those that
triggered a compensation recovery analysis. Although the Reopening
Release did not specifically ask about Forms 20-F and 40-F, these forms
serve corresponding purposes as Form 10-K, and for similar reasons, we
believe it will be beneficial to investors to include similar check
boxes on the cover pages of these forms and note that their inclusion
will be a relatively low burden. We are not adopting the check-box
requirement for annual reports filed on Form N-CSR because the current
content and formatting requirements for registered management
investment companies' annual reports do not otherwise include check
boxes, and because we anticipate that a limited number of registered
management investment companies will be affected by the final
rules.\354\
---------------------------------------------------------------------------
\352\ In a nonsubstantive change from the Reopening Release, we
have refined certain terminology for clarity.
\353\ While we recognize some commenters' concerns regarding the
usefulness of the information provided by the check boxes and their
views that additional check boxes do not simplify the disclosure, we
believe that the check boxes will help investors more readily
identify restatements by issuers and whether any of the restatements
triggered a compensation recovery analysis. See supra note 324. We
agree with those commenters that suggested that compensation
recovery analysis is relevant to investors such that a check box
appropriately highlights the issue. See supra note 323.
\354\ We estimate that only seven registered management
investment companies that are listed issuers and are internally
managed may have executive officers who receive incentive-based
compensation, and thus could be subject to the new rules.
---------------------------------------------------------------------------
Relatedly, in a modification from the proposal, to allow investors
to understand the check boxes in the appropriate context of the
issuer's application of its recovery policy, we are adding a disclosure
requirement in a new 17 CFR 229.402(w)(2) to require that, if at any
time during its last completed fiscal year a registrant prepared an
accounting restatement, and the registrant concluded that recovery of
erroneously awarded compensation was not required pursuant to the
registrant's
[[Page 73109]]
compensation recovery policy required by the listing standards adopted
pursuant to Rule 10D-1, the issuer must briefly explain why application
of its recovery policy resulted in this conclusion. The additional
disclosure will provide useful context to investors and the exchanges
when an issuer has issued an accounting restatement and facilitates a
better understanding of how an issuer is applying its recovery policy.
Finally, in a modification from the proposal, we are requiring
tagging of any specific data points included within the compensation
recovery disclosures, as well as block text tagging of those
disclosures, in Inline XBRL.\355\ Because existing Commission rules
require the Inline XBRL tagging of all cover page information on Forms
10-K, 20-F, and 40-F, the two new cover page check boxes will be tagged
in Inline XBRL.\356\ We recognize some commenters' concerns relating to
the costs of implementing the use of XBRL and their additional concerns
that the data may lack comparability across filers, including as a
result of custom tagging, which may limit its utility to investors.
However, we agree with other commenters that Inline XBRL requirements
will facilitate analysis of the new compensation recovery disclosures,
even in situations where the particular characteristics of compensation
recovery programs, such as the methods by which filers calculate the
amount of erroneously awarded compensation, may not be fully comparable
across filers (e.g., by enabling analysis of trends in a single filer's
disclosures over multiple reporting periods). Requiring Inline XBRL
tagging of the compensation recovery disclosure benefits investors by
making the disclosures more readily available and easily accessible to
investors, market participants, and others for aggregation, comparison,
filtering, and other analysis, as compared to requiring a non-machine-
readable data language such as ASCII or HTML. At the same time, we do
not expect the incremental compliance burden associated with tagging
the additional information to be unduly burdensome, because issuers
subject to the tagging requirements are, or in the near future will be,
subject to similar Inline XBRL requirements in other Commission
filings.\357\
---------------------------------------------------------------------------
\355\ See 17 CFR 229.402(w)(4) of Regulation S-K and 17 CFR
232.405 (Rule 405 of Regulation S-T). In a nonsubstantive
modification from the proposal, we have moved the appearance and
formatting requirement to 17 CFR 229.402(w)(3) and have separately
addressed requirements relating to interactive data in 17 CFR
229.402(w)(4).
\356\ See 17 CFR 229.601(b)(104) and 17 CFR 232.406 (Rule 406 of
Regulation S-T). Issuers will thus be required to use the most
updated versions of all taxonomies used to tag the filing to comply
with the rule.
\357\ As noted in the Reopening Release, subsequent to the
proposal, the Commission adopted rules replacing XBRL tagging
requirements for issuer financial statements and open-end fund risk/
return summary disclosures with Inline XBRL tagging requirements.
Inline XBRL embeds the machine-readable tags in the human-readable
document itself, rather than in a separate exhibit. See Inline XBRL
Filing of Tagged Data, Release No. 33-10514 (June 28, 2018) [83 FR
40846 (Aug. 16, 2018)]. As a result of those changes, we are using
Inline XBRL, rather than XBRL, for the tagging requirements. See
also Securities Offering Reform for Closed-End Investment Companies,
Release No. 33-10771 (Apr. 8, 2020) [85 FR 33290 (June 1, 2020) at
33318]. Inline XBRL requirements for business development companies
will take effect beginning Aug. 1, 2022 (for seasoned issuers) and
Feb. 1, 2023 (for all other issuers).
---------------------------------------------------------------------------
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. In the context of Securities
Act registration statements, a registrant is required to state the
general effect of any statute, charter provisions, bylaws, contract or
other arrangements under which any controlling person, director, or
officer of the registrant is insured or indemnified in any manner
against liability which he may incur in his capacity as such.\358\
---------------------------------------------------------------------------
\358\ See 17 CFR 229.702.
---------------------------------------------------------------------------
1. Proposed Amendments
The Commission proposed that listed issuers would be prohibited
from indemnifying any executive officer or former executive officer
against the loss of erroneously awarded compensation. 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 officer for premiums for such an insurance policy.
Comments
We received mixed comments on the proposal that listed issuers be
prohibited from indemnifying any executive officer or former executive
officer against the loss of erroneously awarded compensation. A number
of commenters expressly supported the proposed treatment of
indemnification and insurance.\359\ Some of these commenters suggested
that permitting indemnification would fundamentally undermine the
purpose of the statute and effectively nullify the mandatory nature of
the compensation recovery.\360\ Some commenters recommended that the
Commission go even further, such as by discouraging or prohibiting
executive officers from procuring their own insurance.\361\
---------------------------------------------------------------------------
\359\ See, e.g., comment letters from; AFL-CIO; AFR 1; CalPERS
1; and Rutkowski 1. See also comment letter from ABA 1 (expressing
qualified support, but stating that issuers should not be prohibited
from indemnifying executives' litigation expenses in compensation
recovery actions consistent with state law, noting that these
arrangements permit advancement of legal expenses incurred in
defending a claim by the issuer if the executive ``acted `in good
faith' and in a manner reasonably believed to be, or not opposed to,
the best interests of the issuer'').
\360\ See, e.g., comment letters from AFL-CIO; AFR 1; and
Rutkowski 1.
\361\ See, e.g., comment letters from American Insurance
Association (``AIA''); Better Markets 1; FSR; and TCA.
---------------------------------------------------------------------------
In contrast, a number of commenters expressed concerns with the
proposed prohibition.\362\ Some of these commenters contended that
Section 10D does not prohibit indemnification.\363\ One commenter
recommended the approach in 17 CFR 229. 512(h) where the Commission
expresses its opinion regarding indemnification, but does not prohibit
it by rule.\364\ Some others asserted that a prohibition on
indemnification or issuer-paid insurance would be appropriate only
where recovery is premised on fraud or
[[Page 73110]]
misconduct.\365\ Commenters additionally expressed concern that the
rule could be construed to conflict with state law provisions providing
for indemnification under certain circumstances.\366\
---------------------------------------------------------------------------
\362\ See, e.g., comment letters from Bishop (expressing concern
over retroactive application to existing compensation agreements);
CCMC 1; Compensia (suggesting compensation payments in the ordinary
course of business could be mistaken for indemnification and
recommending guidance); NACD; Pearl Meyer (expressing concern that a
prohibition on indemnification could adversely affect a public
company's ability to hire executive officers); and SCG 1.
\363\ See, e.g., comment letters from Bishop (suggesting that
``will'' in Section 10D expresses ``a simple futurity'' whereas
``shall'' expresses an obligation); CCMC 1 (suggesting the proposal
may exceed the Commission's authority as it would touch on state
regulation of insurance products); and SCG 1.
\364\ See comment letter from CCMC 1. 17 CFR 229.512(h) provides
that if acceleration of a Securities Act registration statement is
requested, the registration statement is required to include an
undertaking stating that the registrant has been advised that in the
opinion of the Securities and Exchange Commission indemnification of
directors, officers and controlling persons for liabilities arising
under the Securities Act is against public policy as expressed in
the Securities Act and is therefore unenforceable. The undertaking
further provides that in the event that such a claim for
indemnification is asserted, the registrant will, unless in the
opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy
as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
\365\ See comment letters from NACD; and SCG 1.
\366\ See comment letters from Bishop; and SCG 1 (suggesting
that the risk of private litigation would justify issuer
indemnification and insurance and citing to the General Corporation
Law of Delaware that provides for indemnification where the agent
has been successful on the merits).
---------------------------------------------------------------------------
3. Final Amendments
After considering the views of commenters, we are adopting as
proposed rules to prohibit issuers from insuring or indemnifying any
executive officer or former executive officer against the loss of
erroneously awarded compensation.\367\ While an executive officer may
be able to purchase a third-party insurance policy to fund potential
recovery obligations, the indemnification provision prohibits an issuer
from paying or reimbursing the executive officer for premiums for such
an insurance policy.\368\
---------------------------------------------------------------------------
\367\ See 17 CFR 240.10D-1(b)(1)(v).
\368\ Such indemnification or reimbursement would also be
prohibited through modification to current compensation arrangements
or other means that would amount to de facto indemnification, such
as, for example, by providing an executive a new cash award which
the issuer would then ``cancel'' to effect recovery of outstanding
recoverable amounts.
---------------------------------------------------------------------------
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.'' \369\ The Proposing Release acknowledged
that 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.\370\ However, 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.\371\
Indemnification arrangements that permit executive officers to retain
or recover compensation that they were not entitled to receive based on
restated financial statements would fundamentally undermine the purpose
of Section 10D.\372\
---------------------------------------------------------------------------
\369\ See Senate Report at 136.
\370\ See Proposing Release at Section II.F.
\371\ See Cohen v. Viray, 622 F.3d 188, 195 (2d Cir. 2010)
(holding that an indemnification agreement cannot be used to release
the CEO and CFO from liability to repay compensation under Sarbanes-
Oxley Act Section 304, 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 officer's
purchase of this coverage, the executive officer retains the excess
compensation to which he or she was not entitled.
\372\ See 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'').
---------------------------------------------------------------------------
We further believe that Section 29(a) of the Exchange Act would
render any indemnification agreement void and unenforceable to the
extent that the agreement purported to relieve the issuer of its
obligation under Section 10(D), Rule 10D-1, and a resulting listing
standard to recover erroneously paid incentive-based compensation.
Section 29(a) provides that any 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.\373\ 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.' '' \374\
---------------------------------------------------------------------------
\373\ 15 U.S.C. 77cc. National securities exchanges and national
securities associations are self-regulatory organizations. 15 U.S.C.
78c(a)(26).
\374\ See 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)). See also Cohen v. Viray,
622 F.3d at 195 (citing Section 29(a) in rejecting indemnification
against Sarbanes-Oxley Act Section 304 liability); and 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).
---------------------------------------------------------------------------
We acknowledge commenters who raised various concerns with respect
to the prohibition on issuers insuring or indemnifying executive
officers with respect to recoverable compensation. While we acknowledge
that states may have specific provisions permitting issuers to
indemnify or insure their executive officers in certain circumstances,
we are unaware of any provisions that mandate such indemnification or
insurance, and as such, we do not believe the final rules are in
conflict with such provisions. We also acknowledge, as one commenter
observed, that states regulate certain insurance products.
Nevertheless, we believe Rule 10D-1's prohibition is necessary to
ensure that the recovery policy mandated by Congress for issuers listed
on U.S. national exchanges is given actual effect. Additionally,
because the rules apply to all listed issuers, with limited exceptions,
we do not find the assertions by commenters that such prohibitions
would put issuers at a disadvantage in the ability to hire executive
officers to be compelling. In light of Section 10D's mandate to return
to issuers and shareholders compensation that was erroneously awarded,
we agree with commenters who asserted that any issuer indemnification
or insurance of an executive officer's obligation to return erroneously
awarded compensation would be contrary to the statute, and therefore,
we continue to believe it is appropriate to restrict an issuer's
ability to do so.
F. Transition and Timing
Section 10D does not address transition and timing of
implementation of the rules.
1. Proposed Amendments
The Commission proposed that each exchange be required to file its
proposed listing standards no later than 90 days following publication
of the final rules in the Federal Register, and that such listing
standards be effective no later than one year following that same
publication date. Further, each listed issuer would be required to
adopt a compliant recovery policy no later than 60 days following the
date on which the listing rules to which it is subject become
effective. The Commission also proposed that each listed issuer be
required to recover pursuant to the issuer's recovery policy 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
[[Page 73111]]
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.
Finally, the Commission proposed that an issuer be required to file
the required disclosures in the applicable Commission filings required
on or after the date on which the listing standards become effective.
2. Comments
We received limited comment on transition and timing. One commenter
found the proposed schedule for the exchanges to file their proposed
listing standards and have them declared effective to be ``workable and
appropriate.'' \375\
---------------------------------------------------------------------------
\375\ See comment letter from ABA 1.
---------------------------------------------------------------------------
Commenters that addressed the issue generally supported applying
recovery policies only to incentive-based awards granted or performance
periods that begin after the effective date of the relevant exchange
listing standards \376\ or the effective date of the final rules.\377\
Some of these commenters expressed concerns regarding retroactive
application of the rules,\378\ with one noting that applying the rule
to awards earned or vested after the effective date of Rule 10D-1 could
pick up awards granted prior to the effective date.\379\ A number of
commenters also expressed concern regarding the effect of the rules on
existing contracts, noting that existing contracts typically can be
amended only with consent.\380\ Finally, some commenters thought the
proposed 60-day period for issuers to adopt their recovery policies
following the effective date of the exchanges' listing rules was too
short and recommended additional time.\381\
---------------------------------------------------------------------------
\376\ See, e.g., comment letters from ABA 1; BRT 1; Compensia;
Chevron; Mercer; and NACD.
\377\ See, e.g., comment letters from CCMC 1; Coalition;
Meridian; and SCG 1.
\378\ See comment letters from CCMC; and Coalition.
\379\ See comment letter from Chevron.
\380\ See, e.g., comment letters from ABA 1 (stating that if the
rule is not applied on a wholly prospective basis, it should apply
only to erroneously awarded compensation granted after the effective
date of final Rule 10D-1); BRT 1; CCMC 1; Coalition; Mercer;
Meridian; NACD (stating that questions of contractual violations are
serious and may not be resolved merely through an amendment to by-
laws); and SCG 1 (suggesting that issuers may only be able to amend
plans on a prospective basis, as plans often prohibit amendments
that impair a participant's rights to an outstanding award, unless
the participant consents). See also comment letters in response to
the Reopening Release from ABA 2; Cravath; Hunton; McGuireWoods; and
SCG 2. Some of these commenters recommended exceptions for existing
contracts or awards (Cravath and Hunton) or an exception for
compensation paid pursuant to existing employment and equity award
agreements (SCG 2).
\381\ See comment letters from ABA 1 (recommending an exemption
or a delayed phase-in of at least two years for SRCs and EGCs); NACD
(recommending 90 days); and Davis Polk 1 (recommending six months).
---------------------------------------------------------------------------
3. Final Amendments
After considering the views of commenters, we are adopting
transition and timing requirements substantially as proposed, with a
modification in response to commenters (as described below). Under the
final amendments, issuer compliance is 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.
Under the rules we are adopting: (i) each exchange will be required
to file its proposed listing standards no later than 90 days following
the November 28, 2022, (ii) the listing standards must be effective no
later than one year following the November 28, 2022, and (iii) each
issuer subject to such listing standards will be required to adopt a
recovery policy no later than 60 days following the date on which the
applicable listing standards become effective.\382\ We would not expect
compliance with the disclosure requirement until issuers are required
to have a policy under the applicable exchange listing standard.
---------------------------------------------------------------------------
\382\ See 17 CFR 240.10D-1(a)(2) and (3).
---------------------------------------------------------------------------
As noted above, several commenters raised concerns about
application of the mandated recovery policy to compensation that was
granted prior to the effective date of the rules. In a modification
from the proposal in response to these concerns, and to provide an
additional transition period, the final rules provide that each listed
issuer is required to comply with the recovery policy for all
incentive-based compensation received (as defined in 17 CFR 240.10D-
1(d) \383\) by current or former executive officers on or after the
effective date of the applicable listing standard (as opposed to the
effective date of Rule 10D-1).\384\ In addition, each listed issuer is
required to provide the disclosures required by the rule and Item
402(w) in the applicable Commission filings required on or after the
date on which the exchanges' listing standards become effective.\385\
---------------------------------------------------------------------------
\383\ Rule 10D-1 states ``[i]ncentive-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.''
\384\ See 17 CFR 240.10D-1(a)(3)(ii). Notwithstanding the look-
back requirement in 17 CFR 240.10D-1(b)(1)(i)(D), an issuer is only
required to apply the recovery policy to incentive-based
compensation received after the effective date of the applicable
listing standard.
\385\ See 17 CFR 240.10D-1(a)(3)(iii). Issuers subject to such
listing standards will be required to adopt a recovery policy no
later than 60 days following the date on which the applicable
listing standards become effective and must begin to comply with
these disclosure requirements in proxy and information statements
and the issuer's annual report on Form 10-K on or after the issuer
adopts its recovery policy.
---------------------------------------------------------------------------
Notwithstanding these extended transition periods, we recognize
that there could be incentive-based compensation that is the subject of
a compensation contract or arrangement that existed prior to the
effective date of Rule 10D-1 which was not received until after the
effective date of the applicable listing standards--and therefore would
be subject to recovery under the final amendments. We do not believe
this would be an inappropriate application of the mandated recovery
policy. In our view, executives do not have a reasonable settled
expectation in retaining compensation that was erroneously awarded
based on misreported financial metrics, particularly when those
financial metrics were attained on or after the effective date of the
applicable listing standards, as contemplated by the final amendments.
For similar reasons, we do not believe it is inappropriate to apply the
mandated recovery policy to pre-existing compensation contracts or
arrangements.
While we acknowledge commenter concerns about the need for adequate
time to prepare for the application of the listing standards and the
development of appropriate recovery policies, including in some cases
the renegotiation of certain contracts, we believe the final rules
provide ample time for such preparations. In that regard, we note that
issuers will have more than a year from the date the final rules are
published in the Federal Register to prepare and adopt compliant
recovery policies. We believe the prescriptive nature of Rule 10D-1
provides issuers with sufficient notice to begin such preparations
concurrently with listing standards being finalized.
III. Other Matters
If any of the provisions of these rules, or the application thereof
to any person or circumstance, is held to be invalid, such invalidity
shall not affect other provisions or application of such provisions to
other persons or circumstances that can be given effect without the
invalid provision or application.
[[Page 73112]]
Pursuant to the Congressional Review Act, the Office of Information
and Regulatory Affairs has designated these rules a ``major rule,'' as
defined by 5 U.S.C. 804(2).
IV. 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 exchanges and associations to prohibit the listing of issuers
that do not develop and implement policies to recover erroneously
awarded incentive-based compensation.\386\ The policies must provide
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,\387\ 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.
From an economic perspective, when implemented, this change will
effectively return the erroneously awarded compensation to the
shareholders. 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 adopting a new rule and rule amendments to
satisfy the statutory mandates of Section 10D. As discussed above, we
believe the intent of these statutory mandates is to require the return
of executive compensation that was awarded erroneously to the issuer
and its shareholders.
---------------------------------------------------------------------------
\386\ See Section I.
\387\ The trigger events would include both ``Big R'' and
``little r'' restatements that correct errors in previously issued
financial statements. See Section II.B.
---------------------------------------------------------------------------
We have reviewed the letters and information provided by
commenters, and performed an analysis of the main economic effects that
may flow from the rules being adopted in this release. We consider the
economic impact--including the costs and benefits and the impact on
efficiency, competition, and capital formation--of the final rule
requirements on issuers and other affected parties, relative to the
baseline discussed below. 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.\388\ Further,
Section 23(a)(2) of the Exchange Act requires us, when making rules
under the Exchange Act, to consider the impact any new rule would have
on competition and 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.\389\ Where practicable, we have attempted
to quantify the effects of the final rules; however, in many cases, we
are unable to do so because we lack the data necessary to provide a
reasonable estimate. For purposes of this economic analysis, we address
the costs and benefits resulting from the statutory mandate and from
our exercise of discretion together, recognizing that it is difficult
to separate the costs and benefits arising from these two sources.
---------------------------------------------------------------------------
\388\ See 15 U.S.C. 78c(f); 15 U.S.C. 80a-2(c).
\389\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
A. Baseline
To assess the economic impact of the final rules, 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. We begin by analyzing affected issuers,
including the prevalence of incentive-based compensation. Next, we
provide information on the frequency of restatements as triggering
events. We also provide information on the regulatory baseline.
Finally, we provide information on how many issuers currently have
compensation recovery provisions, as well as descriptive information
regarding those provisions.
We recognize that a substantial number of issuers \390\ will be
affected, since incentive-based compensation \391\ is widely used.
Although statistics reflecting the prevalence of incentive-based
compensation precisely as defined in this rulemaking are not available,
one study \392\ found that 97% of a representative sample of the S&P
500 companies grant performance-based compensation as part of their
long-term incentive plans, though the prevalence might be lower among
smaller companies.\393\
---------------------------------------------------------------------------
\390\ As a starting point to describe the number of affected
issuers, we identify the number of exchange listed companies. As of
Dec. 31, 2021, there were approximately 5,300 exchange listed
companies (excluding closed end funds and REITs). We recognize that
there are many companies that, because they are not exchange listed,
will not be affected by these rules. For instance, on Aug. 22, 2022,
there were 12,454 securities quoted on OTCmarket.com, (see OTC
Markets Grp. Inc., Current Market, OTC Markets (Aug. 22, 2022),
https://www.otcmarkets.com/market-activity/current-market) and from
2013-2015 there were roughly 10,000 stocks quoted on OTC markets.
See Josh White, Outcomes of Investing in OTC Stocks, (working paper,
Dec. 16, 2016), available at https://www.sec.gov/files/White_OutcomesOTCinvesting.pdf.
\391\ Compensation that may trigger recovery under the final
rules includes amounts awarded under long-term incentive plans (such
as performance-based equity) or short-term incentive plans (such as
cash bonuses) that are granted, vested, or whose size is determined
based on a financial metric.
\392\ See Meridian Compensation Partners, 2021 Corporate
Governance and Incentive Design Survey (Fall 2021), available at
https://www.meridiancp.com/insights/2021-corporate-governance-and-incentive-design-survey/ (``Meridian Report'') (97% of a
representative sample of S&P 500 companies grant performance-based
vehicles as part of their long-term incentive plans as of 2021); see
also Andrea Pawliczek, Performance-Vesting Share Award Outcomes and
CEO Incentives, 96 Acct. Rev. 337 (2021) (``As of 2014, about 60
percent of S&P 1500 companies granted some form of performance-based
equity awards''). These studies describe performance-based incentive
awards, which may often, but not always, be included in the
incentive-based compensation affected by this rulemaking. For
example, as described in Section II.C.2.a.iii, incentive-based
compensation would not include awards based on nonfinancial events,
such as opening a specified number of stores, and it would include
cash awards based on satisfaction of a performance target that is
based on a financial reporting measure even if the performance
target was not pre-established or communicated, or the outcome was
not substantially uncertain.
\393\ The three most common performance metrics used by the
representative sample of the S&P 500 companies in long-term
incentive plans were relative TSR (74%), return measures (46%), and
earnings per share (31%). See Meridian Report. An alternative sample
of firms, including smaller and foreign firms, yields slightly
different results. Based on Commission staff analysis of 145
randomly sampled issuers drawn from the full population of issuers
that filed an annual proxy statement in calendar year 2021, we
estimate that approximately 42% of proxy statement filers used stock
price and/or TSR as an element of their incentive-based
compensation. Staff manually examined the CD&A in each of the 145
proxy statements to identify issuers that disclosed the use of stock
price and/or TSR as compensation performance metrics in 2021. For
purposes of this analysis, TSR may refer to relative TSR as well as
TSR. This estimate is broadly consistent (see Scott Allen, et al.,
The Latest Trends in Incentive Plan Design as Firms Adjust Plans
Amid Uncertainty, Humancapital/Aon Blog (Oct. 2020), available at
https://humancapital.aon.com/insights/articles/2020/the-latest-trends-in-incentive-plan-design-as-firms-adjust-plans-amid-uncertainty (indicating, in Figure 9, that TSR is the most commonly
used metric in the CEO's long-term incentive plan among S&P 500
companies in most industries, where the use of TSR ranges from 22%
to 61% of companies depending on the industry). See also comment
letter from CEC 2, noting that in 2020, the average portion of
equity awards tied to performance metrics (not including stock
options) surpassed 50%, and that the average portion of at risk pay
in a CEO's compensation package exceeds 80%.
---------------------------------------------------------------------------
The incidence of events where incentive-based compensation would be
[[Page 73113]]
required to be recovered is affected by the number of restatements. One
report indicates that 4.8% of companies disclosed a restatement in
2020.\394\ As discussed above, both ``Big R'' and ``little r''
restatements may trigger compensation recovery analysis under the final
rules.\395\ As reported in the 2022 staff memorandum, we estimate that
``little r'' restatements may account for roughly three times as many
restatements as ``Big R'' restatements.\396\ Similarly, one recent
study of accounting restatements between 2008 and 2015 identifies 634
``Big R'' restatements and 1,653 ``little r'' restatements.\397\
---------------------------------------------------------------------------
\394\ See A Twenty-One Year Review. In 2021, the number of
restatements was substantially higher due to Special Purpose
Acquisition Company (``SPAC'') restatements. Excluding SPAC
restatements, there was a 10% year-over-year decrease in the number
of restatements. See A Twenty-One-Year Review. Studies cited and
data included in this release on ``little r'' restatement frequency
may define ``little r'' restatements differently than the definition
included in Section II, and are generally based on the total number
of revisions to previously issued financial statements where the
issuer did not file an Item 4.02 8-K. We note that one commenter
observed that, ``if Dodd-Frank section 954 were in place in 2009,
executive officers at up to 674 companies would have been subject to
the clawback provisions,'' see comment letter from Kovachev, 2015.
The commenter cited Audit Analytics, 2009 Financial Restatements, A
Nine Year Comparison. The number of restatements has substantially
declined since 2009 to 338 in 2021, after excluding SPAC
restatements, see A Twenty-One Year Review (non-SPAC restatements
comprise 23% of the total 1,470 restatements). We note that another
commenter observed that since the initial 2015 proposal,
``improvements in checks and balances--such as board governance,
audit committee oversight, and company systems of internal control
over financial reporting--along with increased regulatory scrutiny
by the SEC and PCAOB have occurred and act to help mitigate the
likelihood of misstatements in financial statements filed with the
Commission,'' see comment letter from CCMC (Nov. 22, 2021) (``CCMC
2'').
\395\ See Section II.B.1.c. The following estimates are based on
historical rates and types of restatements, which may not be
indicative of future rates and types of restatements.
\396\ This estimate, based on exchange-listed companies during
calendar year 2021, excluding SPACs, reflects approximately 54 ``Big
R'' restatements and 173 ``little r'' restatements; including SPACs
would have yielded 837 ``Big R'' and 474 ``little r'' restatements.
These estimates were obtained from the Audit Analytics Restatement
database which covers all Commission registrants who have disclosed
a financial statement restatement in electronic filings since Jan.
1, 2000. To remove SPACs from the restatements, these calculations
exclude blank check companies (SIC code 6770) and shell companies.
SPAC restatements were excluded because they were unusually high in
2021 due to Commission guidance that year that SPACs account for
their warrants as liabilities instead of equity, prompting a wave of
one-time restatements.
\397\ These figures were provided in the 2022 staff memorandum.
That memo also noted that ``little r'' restatements as a percentage
of total restatements rose to nearly 76% in 2020, up from
approximately 35% in 2005.
---------------------------------------------------------------------------
We note that not all accounting restatements will trigger a
recovery of compensation that was earned as a result of meeting
performance measures. Using incentive-based compensation tied to net
income as an example, in order for that compensation to be required to
be recovered, there would have to be an accounting error that increased
net income. Based on one recent study, 60% of all ``Big R''
restatements made between 2008 and 2015 had a negative impact on net
income, and only 25% of ``little r'' restatements had a negative impact
on net income.\398\ Thus, not every restatement would trigger a
recovery of compensation that is tied to net income.\399\ Also, we
expect that recovery of incentive-based compensation that is tied to
TSR would be relatively small and infrequent as a result of ``little
r'' restatements, since these restatements are less likely to be
associated with significant stock price reactions.\400\
---------------------------------------------------------------------------
\398\ See Choudhary et al., supra note 61. See also Thompson,
supra note 79 (finding that 74% of ``Big R'' and 31% of ``little r''
restatements have a negative effect on net income); Christine Tan
and Susan Young, An Analysis of `Little r' Restatements, 29 Acct.
Horizons 667 (2015) (finding that 11.8% of ``little r'' restatements
revise net income downwards).
\399\ Incentive-based compensation is more likely to be
recovered if it is tied to more reported items on the financial
statements. For example, incentive-based compensation tied to
earnings or operating income is more likely to be recovered than
incentive-based compensation tied to only revenue or only expenses.
Between 2008 and 2015, approximately eight% of restatements involved
expense recording (such as payroll or selling, general and
administrative expenses). See Choudhary et al., supra note 61.
\400\ See Choudhary et al., supra note 61 (finding an average
stock price reaction of -3.3% to ``Big R'' restatements and -0.3%
for ``little r'' restatements); Thompson, supra note 79 (finding an
average stock price reaction of -1.5% to ``Big R'' restatements and
-0.3% for ``little r'' restatements).
---------------------------------------------------------------------------
The final rules will require exchanges to apply the compensation
recovery requirement to all listed issuers, including EGCs, SRCs, FPIs,
debt-only issuers, and controlled companies, with only limited
exceptions. As outlined in the table below, we estimate that Rule 10D-1
would be applicable to approximately 5,364 registrants.\401\ We
estimate that, of those 5,364 registrants, there are 1,039 SRCs (that
are not also EGCs), 160 EGCs (that are not also SRCs or FPIs),\402\ 757
issuers that are both SRCs and EGCs, 722 FPIs (filing annual reports on
Form 20-F), and 132 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 final rules.\403\
---------------------------------------------------------------------------
\401\ We estimate the number of issuers subject to the final
rule based upon Commission staff analysis of issuers that filed
annual reports on Form 10-K, Form 20-F, or Form 40-F in calendar
year 2021, regardless of the fiscal year of the filing, and that
filed a proxy statement in 2021. The staff verified an issuer's Form
10-K to determine if the issuer is an SRC. The staff also checked an
issuer's Form 10-K and registration statement to determine if the
issuer is an EGC. The issuer's 12B status was used to identify
exchange-listed companies. Staff determined an issuer's Section
12(b) registration status based, in part, on the self-reported
status disclosed on the annual report cover page, as well as other
determining factors such as the number or holders of record, the
issuer's total assets, and the issuer's filing history of long- and
short-form registrations (on Form 10-12 or Form 8-A12,
respectively), deregistration filings (on Form 15), and delisting
filings (on Form 25 or Form 25-NSE). 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.
\402\ We include the U.S. EGCs only (that are not also SRCs or
FPIs) in our estimate. The total count of EGCs (that are not also
SRCs) including U.S. EGCs, FPI EGCs, and MJDS EGCs (that are not
also SRCs) was 434 based on 2021 registrant filings).
\403\ See supra note 41. Certain commenters describe the costs
associated with compliance for registered management investment
companies. We recognize that, in addition to internally managed
funds, some externally managed funds may incur compliance costs if,
for instance, they employ a chief compliance officer and include
incentive based compensation as part of their pay package. See,
e.g., comment letter from ICI.
---------------------------------------------------------------------------
[[Page 73114]]
As described in the 2022 staff memorandum, compared to the baseline
for the Proposing Release, in today's markets, many more companies have
adopted compensation recovery policies.\404\ For instance, one study of
more than 17,000 companies from 1996 to 2017 reports that as of
December 2017, 5,358 companies had a compensation recovery policy in
place.\405\ The rate of adoption may be higher among the larger U.S.-
listed companies. Survey results indicate that 98% of a representative
sample of S&P 500 companies have adopted compensation recovery policies
as of 2021,\406\ and 83% of a representative sample of mid-cap (S&P
400) companies as of 2020.\407\
---------------------------------------------------------------------------
\404\ See 2022 staff memorandum.
\405\ Ilona Babenko, et al., Clawback Provisions and Firm Risk
(working paper 2021), available at http://ssrn.com/abstract=4006661
(retrieved from SSRN Elsevier database) (``Babenko et al.''). One
commenter reports 100% of the S&P 500 companies, and 99.7% of the
remaining 2,500 companies in the Russell 3000 index, have some form
of compensation recovery policy, according to the ISS QualityScore
database, see comment letter from the Office of the Comptroller of
the State of New York. See also comment letter from CEC 2
(indicating based on an Oct. 2021 survey of their subscribers, more
than 90% maintain a clawback policy, and citing a study finding that
the number of large companies with clawback policies may be as high
as 97%). As discussed below, we expect that most of these policies
will require revision to meet the requirements in this rule. See,
e.g., note 413.
\406\ See Meridian Report.
\407\ See Clearbridge Compensation Grp., Executive Compensation
Policies, The Clearbridge 100 Report for Mid-Cap Companies (Dec
2020) available at https://www.clearbridgecomp.com/wp-content/uploads/CB100-Report-for-Mid-Cap-Companies-Exec-Comp-Policies-12-11-20.pdf (``Clearbridge Report'').
---------------------------------------------------------------------------
As outlined in the table below, we estimate that approximately 46%
of all filers currently disclose some form of an executive compensation
recovery policy.\408\ We further estimate that approximately 34% of
SRCs, 19% of EGCs, nine % of issuers that are both SRCs and EGCs, 25%
of FPIs, and 13% of MJDS issuers disclose some form of a recovery
policy.
---------------------------------------------------------------------------
\408\ 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, et al.). In
contrast to the analysis provided in the Proposing Release, we
modified the keyword search because the searches identified issuers
that disclosed they had not adopted or were considering adopting,
compensation recovery provisions. Specifically, 3 out of 5,367
(0.6%) of companies did not file DEF 14A in 2021. We further
eliminated 235 out of 5,364 (4%) of issuers flagged by the keyword
search because the disclosures indicated the absence or
consideration of compensation recovery provisions rather than their
presence. 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).................................. 2,451 5,364 46%
SRCs......................................................... 352 1,039 34
EGCs......................................................... 31 160 19
SRC and EGCs................................................. 71 757 9
FPIs......................................................... 178 722 25
MJDS......................................................... 17 132 13
All other filers............................................. 1,804 2,554 71
----------------------------------------------------------------------------------------------------------------
In addition to the issuers with company-specific executive
compensation recovery policies, under the baseline there are existing
provisions of law concerning the recovery of such compensation under
certain circumstances, as well as certain disclosure requirements.
Sarbanes-Oxley Act Section 304 contains a recovery provision that is
triggered when a restatement is the result of issuer misconduct. This
provision applies only to CEOs and 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.\409\ In addition, interim final
rules under Section 111 of the Emergency Economic Stabilization Act of
2008 (``EESA'') required institutions receiving assistance under the
Troubled Asset Relief Program (``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, or other criteria were later found to be materially
inaccurate.\410\ As discussed above, relative to either the Sarbanes-
Oxley Act or EESA, the compensation recovery requirement of the final
rules has a different scope because it would affect any current or
former executive officer of a listed issuer 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 officer in preparing the
financial statements. Finally, we note that currently issuers other
than SRCs, EGCs, and FPIs are required to disclose in their 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.\411\
---------------------------------------------------------------------------
\409\ See 15 U.S.C. 7243.
\410\ 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
Exchange Act. See Department of Treasury interim final rule, TARP
Standards for Compensation and Corporate Governance, 74 FR 28394
(June 15, 2009).
\411\ See 17 CFR 229.402(b)(2)(viii).
---------------------------------------------------------------------------
Although there has been a large increase in the percentage of
filers that disclose a compensation recovery policy since 2015,\412\
recent studies indicate that these policies establish more limited
circumstances in which a compensation recovery analysis would be
triggered than would be the case under the final rules.\413\ Many of
the issuers that disclose having recovery policies require misconduct
on the part of the executive officer to trigger recovery. For instance,
a recent study reports that 52 out of 98 firms with misstatements and
compensation recovery provisions required the employee to have
contributed to the
[[Page 73115]]
restatement with fraudulent actions or misconduct, whereas 46 of the 98
do not explicitly require fraud or misconduct as a condition of the
recovery.\414\ By contrast, the final rules would require a listed
issuer to have a recovery policy that applies to ``Big R'' and ``little
r'' restatements, without regard to misconduct.
---------------------------------------------------------------------------
\412\ See 2022 staff memorandum.
\413\ See, e.g., Tor-Erik Bakke et al., The Value Implications
of Mandatory Clawback Provisions (working paper June 28, 2018),
available at https://ssrn.com/abstract=2890578 (retrieved from SSRN
Elsevier database) (as of 2014-2015, only 5% (43 of 1,123) of
companies with a voluntarily adopted compensation recovery policy
have policies that are comparable to the Proposing Release); see
also Meridian Report and ClearBridge Report. Cf. Erkens et al.,
supra note 62 (developing a ``Clawback Strength Index,'' and finding
that adopters of stronger policies experience more benefits).
\414\ See Thompson, supra note 78. Similarly, according to a
study of a representative sample of S&P 500 companies, 53% of
compensation recovery policies are triggered by financial
restatements without requirement of ethical misconduct, regardless
of cause, see Meridian Report. In addition, Babenko et al. (finding
that 69% of compensation recovery policies specify that recovery
applies only to persons directly responsible for the triggering
event, and that 63% of companies have a disclosed ``statute of
limitations'' for the recovery policy that is less than three
years). In an earlier study of 2,326 companies in the Corporate
Library database, DeHaan et al. supra note 62 find that 39% had
compensation recovery policies that did not require executive
misconduct in order to be triggered.
---------------------------------------------------------------------------
There appears to be considerable variation in the coverage of
executive officers subject to recovery under currently disclosed
recovery policies.\415\ Under the final rules, a listed issuer's
compensation recovery policy will require recovery of erroneously
awarded compensation received after an individual began serving as an
executive officer of the issuer during the recovery period. As a
result, in some cases, recovery will 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. By contrast, most of the
issuer-specific executive compensation recovery policies do not apply
to former executive officers. For example, in a representative sample
of firms from the S&P 500, only 13% of executive compensation recovery
policies would apply to former executive officers as well as current
executive officers,\416\ and a study of mid-cap companies reports that
19% of executive compensation recovery policies would apply to former
executive officers.\417\ Therefore, according to recent studies, the
majority of issuers disclose having recovery policies that require
compensation recovery from a narrower range of individuals than a
recovery policy that would comply with the final rule requirements.
---------------------------------------------------------------------------
\415\ As of 2021, approximately 60% of a representative sample
of S&P 500 companies had recovery policies that applied to current
key executives (e.g., Section 16 officers); approximately 23%
applied to all incentive (annual and/or equity) plan participants;
approximately 13% applied to current and former key executives
(e.g., Section 16 officers); and the remaining 4% applied to current
named executive officers only. See Meridian Report. See also
Shearman & Sterling, Corporate Governance & Executive Compensation
Survey 2021 (2021), available at https://www.shearman.com/Perspectives/2021/11/Shearman-Releases-19th-Annual-Corporate-Governance-and-Executive-Compensation-Survey (reporting similar
results from a survey of the 100 largest U.S. public companies)
(``S&S Report''). One commenter estimated that the rule may cover
approximately 50,000 executives, if there are on average ten
executive officers subject to recovery provisions at each issuer
subject to Rule 10D-1. See comment letter from Fried. Although in
some cases, there may be many affected executive officers, we expect
that the number of affected executive officers will vary depending
on several factors, including the structure of the issuer and its
history of executive turnover.
\416\ See Meridian Report. See also S&S Report.
\417\ See Clearbridge Report.
---------------------------------------------------------------------------
While recent studies have shown that many issuers' current recovery
policies differ from the requirements of the final rules, certain
aspects of currently disclosed recovery policies are generally
consistent with the final rules. For example, in a representative
sample of firms from the S&P 500, 98% of issuers that disclosed
recovery policies indicate that both cash and equity incentives would
be included in the policy.\418\ Also, most mid-cap issuers (74%)
specified a look-back period of three years.\419\ Thus a number of
issuers with disclosed recovery policies include compensation scope and
look-back provisions that may be consistent with the requirements under
the final rules.
---------------------------------------------------------------------------
\418\ See Meridian Report. Similarly, a study of the largest 100
U.S. public companies shows that 79 of the 95 companies that
maintain a compensation recovery policy may recoup both cash and
equity incentives (see S&S Report), and a study of midcap companies
shows that 95% of companies with a compensation recovery policy
would include the annual cash bonus and 90% would include PSUs (see
Clearbridge Report).
\419\ See Clearbridge Report.
---------------------------------------------------------------------------
In summary, many issuers have voluntarily adopted compensation
recovery policies. However, studies suggest that there may be
substantial gaps between those voluntarily adopted policies and the new
requirements, particularly with respect to inclusion of former
executive officers, the events that would trigger recovery analyses,
and the ``no-fault'' nature of the final rules.
B. Analysis of Potential Economic Effects
The final rules require exchanges and associations to establish
listing standards that will require each issuer to implement and
disclose a policy providing for the recovery of erroneously awarded
incentive-based compensation. Consistent with Section 10D, the final
rules 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.\420\ The final rules are
predicated on the premise that an executive officer should not retain
compensation that, had the issuer's accounting been done properly in
the first instance, would never have been received by the executive
officer, regardless of any fault of the executive officer for the
accounting errors. One benefit of the rule is that it will effectively
return the erroneously awarded compensation to issuers and
shareholders. In addition, the rule may reduce the likelihood of
accounting errors because executive officers--insofar as they have the
ability to affect financial reporting--may have an enhanced incentive
to ensure that greater care is exerted in preparing accurate financial
reports, and a reduced incentive to engage in inappropriate accounting
practices for the purpose of increasing incentive-based compensation
awarded to them.\421\ While these incentives could result in higher-
quality financial reporting \422\ that would benefit investors, they
may also distort capital allocation decisions.
---------------------------------------------------------------------------
\420\ The set of relevant restatements includes those that
correct errors in previously issued financial statements that are
material to those previously issued financial statements or that
would result in a material misstatement if the errors were corrected
in or left uncorrected in the current report. See Section II.B.1.
\421\ We recognize that some of the executive officers affected
by the amendments may not have the ability to directly affect the
financial reporting of the issuer.
\422\ For purposes of this economic analysis, high-quality
financial reporting means that the financial disclosure is
informative about the actual performance and condition of the
issuer, and should be informative about its value.
---------------------------------------------------------------------------
The requirement that an issuer implement a recovery policy may
introduce uncertainty about the amount of incentive-based compensation
the executive officer will be able to retain.\423\ As a result,
executive officers may demand that incentive-based compensation
comprise a smaller portion of their compensation packages, or that they
receive a greater total amount of compensation, to adjust for the
possibility that the awarded
[[Page 73116]]
incentive-based compensation may be reduced due to future recovery. And
to the extent that executive officers respond negatively to the
expected effects of the compensation recovery policies developed and
implemented by issuers, the final rules may cause affected issuers to
be less able to attract and retain executive talent. But we expect that
investors may benefit to the extent that incentive based compensation
will become more sensitive to the true performance of the issuer, which
would better align the interests of the executive officers with those
of the shareholders.
---------------------------------------------------------------------------
\423\ The recovery policy would require listed issuers to
recover excess compensation paid, but it would not require them to
provide additional payment to executive officers in cases where a
restatement would have resulted in a greater amount of compensation.
We recognize that, absent any requirements and under the baseline,
issuers may voluntarily compensate executives under such
circumstances. But if executives are not compensated when a
restatement would have resulted in a greater amount of compensation,
this asymmetry may further reduce the value executive officers place
on compensation subject to such a recovery policy.
---------------------------------------------------------------------------
Thus, as previewed above and discussed in more detail below, the
final rule may produce both benefits and costs for the affected
parties. Economists have analyzed the effects of the benefits and costs
of issuer compensation recovery policies on issuer valuation.
Specifically, one study analyzed the stock price reactions to the
issuance of the Proposing Release and a second study examined stock
price reactions to the adoption of voluntary compensation recovery
provisions. The studies find, with certain caveats and limitations,
positive average stock price reactions to the announcement of the
events--whether the proposal of the regulations, or a particular
issuer's adoption of voluntary compensation recovery provisions.\424\
These stock price reactions indicate that market participants have
assigned an overall positive value to the adoption of such provisions,
leading to the observed increase in stock price on the date of the
announcement.\425\ These results support the inference that the
benefits associated with adoption of compensation recovery provisions
may justify the costs.\426\
---------------------------------------------------------------------------
\424\ We note that the events studied may reflect the
expectation and adoption of less stringent recovery provisions than
required by the new rules. The studies report that issuers with more
powerful management teams (see Bakke et al.) and issuers with
previous restatements (see Iskandar-Datta et al.) experience larger
economic gains associated with the Proposing Release and the
adoption of voluntary recovery provisions.
\425\ There are certain limitations on these event studies. The
results reflect market participants' response to the new information
released in the event, relative to the expectations prior to the
event. As a result, the positive market reaction to the Proposing
Release reflects the difference between expectations and the actual
proposing release. We also note that the observed stock price
reaction to individual issuer's adoption of compensation recovery
provisions would reflect the benefits associated with the specific
provisions adopted by those firms, which were likely tailored to the
issuer's needs and also unlikely to fully comply with the new rules.
\426\ Bakke et al., supra note 413, find that issuers without a
compensation recovery provision experienced positive abnormal
returns of 0.6% on average around the announcement of the Proposing
Release, relative to issuers with an existing compensation recovery
provision. These results suggest that the effects of the proposed
rules would provide a net benefit to issuers that do not have a
compensation recovery provision, but that the aggregate benefits of
the rulemaking would be reduced due to the increase in issuers with
compensation recovery provisions in place. More broadly, there is
evidence regarding the benefits to issuers of adopting compensation
recovery provisions. See, e.g., Mai Iskandar-Datta and Yonghang Jia,
Valuation Consequences of Clawback Provisions, 88 Acct. Rev. 171
(2013) (finding that shareholders of issuers that adopt voluntary
recovery provisions experience statistically significant positive
stock-valuation consequences ranging between 0.79% and 1.23%, and
that issuers with previous financial restatements had the largest
gains).
---------------------------------------------------------------------------
The discussion below analyzes the economic effects of the final
rules, 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 direct effects of the final rule on issuers and shareholders. We
also discuss the effects on U.S. exchanges and discuss the costs of
recovery. We then examine the indirect effects the final rule may have
on financial reporting and executive compensation. We analyze the
expected effects of the rule's disclosure requirements, as well as the
effects from the rule's provisions on indemnification and insurance.
Finally, we note that these effects may differ for different types of
issuers.
1. Direct Effects on Issuers and Shareholders
The most immediate outcome of the final rules will be the
establishment of listing standards that will result in issuers
implementing recovery policies consistent with Section 10D.\427\ Such
recovery policies, when triggered, will provide a direct benefit for a
listed issuer as well as its shareholders, when the company recovers
incentive-based compensation that was erroneously paid to current or
former executive officers. The recovered amounts will be available for
the issuer to return to investors or invest in productive assets to
generate value for shareholders.\428\ Thus when erroneously awarded
compensation is recovered, the recovered amounts will directly benefit
issuers and shareholders.
---------------------------------------------------------------------------
\427\ Although, as described in the baseline section, many
issuers have already implemented recovery policies that may be
somewhat consistent with the final rule requirements, we recognize
that most of the existing recovery policies will require revision to
comply with the listing standards.
\428\ Given the number of affected issuers and size of executive
compensation packages, the amount of compensation recovered by
issuers under the policies could be substantial. Although recovery
of erroneously paid compensation would provide an immediate benefit
for issuers and shareholders, these funds may not be large relative
to the issuer's business operations. Based on an analysis of
executive compensation using Standard & Poor's Compustat and
Executive Compensation databases, in fiscal year 2020 non-salary
compensation for all named executive officers combined was 0.7% of
net income, and 0.44% of its market value of equity. This represents
an upper bound for the amount of incentive-based compensation for
named executive officers. These ratios do not include current and
former executive officers that would be covered by the final rule
but are not named executive officers.
---------------------------------------------------------------------------
We also expect a number of direct costs for issuers resulting from
the final rules. To ensure that issuers have a recovery policy that
meets the final rule requirements, issuers will likely incur legal and
consulting fees to develop or revise recovery policies, and to modify
the compensation packages of executive officers to conform to those
policies. We expect that these costs may decrease over time, after
initial development.
We have received several comment letters describing direct
implementation costs. For example, several commenters have noted that
even those issuers that already have recovery policies would likely
incur some costs to revise those policies to comply with the final rule
requirements.\429\ One commenter indicated that issuers will likely
incur significant costs including legal fees and litigation risks
because they will need to revise existing policies.\430\ Another
commenter indicated that existing recovery plans include restrictions
that may prohibit or restrict amendments to those plans, and noted that
plan participants, particularly those no longer employed by the issuer,
may not consent to an amendment that results in significant economic
costs to themselves.\431\ We acknowledge that
[[Page 73117]]
issuers will incur direct implementation costs, and recognize that even
those issuers that have implemented recovery provisions will likely
incur costs to revise them and those costs will likely be higher for
issuers that have implemented recovery plans with restrictions that
prohibit or restrict amendments to those plans. 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, and may be initially substantial in a number of
cases. However, as stated above, we expect once issuers adopt a
recovery policy or revise their existing recovery policy, these costs
may decrease over time. We also note that issuers will have additional
time between adoption of these rules and exchange listing standards
implementing the rules to amend any contracts to accommodate recovery.
---------------------------------------------------------------------------
\429\ See, e.g., comment letter from CEC (noting that the rules
would impose additional implementation costs and require issuers to
adjust their policies); Davis Polk 3 (noting that issuers will incur
compliance costs associated with formulating recovery policies and
modifying them over time); and Pay Governance (noting that the new
rules will require substantive changes to many existing compensation
recovery policies). See also comment letter from FedEx Corporation
(Nov. 22, 2021) (noting that publicly traded corporations that
adopted compensation recovery provisions based on the proposed rule
issued in 2015 would incur implementation costs to adapt to the
expanded scope of the final rule).
\430\ See comment letter from Bishop (stating that issuers that
have adopted recoupment policies specifying the ``3-year period
preceding the date on which the issuer is required to prepare an
accounting restatement'' will likely incur significant costs, such
as legal fees and litigation risks because the rule specifies
``three completed fiscal years immediately preceding the date the
issuer is required to prepare an accounting restatement'').
\431\ See comment letter from SCG 1.
---------------------------------------------------------------------------
2. Effects on U.S. Exchanges and Listings
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 final rules. 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 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 small as exchanges likely already have robust
compliance tracking systems and personnel that are dedicated to
ensuring listing standards are met.\432\ 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 final rules and delist
the issuer for noncompliance. This would also result in a loss of the
revenue from listing if the issuer were ultimately delisted.\433\
---------------------------------------------------------------------------
\432\ See comment letter from NYSE, supporting the approach to
delisting in the Proposing Release, and describing the existing
functions of exchange personnel.
\433\ If an issuer chooses to delist or is delisted by the
exchange or association, the issuer's securities may become less
liquid in the U.S. market, and the issuer's share price may be
negatively affected. For issuers that fail to adopt or implement a
recovery policy, delisting under the rule would be expected to
increase the issuer's cost of capital. We also note that other
factors may affect the decision for an issuer to delist and any
effect from the final rules would be incremental to these other
factors.
---------------------------------------------------------------------------
One commenter specifically requested an economic analysis
addressing whether the rule will create conditions that will lead to a
decrease in the number of U.S. public companies.\434\ While we
recognize that the rules are associated with costs for listed issuers,
we also recognize and describe the benefits for listed issuers
associated with the rules. In light of the significant uncertainty
regarding the net effects for issuers, it is unclear whether the net
effects of the rules would lead to a decrease in the number of issuers
listed on U.S. exchanges.
---------------------------------------------------------------------------
\434\ See comment letters from CCMC (noting that the number of
public companies has steadily declined to the point that it is half
what it was in 1996, and that a similar rate of decline in the
number of IPOs occurred concurrently, while the same period
experienced the explosion of the size of the proxy and emergence of
disclosure overload issues). See also comment letter from NACD
(noting that the rule might have a dampening effect on the market
for public companies themselves if it and other rules like it
influence private companies to remain private or push public
companies to go private).
---------------------------------------------------------------------------
In the event that issuers alter their decisions regarding where to
list due to the final rules, 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 final rule to securities listed on U.S. exchanges,
we do not believe it is likely that the final rule requirements would
compel a typical issuer in the short-term to find a new trading venue
not subject to these requirements.\435\ The final rules 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 final
rule requirements, choose to forgo listing or delay listing until the
issuers' circumstances change.\436\ The magnitude of this effect on
exchanges and issuers 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 time, thus having lasting impact on the exchanges'
revenue. Finally, the final rules apply to issuers who list securities
on a national securities exchange. As such there are unlikely to be
competitive effects among national securities exchanges due to all
national securities exchanges being affected by the final rule
requirements.
---------------------------------------------------------------------------
\435\ We note that changes in laws in foreign jurisdictions
regarding compensation recovery after the publication of the final
rules in the Federal Register could potentially reduce the relative
value of a U.S. listing. We also note that the revenue effect on
U.S. exchanges resulting from the behavior of FPIs is unclear,
because while some FPIs may choose to delist as a result of the
final rules, it is at least theoretically possible that others may
choose to list because of them. Although issuers can voluntarily
adopt compensation recovery provisions without listing on a U.S.
exchange, the decision to list on a U.S. exchange after the adoption
of the final rule would reflect a stronger commitment to enforcing
such provisions. See Section IV.B.8.
\436\ We note that capital formation could be hindered if an
issuer chooses to forgo or delay listing because of the final rules
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 final rules would be
incremental to these other factors.
---------------------------------------------------------------------------
3. Costs of Recovery
We recognize that, as a result of this rulemaking, issuers will
face costs to calculate the amount to be recovered should an event
trigger the compensation recovery provision. The calculations could be
done internally or the issuer could choose to retain an outside 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 issuers' compensation structure, the type of compensation involved,
the periods affected, and the method selected for calculation.
The costs of calculating an amount to be recovered are expected to
be higher when incentive-based compensation that is based on stock
price or TSR is subject to recovery. In this context, issuers will need
to determine the amount of compensation that was erroneously awarded
based on the extent to which an inflated stock price results from an
accounting error. One key input for such calculations would be the
difference between the historical stock prices and the ``but for''
stock price, where the ``but for'' stock price is the price at which
the security would have sold, absent the accounting error. This section
provides background information on methods to estimate the amount of
inflation in stock prices as a result of accounting errors.
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
[[Page 73118]]
related costs.\437\ One such method, which is often used in accounting
fraud cases to determine the effects of restatements 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 \438\ that
restated financial information is required, separate from any change in
the stock price due to market factors.\439\ An event study therefore
measures the net-of-market drop in the stock price, 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 need 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.\440\ 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.\441\
---------------------------------------------------------------------------
\437\ 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.
\438\ 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.
\439\ Note that the ``announcement'' may take a variety of
forms. For instance, an analyst or reporter may publicly disclose
information about the company that serves as a corrective
disclosure, even if the company does not make an announcement. In
addition, since companies would generally not issue a Form 8-K
release for a ``little r'' restatement, the publication of revised
financials may serve as a public disclosure.
\440\ 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 Mark L. Mitchell and Jeffrey
M. Netter, The Role of Financial Economics in Securities Fraud
Cases: Applications at the Securities and Exchange Commission, 49
Bus. Law 565 (Feb. 1994); S. P. Kothari and Jerold B. Warner,
Econometrics of Event Studies (B. Espen Eckbo ed.), Handbook Corp.
Fin. Empirical Corp. Fin vol. I (Elsevier/North-Holland 2004); and
John Y. Campbell et al., The Econometrics of Event Studies,
Princeton University Press (1997).
\441\ Issuers may conduct event studies of restatement effects
for a variety of reasons, including the possibility of shareholder
litigation and government investigations. If an issuer has already
conducted an event study to estimate the amount of inflation in the
stock price due to a restatement, that would reduce the costs of
conducting an event study for purposes of compensation recovery
analysis while also limiting the latitude associated with utilizing
different design choices.
---------------------------------------------------------------------------
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.\442\ Because certain
executive officers may have influence over the timing of the release of
issuer-specific information, they may have the ability to affect 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, certain executive officers may have an incentive
and 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 the board of directors to evaluate the effect of the restatement on
the stock price.
---------------------------------------------------------------------------
\442\ 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 economy, and information about expected
inflation).
---------------------------------------------------------------------------
As discussed above, the final rules do not require an event study
to calculate a reasonable estimate of the erroneously awarded
compensation tied to stock price to be recovered after an accounting
error leading to a restatement. Instead, the final rules permit an
issuer to use any reasonable estimate of the effect of the restatement
on stock price and TSR. In addition, we note that an issuer may 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 final rules. In choosing a methodology to derive a reasonable
estimate of the effect of the accounting restatement on stock price and
TSR, issuers would likely weigh the costs of implementing any
methodology and the potential need to justify that estimate, under
their unique facts and circumstances. We have received a number of
comments regarding the costs of calculating the recoverable amount. For
example, some commenters noted that determining the amount of
compensation that was based on or derived from the financial reporting
measure may be challenging because incentive compensation award amounts
may include multiple metrics, and reflect judgment and discretion
rather than a formulaic calculation.\443\ In addition, commenters
indicated that the calculations will expose managers and boards of
directors to litigation risk.\444\
---------------------------------------------------------------------------
\443\ See comment letters from Chevron; Coalition; Osler; and
TELUS.
\444\ See, e.g., comment letters from Chevron; and Coalition. To
the extent that issuers perceive more costly estimation methods to
be a preferred approach in the context of potential litigation, the
risk of litigation may increase the costs of compliance with the
final rules.
---------------------------------------------------------------------------
Commenters have also noted that issuers will face additional costs
associated with estimating the amount of incentive-based compensation
when the compensation is linked to stock price and TSR because of the
complexity of the calculations.\445\ A number of commenters requested
additional guidance and examples of calculations,\446\ and some
expressed concern that issuers may consider moving away from TSR-based
incentive plans to avoid the potential costs and uncertainty that may
result should a recovery be triggered.\447\ Some commenters noted that
there would be increased litigation risk regarding recoveries of
compensation linked to stock price and TSR due to the potential range
of reasonable estimates.\448\
---------------------------------------------------------------------------
\445\ See, e.g., comment letters from CAP; CEC 1; Chevron;
Compensia; NAM; SH&P (stating that incentive compensation based on
performance metrics such as stock price or total shareholder return
cannot be accurately recalculated); Pearl Meyer; Davis Polk 1; and
Kovachev. For example, CAP noted that estimates of the impact of the
restatement when stock price/TSR metrics are involved, ``will be
extremely difficult to put into practice and will force Boards to
hire outside experts to perform the calculations. We predict that
this will benefit professional service firms willing to perform the
analyses, but will return little value to shareholders.''
\446\ See, e.g., comment letters from Chevron; Compensia; Hay
Group; Pay Governance; Pearl Meyer; and WAW.
\447\ See comment letters from Compensia; and WAW.
\448\ See, e.g., comment letters from Chevron; Coalition;
Compensia; IBC (stating ``[o]ften [the methods] produce ranges of
numbers, rather than a definite amount, introducing more uncertainty
and opportunity to second guess the company's decision on how much
to recover, therefore opening the door for potential additional
shareholder derivative litigation''); and Pearl Meyer (noting the
possibility of challenges from interested parties, including current
executive officers as well as individuals who were executive
officers at some point during the lookback period but are no longer
holding such position).
---------------------------------------------------------------------------
[[Page 73119]]
Since there is considerable variation in incentive compensation
plans as well as restatements, and in addition, issuers may choose
different reasonable approaches to calculation, we cannot estimate the
total costs of calculating the amounts to be recovered. Nor can we
estimate the likelihood that companies will move away from TSR-based
incentive plans.\449\ These uncertainties also may undermine issuers'
incentives to enforce their recovery policies and make it more
difficult for exchanges to monitor compliance.\450\ 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 issuers to carefully
document the considerations that went into the determination to enforce
(or not enforce) their recovery policy.
---------------------------------------------------------------------------
\449\ See Section IV.B.5 for additional discussion of the
economic effects of the potential decision to move away from
incentive based compensation that is subject to recovery, such as
TSR-based incentive plans.
\450\ 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 erroneously awarded compensation required to be recovered.
This may make it more difficult for exchanges to monitor compliance.
---------------------------------------------------------------------------
Although the costs of hiring outside experts may vary depending on
the circumstances, we estimate that if outside professionals are
retained to assist with the calculations, they will likely charge
between $80 and $1,800 per hour for their services.\451\ One commenter
indicated that the expert fees will be closer to $800 per hour when
determining the impact of an accounting restatement on stock price or
TSR.\452\ Another commenter indicated that the cost of an event study
may range from $100,000 to $200,000.\453\
---------------------------------------------------------------------------
\451\ The range is based on comment letters from TCA and Davis
Polk 1 as well as the SEAK, Inc., 2021 Survey of Expert Witness Fees
report indicating that the hourly fee for case review/preparation
ranges from $80 to $1,800 with an average fee of $422 per hour. See
SEAK, Inc., 2021 Survey of Expert Witness Fees, SEAKexperts.com Blog
(July 25, 2022, 3:54 p.m.), available at https://
blog.seakexperts.com/expert-witness-fees-how-much-should-an-expert-
witness-charge/
#:~:text=According%20to%20SEAK%27s%202021%20Survey,experts%20respondi
ng%20is%20%24500%2Fhour. We note that this range is also roughly
consistent with the 90th percentile of wage information compiled by
the U.S. Bureau of Labor Statistics, Occupational Employment
Statistics for the Financial and Investment Analyst occupation. As
of May 2021, the median hourly wage for a financial and investment
analyst was $44.03 and the 90th percentile hourly wage was $80.08.
\452\ See comment letter from TCA.
\453\ See comment letter from Davis Polk 1 (citing a study by
Marsh & McLennan Companies).
---------------------------------------------------------------------------
We acknowledge the costs and the potential complexity associated
with calculating amounts to be recovered and acknowledge that the
hourly rate may exceed its estimated values in some cases, depending on
the complexity of the calculations. In addition, we recognize the
likelihood of higher costs associated with the recovery calculations
for incentive-based compensation linked to stock price and TSR as well
as the widespread use of this type of incentive-based
compensation.\454\ However, we are adopting the new rule and rule
amendments to implement the statutory mandates of Section 10D, which is
intended to require the return of executive compensation that was
awarded erroneously to the issuer and its shareholders. The costs of
calculating amounts to be recovered may be mitigated as issuers
exercise flexibility to determine the method of calculation that is
most appropriate given the circumstances. Also the costs of calculating
recovery amounts may be lower to the extent that the calculations would
have been performed in the context of the restatement, because the
effect of the misstatement on management's compensation is a
qualitative factor in a materiality analysis.\455\
---------------------------------------------------------------------------
\454\ See supra note 393.
\455\ See supra, note 80.
---------------------------------------------------------------------------
Depending on the circumstances, there may be other costs associated
with enforcing the mandatory recovery policy. If the current or former
executive officer is unwilling to return erroneously awarded
compensation, the issuer may incur legal expenses to pursue recovery
through litigation or arbitration.\456\ However, if the direct expense
paid to a third party to assist in enforcing the recovery policy from
an executive or former executive officer would exceed the erroneously
paid incentive-based compensation, the final rules allow the issuer,
under certain circumstances, to determine that recovery would be
impracticable, and therefore not pursue the recovery. This may mitigate
the direct costs of enforcement to issuers.\457\ 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.
---------------------------------------------------------------------------
\456\ Issuers may incur additional costs associated with the
rules to the extent that they create an impediment to litigation
settlements because they do not include an exception for releases of
potential recoupment claims. This may impose costs directly on
issuers and indirectly on the economy as litigation could
potentially be prolonged. See, e.g., comment letter from SCG 1.
\457\ Since the final rule will permit issuers to forgo recovery
from tax-qualified retirement plans, we expect that issuers and plan
participants will avoid the costs associated with such recovery.
---------------------------------------------------------------------------
4. 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
assessment of the issuer's performance and should be informative about
its value. Erroneous financial reporting can mislead investors about
the issuer's value. For instance, improper financial reporting may
overstate demand for the issuer's products, or exaggerate its ability
to manage costs. 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.
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. For example, in some instances,
executives might have incentives to pursue impermissible accounting
methods under GAAP that result in a material misstatement of financial
performance, to realize higher compensation.\458\ This potential for
deliberate misreporting reflects a principal-agent problem that is
detrimental for shareholders.\459\
[[Page 73120]]
Although civil and criminal penalties already create disincentives to
deliberate misreporting, the recovery requirements under the final
rules will 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 will depend on the particular circumstances of
an issuer.
---------------------------------------------------------------------------
\458\ We also note that some estimates and judgments permissible
under GAAP may allow executive officers to realize higher
compensation, without resulting in a material misstatement of
financial performance and thus without triggering recovery
consistent with Section 10D.
\459\ Among other decisions, executive officers 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 and
condition of the issuer. To the extent 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,
executive officers 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 officer's incentive to
allocate the appropriate amount of resources to produce high-quality
financial statements, which reduces the information value of
financial reporting. In addition, the issuer may not realize all of
the benefits from high quality financial reporting. For example,
accurate financial reporting by one issuer provides a useful
benchmark to investors in evaluating other issuers. As a result,
issuers may underinvest in the production of high-quality financial
statements, relative to the benefits for investors.
---------------------------------------------------------------------------
The final rules may also provide executive officers with an
increased incentive to take steps to reduce the likelihood of
inadvertent misreporting.\460\ Most directly, because executive
officers are less likely to benefit from reporting errors, they have
stronger incentives to increase the amount of time and resources they
spend on the production of high-quality financial reporting, and may
also, for instance, increase the staffing of the internal audit
function.\461\ These actions would reduce the likelihood of an
accounting error that requires restatement.
---------------------------------------------------------------------------
\460\ One commenter noted while intentional reporting errors are
relatively infrequent between 1996 and 2005 (1% error rate),
unintentional misstatements are far more frequent (2.89% error
rate). See comment letter from Vivian Fang.
\461\ See, e.g., comment letters from NYCRS; Fried; and Public
Citizen 1. We recognize that there may be some limit beyond which
the utilization of additional resources in order to further limit
the likelihood of small, inadvertent accounting errors may not be
the optimal use of these resources. It is unclear where the current
expenditures of issuers stand relative to these limits. We also
recognize that financial reporting decisions may be outside of the
scope of responsibilities of some of the executive officers who will
be subject to compensation recovery as a result of the final rules,
see Section II.C.1.
---------------------------------------------------------------------------
Research studies provide mixed results on the impact of
compensation recovery on financial reporting accuracy and reliability.
Several studies have analyzed outcomes after the implementation of a
voluntary recovery policy, finding results that are consistent with
issuers devoting more resources to internal control over financial
reporting.\462\ In addition, some studies show that adoption of
voluntary recovery provisions is associated with improved managerial
decision making.\463\ However, we acknowledge that multiple studies
find that the adoption of recovery provisions may lead to outcomes such
as real earnings management to achieve short-term earnings goals.\464\
To the extent that the final rules lead some issuers to increase real
earnings management, investors and issuers could bear increased costs.
---------------------------------------------------------------------------
\462\ See Michael H.R. Erkens et al., Not All Clawbacks Are the
Same: Consequences of Strong Versus Weak Clawback Provisions, 66 J.
Acct. & Econ. 291 (2018) (finding that companies that voluntarily
adopt stronger clawback measures experience improvements in
reporting quality); Lillian H. Chan et al., The Effects of Firm-
Initiated Clawback Provisions on Earnings Quality and Auditor
Behavior 54 J. Acct. & Econ. 180 (2012) (finding that after the
adoption of clawback provisions, incidence of accounting
restatements declines, firms' earnings response coefficients
increase, and auditors are less likely to report material internal
control weaknesses, charge lower audit fees, and issue audit reports
with a shorter lag); DeHaan, et al., supra note 62 (finding
improvements in financial reporting quality following clawback
adoption, including decreases in meet-or-beat behavior and
unexplained audit fees, a decrease in restatements, a significant
increase in earnings response coefficients and a significant
decrease in analyst forecast dispersion). See also Henry K. Mburu
and Alex P. Tang, Voluntary Clawback Adoption and Analyst Following,
Forecast Accuracy, and Bias, 18 J. Acct & Fin. 106 (2018) (finding
that voluntary adoption of compensation recovery provisions leads to
an increase in analyst coverage and analyst accuracy, as well as
reduced optimistic bias by analysts); Mark A. Chen et al., The Costs
and Benefits of Clawback Provisions in CEO Compensation, 4 Rev.
Corp. Fin. Stud. 108 (2015) (finding lower earnings variability and
reduced aggressiveness in financial reporting after voluntary
adoption of a compensation recovery provision); Bradley Benson et
al., Will the Adoption of Clawback Provisions Mitigate Earnings
Management?, 18 J. Acct. & Fin. 61 (2018) (finding that when
compensation recovery provisions are implemented by a company with
an independent board, earnings quality improves).
\463\ See, e.g., Yu-Chun Lin, Do Voluntary Clawback Adoptions
Curb Overinvestment?, 25 Corp. Govern. Int'l Rev. 255 (2017)
(finding that compensation recovery provisions mitigate
overinvestment); Dina El-Mahdy, The Unintended Consequences of
Voluntary Adoption of Clawback Provisions on Managerial Ability, 60
Acct. & Fin. 2493 (2020) (finding that voluntary adoption of
compensation recovery provisions is associated with an increase in
productivity as measured by revenues generated for a given level of
costs); Thomas Kubrick, Thomas Omer, and Zac Wiebe, The Effect of
Voluntary Clawback Adoptions on Corporate Tax Policy, 95 Acct. Rev.
259 (2020) (finding that adoption of compensation recovery
provisions may lead to more effective tax planning and lower
effective tax rates); Anna Brown et al., M&A Decisions and US Firms'
Voluntary Adoption of Clawback Provisions in Executive Compensation
Contracts, 42 J. Bus. Fin. & Acct. 237 (2015) (finding that adoption
of compensation recovery provisions leads to improved decisions in
the context of mergers and acquisitions); Matteo P. Arena and Nga
Nguyen, Compensation Clawback Policies and Corporate Lawsuits, 27 J.
Fin. Reg. & Compliance 70 (2019) (finding that after the adoption of
compensation recovery provisions, litigation risk significantly
declines). One paper finds that firms' investment risk decreases
with the voluntary adoption of a compensation recovery provision,
but notes that this effect may be either value-increasing or value-
decreasing, depending on the circumstances. See Yu Chen and Carol
Vann, Clawback Provision Adoption, Corporate Governance, and
Investment Decisions, 44 J. Bus. Fin. Acct. 1370 (2017) (finding
that after adopting a compensation recovery provision, firms'
abnormal investment decreases and the firms' investments are less
risky).
\464\ See, for instance, Lilian Chan et al., Substitution
between Real and Accruals Based Earnings Management after Voluntary
Adoption of Compensation Clawback Provisions, 90 Acct. Rev. 147
(2015) (finding that the total amount of earnings management does
not decrease after recovery provisions are adopted, and that
companies are more likely to lower research and development expenses
to achieve short term earnings goals after adoption). Similar
results are provided by Gary Biddle et al., Clawback adoptions,
managerial compensation incentives, capital investment mix and
efficiency, (working paper Dec. 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3042973 (retrieved from
SSRN Elsevier database). A related paper, Dichu Bao et al., Can
Shareholders Be at Rest After Adopting Clawback Provisions? Evidence
from Stock Price Crash Risk, 35 Contemp. Acct. Res., 1578 (2018),
finds that voluntary recovery provision adoption is associated with
an increase in stock price crash risk, that after the adoption some
companies reduce the readability of their Form 10-K filings, and
increase real earnings management through abnormal production costs,
abnormal expenses, and abnormal cash flows. See also Hangsoo Kyung
et al., The Effect of Voluntary Clawback Adoption on non-GAAP
Reporting, 67 J. Acct. & Econ. 175 (2019) (finding that issuers
adopting recovery provisions increase the frequency of disclosure of
non-GAAP earnings, and non-GAAP exclusion quality decreases after
the adoption); Thompson, supra note 69 (finding that issuers with
compensation recovery provisions are more likely to report
misstatements as ``little r'' restatements instead of ``Big R''
restatements). Consistent with the possibility that the rules as
proposed may create incentives to reduce research and development
expenditures, Bakke et al., supra note 413, find that the stock
price reaction to the Proposing Release was less positive for
issuers with high cash flow activity and companies engaged in
research and development activity, and it was negative for issuers
that have already adopted a compensation recovery provision and are
engaged in research and development. See also comment letter from
Fried (noting the potential to incentivize executive officers ``to
shift from value-reducing earnings manipulation to even more
destructive real earnings management'').
---------------------------------------------------------------------------
Executive officers may also take other steps to reduce the
likelihood of inadvertent misreporting. An executive officer could
change the business practices of the issuer, thereby affecting the
opportunity for an accounting error to arise. For example, an executive
officer 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, which may reduce
the likelihood of accounting errors. As another example, the executive
officer could make accounting judgments on loan loss reserves that are
less likely to result in
[[Page 73121]]
an accounting restatement. 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.\465\
---------------------------------------------------------------------------
\465\ One academic study finds 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, issuers 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 Christopher S. Armstrong et al., When Does Information Asymmetry
Affect the Cost of Capital, 49 J. Acct. Rsch. 1, (Mar. 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 Patricia M. Dechow and Ilia D. Dichev, The Quality
of Accruals and Earnings: The Role of Accrual Estimation Errors, 77
Acct. Rev. 35, (2002); and Jennifer Francis et al., The Market
Pricing of Accruals Quality 29 J. Acct. & Econ. 295, (2005).
---------------------------------------------------------------------------
As a result of the final rules, we believe that the increased
incentives to generate high-quality financial reporting may improve the
overall quality of financial reporting. For some issuers that are
already producing high-quality financial reports, there may be limits
to the benefits of incremental increases in financial reporting
quality. However, we believe that a substantial number of issuers will
benefit from an increase in the quality of financial reporting. These
improvements 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.\466\ While we lack the data to quantify
the potential benefits to shareholders from a reduced likelihood of an
accounting error, evidence suggests that penalties imposed by the
market for accounting restatements can be substantial. For example, one
recent study \467\ found that over the period 2008 to 2015 the market
value of equity of the average issuer declined by 3.3% upon
announcement of a ``Big R'' financial restatement, and by 0.3% upon
announcement of a ``little r'' restatement.
---------------------------------------------------------------------------
\466\ In addition, to the extent that investors cannot
differentiate between issuers with high quality financial reporting
and issuers with low quality financial reporting, they may
underinvest in issuers with high quality financial reporting. But an
improvement in the reporting of issuers with low quality financial
reporting would raise the average issuer's quality of financial
reporting. This improvement for the average issuer may mitigate the
underinvestment in issuers with high quality financial reporting and
therefore lower their cost of capital as well.
\467\ See Choudhary et al., supra note 61. See also Christine
E.L. Tan et al., An Analysis of ``Little r'' Restatements, 29 Acct.
Horizons 667 (2015) and Susan Scholz, Financial Restatement: Trends
in the United States: 2003-2012, Center for Audit Quality, (July 24,
2014), available at https://www.thecaq.org/financial-restatement-trends-united-states-2003-2012.
---------------------------------------------------------------------------
More broadly, the availability of more informative or accurate
information regarding the financial performance of issuers may also
have the effect of increasing the efficient allocation of capital among
corporate issuers. Because investors will be better informed about the
potential investment opportunities at any given point in time, they
will 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 final 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 final rule requirements.\468\
In contrast, without the final rules, 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.
---------------------------------------------------------------------------
\468\ See Brian J. Bushee et al., Economic Consequence of SEC
Disclosure Regulation: Evidence From the OTC Bulletin Board, 39 J.
Acct. & Econ. 233 (2005).
---------------------------------------------------------------------------
We are aware, however, that these potential benefits of the final
rules are not without associated costs. Under the final rules, as a
commenter asserted, the increased allocation of resources to the
production of high-quality financial reporting may divert resources
from other activities that may be value enhancing.\469\ Moreover, while
the increased incentive to produce high-quality financial reporting and
thus reduce the likelihood of accounting errors should increase the
informational efficiency of investment opportunities, it may also
encourage, as a few commenters noted, executive officers to forgo
value-enhancing projects if doing so would decrease the likelihood of a
financial restatement.\470\ For example, when choosing among investment
opportunities for the issuer, executive officers may have an increased
incentive to avoid those projects that would require more complicated
accounting judgments, because such projects may be more likely to
trigger a restatement.\471\ That is, the final rules may reduce
incentives for an executive officer to choose projects for which it is
more difficult to generate high-quality financial reporting.\472\ This
could have a beneficial impact on the value of the issuer to the extent
that the forgone projects would have resulted in lower value than those
that were ultimately chosen.\473\ The final rules may also be value-
enhancing to listed issuers by reducing the likelihood of accounting
errors because executive officers may be
[[Page 73122]]
incentivized to ensure that greater care is exerted in preparing
accurate financial statements, thus avoiding the costs associated with
a restatement.
---------------------------------------------------------------------------
\469\ See, e.g., comment letter from NACD (noting the proposal
could divert resources to financial reporting that would otherwise
be used for other value enhancing activities).
\470\ 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 a
restatement. See Patricia M. Dechow et al., Predicting Material
Accounting Misstatements, 28 Contemp. Acct. Rsch. 17 (Spring 2011).
Consistent with these findings that riskier operations are
associated with an increased likelihood of restatements, Babenko et
al. find that firms that adopt a recovery provision subsequently
reduce their research and development spending, file fewer patents,
and decrease their capital expenditures. The authors also find that
firms adopting a recovery provision subsequently hold more cash,
issue less net debt, and experience an increase in credit rating.
See, e.g., comment letters from Fried; NACD; and NAM.
\471\ 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. See comment letter from NAM.
\472\ See Babenko et al. The study finds that executives respond
to the implementation of a compensation recovery policy by reducing
firm risk. For example, the authors report that issuers spend less
on research and development, and file for fewer patents. This is
consistent with executives changing their project selection policy
as the result of implementing a compensation recovery policy. 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.
\473\ See Babenko et al. The authors address the question of
whether the reduction in risk associated with the voluntary adoption
of a compensation recovery policy is beneficial for shareholders.
They find a positive and significant relation between adoption of
such a policy and long-term stock and accounting performance and a
positive and significant short-term stock-market reaction around the
date of the adoption. The stock market response to compensation
recovery policy adoption, as well as stock and accounting
performance over the year subsequent to adoption, are significantly
larger the greater the reduction in actual and predicted firm risk
associated with the recovery provision. See also California Public
Employees' Retirement System (Nov. 22, 2021) (``CalPERS 2'') (noting
that ``clawback policies potentially mitigate excessive risk-taking
that certain compensation may incentivize'').
---------------------------------------------------------------------------
As described above, some studies suggest that a compensation
recovery policy could result in an increased likelihood of an executive
officer 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.\474\ For example, if an executive officer is under
pressure to meet an earnings target, rather than manage earnings
through accounting judgments, an executive officer 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.
---------------------------------------------------------------------------
\474\ See supra note 464. See also Sohyung Kim et al., Other
Side of Voluntary Clawback Provisions in Executive Compensation
Contracts: Evidence From the Investment Efficiency, 25 Rev. Pacific
Basin Fin. Mkts. & Policies 1 (2022) (finding evidence that the
voluntary adoption of compensation recovery policies decreases the
investment efficiency in the post-adoption period, especially for
issuers whose ex ante probability of underinvestment is high).
---------------------------------------------------------------------------
Under the final rules, if it appears that previously issued
financial statements may contain an accounting error, there would be a
potential incentive for issuers or individual executive officers (to
the extent they are in a position to do so) to cause the company to
avoid characterizing the accounting error in such a way that would
trigger application of the final rules. Such an incentive exists
because compensation recovery is only required after the conclusion
that an accounting restatement is required to correct an error in
previously issued financial statements that is material to the
previously issued financial statements or that would result in a
material misstatement if the error were corrected in or left
uncorrected in the current period. 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.
However, we note that there are serious consequences, including
criminal penalties, that help to deter either a delay or
mischaracterization. In addition, the rule discourages delays by
defining the trigger date as the date on which the issuer concludes, or
reasonably should have concluded, that the issuer's previously issued
financial statements contain an error that requires a restatement. In
addition, the inclusion of ``little r'' restatements eliminates the
incentive to mischaracterize ``Big R'' restatements as ``little r''
restatements. Finally, oversight by audit committees and outside
auditors may serve as an additional mitigating factor.
5. Effects on Executive Compensation
When setting the compensation for executive officers, 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.\475\ The purpose of tying compensation to
performance is to provide an incentive for executive officers to
maximize the value of the enterprise, thus aligning their incentives
with other shareholders. The proportion of the compensation 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 officer's
risk aversion may make compensation packages with strong performance
incentives undesirable for the executive officer 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.\476\
---------------------------------------------------------------------------
\475\ Executive compensation may be tied to issuer performance
implicitly, as in the case of awards of options or restricted stock
that have only service-based vesting conditions, or more explicitly,
as in the case of incentive-based compensation with market or
performance conditions that affect the amount of compensation or
whether it vests.
\476\ Executive officers typically have personal preferences
regarding the form of compensation received. To the extent that
executive officers have different levels of risk aversion, they can
arrive at different personal valuations of the same incentive-based
compensation package. Hence, more risk-averse executive officers may
require additional compensation when paid in the form of less
certain incentive-based compensation.
---------------------------------------------------------------------------
Several commenters have indicated that the requirements of the
final rules could meaningfully affect the size and composition of the
compensation packages awarded to executive officers of listed
issuers.\477\ In particular, some commenters argued that the final
rules would encourage executive officers to favor compensation that
would not be subject to potential recovery, such as base salary, over
incentive-based compensation.\478\ The Commission acknowledges that the
composition of executive compensation could be impacted by the final
rules. On the one hand, the final rules could encourage greater use of
certain kinds of incentive-based compensation. The implementation of a
mandatory recovery policy may make it less costly for the issuer to use
the types of incentive-based compensation that would be subject to
recovery (those with explicit market or performance conditions tied to
the issuer's financial reporting or stock price).\479\ Most directly,
such a policy would reduce the cost of such compensation by recovering
overpayments associated with misstatements. Further, adopting a
recovery policy may reduce the potential incentives that may arise from
incentive-based compensation to engage in practices resulting in
inaccurate reporting.
---------------------------------------------------------------------------
\477\ See, e.g., comment letters from TCA; Ensco; WAW; NAM; CAP;
NACD; and American Vanguard.
\478\ See, e.g., comment letters from American Vanguard, NAM,
and WAW. Further, some commenters argued that the final rules would
encourage the use of incentive-based compensation tied to
performance measures that fall outside the scope of the rules, such
as strategic measures, subjective measures, or operational measures.
See, e.g., comment letter from Ensco.
\479\ This effect was observed in a recent study examining
voluntarily adopted compensation recovery provisions. See, e.g.,
Peter Kroos et al., Voluntary Clawback Adoption and the use of
Financial Measures in CFO Bonus Plans, 93 Acct. Rev. 213 (2018)
(finding that adoption of compensation recovery provisions is
associated with greater CFO bonus incentives because such
compensation recovery provisions serve as an effective check on the
ability of CFOs to manipulate the performance metrics that could
influence their performance-based compensation). The final 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 relative to
voluntarily adopted recovery provisions.
---------------------------------------------------------------------------
On the other hand, as noted by some commenters, the final rules
could discourage the use of certain kinds of incentive-based
compensation. As noted at the beginning of this section, risk-averse
executive officers prefer predictable compensation, and the mandatory
implementation of a recovery policy that meets the requirements of the
final rules would introduce an additional source of uncertainty in the
compensation of the executive officer.\480\ In addition, the expected
value of executive compensation subject to the rule could decrease
because, to the extent any such compensation is erroneously awarded, it
[[Page 73123]]
must be recovered. Therefore, because incentive compensation based on
financial metrics could be both more uncertain and lower in expected
value, executives may seek a shift away from such compensation and
towards base salary or other forms that are not recoverable, such as
options or restricted stock with time-based vesting, incentive-based
compensation tied to operational metrics, or bonuses awarded at the
discretion of the board. To the extent these forms of compensation have
reduced incentive alignment between executive pay and shareholder
interests, i.e., pay-for-performance sensitivity,\481\ this potential
shift in compensation composition, as noted by several commenters, may
lessen the alignment with the interests of shareholders.\482\
---------------------------------------------------------------------------
\480\ The ``no-fault'' nature of the recovery policy, which
mandates that executive officers return erroneously awarded
compensation even if they had no role in the accounting error, along
with the issuer's choice of a calculation methodology and the
variation in assumptions that underlie it could also add to this
uncertainty.
\481\ 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., Michael Jensen and Kevin Murphy,
Performance Pay and Top Management Incentives, 98 J. Pol. Econ. 225
(1990).
\482\ See, e.g., comment letter from Davis Polk 3 (suggesting
that decreasing the use of accounting-based incentive compensation
by increasing base salary may weaken the alignment between
executives' incentives and those of the company and shareholders).
See also comment letters from TCA; Ensco; Pearl Meyer; WAW; NAM;
CAP; NACD; and American Vanguard.
---------------------------------------------------------------------------
We acknowledge this potential cost but believe a number of factors
and findings mitigate this concern. First, as noted earlier in this
section, the issuer, in contrast to the executive, has incentives to
push for more incentive-based compensation. This is because erroneous
payments can now be recouped, and incentive-based compensation will
generate less temptation to manipulate financial metrics, potentially
leading to more accurate reporting. Thus issuer incentives could offset
executive desire to shift away from incentive-based compensation.
Second, it is not obvious that a shift away from incentive-based
compensation covered by this rule lessens the alignment with the
interests of shareholders. Less incentive-based compensation reduces
incentives for financial misreporting, contributing to more reliable
financial statements, which benefits issuers and shareholders. In
addition, recent evidence indicates some investor dissatisfaction with
performance-based pay \483\ as well as a growing interest in
nonfinancial metrics pay.\484\ Third, to the extent that financial
reporting quality improves because of the rule and reduces the
likelihood of a restatement, this may reduce the uncertainty in
executive compensation resulting from the rule. Lastly, other factors,
such as shareholder engagement, other governance controls, and market
forces play an important role in the level and design of executive
compensation and may mitigate changes due to the final rules.\485\
---------------------------------------------------------------------------
\483\ See, e.g., Council of Institutional Investors, Policies on
Corporate Governance Sec. 5 Executive Compensation (rev. Mar. 7,
2022), available at https://www.cii.org/corp_gov_policies#exec.
\484\ See, e.g., ISS Governance, 2021 Global Benchmark Policy
Survey (Oct. 2021), available at https://www.issgovernance.com/file/publications/2021-global-policy-survey-summary-of-results.pdf
(reporting that while there has been an upsurge in interest in
environmental, social, and governance (ESG) metrics in executive
compensation, some observers have criticized the increasing use of
poorly defined ESG metrics).
\485\ Recent regulatory changes have not always impacted
executive compensation in ways that may have been expected, perhaps
because of the offsetting effect of heightened investor engagement
on pay structure since the introduction of say-on-pay votes. See,
e.g., Lisa De Simone, Charles McClure and Bridget Stomberg,
Examining the Effects of the TCJA on Executive Compensation (Apr.
15, 2022). Kelley School of Business Research Paper No. 19-28,
available at https://ssrn.com/abstract=3400877 (finding no evidence
that the repeal of a long-standing exception under Section 162(m) of
the tax code that allowed companies to deduct executives' qualified
performance-based compensation in excess of $1 million reversed a
related shift in executive compensation away from cash compensation
and towards performance pay). In addition, the board, via the
compensation committee, has oversight over executive compensation,
and typically weighs a number of considerations in determining how
best to incentivize performance. See, e.g., Alex Edmans, et al.,
Executive Compensation: A Survey of Theory and Evidence (Eur. Corp.
Governance Inst. (ECGI) Fin. Working Paper No. 514/2016), available
at https://ssrn.com/abstract=2992287 (retrieved from SSRN Elsevier
database) (describing the influences of boards, executives, and
institutional factors such as legislation, taxation, accounting
policy, compensation consultants, and proxy advisory firms on
compensation outcomes).
---------------------------------------------------------------------------
Separate from changes to the composition of compensation, the size
of total compensation may also be impacted by the rule. In response to
potential increased uncertainty, risk-averse executives may demand an
offset to bear this uncertainty. Executives may also demand higher
total compensation to offset the expected loss from potential recovery.
This possibility was noted by a number of commenters, who suggested
this increase in executive compensation would harm shareholders.\486\
---------------------------------------------------------------------------
\486\ See, e.g., comment letters from TCA; Ensco; Pearl Meyer;
WAW; NAM; NACD; and American Vanguard.
---------------------------------------------------------------------------
We acknowledge that an increase in executive pay is a possibility.
Some research suggests that as a result of recovery provisions, the
total compensation of executive officers may increase, but other
studies do not support this hypothesis.\487\ The extent of any such
increase will depend on the structure and conditions of the labor
market for executive officers as well as other economic factors,
including the negotiating environment and particular preferences of
executives. We also note that although executives may demand and
receive an increase in total compensation relative to the baseline to
offset potential losses from recovery, their new compensation
agreements would reasonably be expected to tie more closely to true
firm performance, as misstatement-driven determinants of pay are
replaced by base pay or pay tied to accurate financial or operational
metrics. This could improve alignment between executives and
shareholders. In addition, improved financial reporting quality that
may result from the rule and reduced likelihood of a restatement would
benefit the issuer and shareholders, mitigating costs associated with
any increase in executive compensation. Finally, as noted earlier in
this section, shareholder engagement, other governance controls, and
market forces may mitigate changes due to the final rules.
---------------------------------------------------------------------------
\487\ See DeHaan et al., supra note 62; Chen et al., supra note
462 (finding that compensation recovery provisions are associated
with higher CEO compensation); and Kroos et al., supra note 479. See
also Ramachandran Natarajan and Kenneth Zheng, Clawback Provision of
SOX, Financial Misstatements, and CEO Compensation Contracts, 34 J.
Acct., Auditing & Fin. 74 (2019) (finding that compared with control
firms, companies with a high restatement likelihood where the CEO is
the chair of the board exhibit an increase in CEO salaries between
the pre- and post-Sarbanes-Oxley Act periods, suggesting that in the
post-Sarbanes-Oxley Act period influential CEOs are able to receive
higher salaries that are not subject to the Sarbanes-Oxley Act
Section 304 clawback provision). By contrast, Erkens et al., supra
note 462, finds results suggesting that while CEO incentive-based
compensation may be reduced for adopters of strong compensation
recovery provisions, for those companies, CEO total compensation is
also reduced. The authors suggest that the findings may indicate
that the adoption of strong compensation recovery provisions is
associated with a broader reform package. Similarly, Iskandar-Datta
et al., supra note 426, find no evidence that compensation recovery
provisions entail costs in the form of higher CEO compensation
following adoption nor do they influence the design of compensation
contracts.
---------------------------------------------------------------------------
A number of commenters stated that the final rules may affect the
competition among issuers to hire and retain executive officers, as
well as recruitment for specific board committees.\488\ Increased
uncertainty
[[Page 73124]]
that reduces the perceived value of the expected incentive-based
compensation of an executive officer, or expectation of lower total
compensation due to recovery, could cause listed issuers to have more
difficulty attracting talented executives. As a result, listed issuers
could potentially experience a comparative disadvantage relative to
companies that are not covered (i.e., unlisted issuers and private
companies).\489\
---------------------------------------------------------------------------
\488\ See, e.g., comment letter from Compensia (noting that no-
fault recovery would have dramatic adverse effects on issuers such
as individuals negotiating to avoid executive officer status). In
addition, Compensia contends that the rule would put increased
pressure on the boards and managers responsible for reviewing
financial statements and executive compensation, making audit
committee and compensation committee service less attractive. See
also comment letters from Ensco; Kovachev; NAM; Pearl Meyer; and
American Vanguard. Another commenter, however, suggests that
clawback rules should not impede the ability of issuers to recruit
executives. See comment letter from Occupy.
\489\ See, e.g., comment letter from IBC (noting that narrowing
the market of available and interested executives in any increment
is not in the shareholders' best interest). See also comment letter
from Davis Polk 3 (noting that having compensation subject to change
for matters out of their control (``no-fault'') could lower
executives' morale and satisfaction, causing executives to shy away
from working with public companies). See also comment letters from
NAM; and American Vanguard.
---------------------------------------------------------------------------
While we acknowledge this possibility, this concern is mitigated if
the potential impacts to compensation discussed earlier in this
section, that total executive compensation may increase or shift to
forms that are not recoverable, manifest to some degree. To the extent
issuers adjust total compensation for executive officers and design
alternative incentive packages, we expect that the competitiveness of
listed issuers in the executive labor market may remain unchanged. In
addition, studies have shown that listed firms offer higher total
executive compensation than unlisted firms of comparable size and other
characteristics.\490\ We thus believe it is unlikely executives will
significantly disfavor listed firms from their choice set of employment
opportunities.
---------------------------------------------------------------------------
\490\ See Huasheng Gao and Kai Li, A Comparison of CEO Pay-
Performance Sensitivity in Privately-Held and Public Firms, J. Corp.
Fin. 35 (2015) available at https://www.sciencedirect.com/science/article/pii/S0929119915001261 (finding that CEOs in public firms are
paid 30% more than CEOs in comparable private firms).
---------------------------------------------------------------------------
One commenter suggested that ``clawback risk may deter executives
from undertaking or approving business strategies with more complex
accounting methods, since the complexity may add to the likelihood of a
reporting error and corresponding clawback of their compensation.''
\491\ We acknowledge this concern but note research shows that adoption
of voluntary recovery provisions is associated with improved managerial
decision making.\492\
---------------------------------------------------------------------------
\491\ See comment letter from NAM.
\492\ As noted above, some research shows that adoption of
voluntary recovery provisions is associated with improved managerial
decision making. See supra notes 463 and 473.
---------------------------------------------------------------------------
6. Effects of Disclosure and Tagging Requirements
Under the final rules, the listed 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. To the extent that listed issuers that
currently have compensation recovery policies might not disclose the
existence or the specific terms of that policy, there may be direct
benefits of this disclosure requirement separate from any pecuniary
recovery following an accounting restatement. The disclosure
requirements are intended to inform shareholders and the listing
exchange as to the substance of a listed issuer's recovery policy and
how the listed issuer implements that policy in practice. For instance,
the disclosure requirements include the date of and amount of
erroneously awarded compensation attributable to the accounting
restatement, certain estimates that were used in determining the
amount, and the amounts that have been collected, are still owed, and
are forgone. The final rules also require issuers to indicate by a
check box on the cover page of their annual reports whether the
financial statements of the registrant included in the filing reflect
correction of an error to previously issued financial statements and
whether any of those error corrections are restatements that required a
recovery analysis.
The final rules also require the disclosure (including the cover
page check boxes) be provided in Inline XBRL, a structured (i.e.,
machine-readable) data language. This may facilitate the extraction and
analysis (e.g., comparison, aggregation, filtering) of the disclosed
information across a large number of issuers or, eventually, over
several years. XBRL requirements for public operating company financial
statement disclosures have been observed to mitigate information
asymmetry by reducing information processing costs, thereby making the
disclosures easier to access and analyze.\493\ While these observations
are specific to operating company financial statement disclosures and
not to disclosures outside the financial statements, such as the
compensation recovery disclosures, they suggest that the Inline XBRL
requirements could directly or indirectly (i.e., through information
intermediaries such as financial media, data aggregators, and academic
researchers) provide investors with increased insight into information
related to compensation recovery at specific issuers and across
issuers, industries, and time periods.\494\ Additionally, requiring
Inline XBRL tagging of the compensation recovery disclosure benefits
investors by making the disclosures more readily available and easily
accessible to investors, market participants, and others for
aggregation, comparison, filtering, and other analysis, as compared to
requiring a non-machine readable data language such as ASCII or HTML.
---------------------------------------------------------------------------
\493\ See, e.g., Jeff Zeyun Chen et al., Information Processing
Costs and Corporate Tax Avoidance: Evidence From the SEC's XBRL
Mandate (Jan. 11, 2021), 40 J. Acct. & Pub. Pol'y 2 (finding XBRL
reporting decreases likelihood of firm tax avoidance because ``XBRL
reporting reduces the cost of IRS monitoring in terms of information
processing, which dampens managerial incentives to engage in tax
avoidance behavior''); see also Paul A. Griffin et al., The SEC's
XBRL Mandate and Credit Risk: Evidence on a Link Between Credit
Default Swap Pricing and XBRL Disclosure, Am. Acct. Ass'n Ann.
Meeting, (2014) (finding XBRL reporting enables better outside
monitoring of firms by creditors, leading to a reduction in firm
default risk); see also Elizabeth Blankespoor, The Impact of
Information Processing Costs on Firm Disclosure Choice: Evidence
from the XBRL Mandate, 57 J. Of Acc. Res. 919, 919-967 (2019)
(finding ``firms increase their quantitative footnote disclosures
upon implementation of XBRL detailed tagging requirements designed
to reduce information users' processing costs,'' and ``both
regulatory and non-regulatory market participants play a role in
monitoring firm disclosures,'' suggesting ``that the processing
costs of market participants can be significant enough to impact
firms' disclosure decisions'').
\494\ See, e.g., Nina Trentmann, Companies Adjust Earnings for
Covid-19 Costs, But Are They Still a One-Time Expense?, Wall St. J.
(Sept. 24, 2020, 3:54AM) (citing an XBRL research software provider
as a source for the analysis described in the article), available at
https://www.wsj.com/articles/companies-adjust-earnings-for-covid-19-costs-but-are-they-still-a-one-time-expense-11600939813 (retrieved
from Factiva database); see also XBRL Int'l, Bloomberg Lists BSE
XBRL Data (Mar. 17, 2019), available at https://www.xbrl.org/news/bloomberg-lists-bse-xbrl-data/; see also Rani Hoitash and Udi
Hoitash, Measuring Accounting Reporting Complexity With XBRL, 93
Acct. Rev. 259 (2018), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2433677 (retrieved from SSRN Elsevier
database).
---------------------------------------------------------------------------
The compliance costs associated with the final rules, which apply
only to listed issuers, would include costs attributable to the Inline
XBRL tagging requirements. Various preparation solutions have been
developed and used by operating companies to fulfill XBRL requirements,
and some evidence suggests that, for smaller companies, XBRL compliance
costs have decreased over time.\495\ The incremental
[[Page 73125]]
compliance costs associated with Inline XBRL tagging requirements under
the final rules are mitigated by the fact that most issuers subject to
the tagging requirements are or will be subject to other Inline XBRL
requirements for other disclosures in Commission filings, including
financial statement and cover page disclosures in certain periodic
reports and registration statements.\496\ Such issuers may be able to
leverage existing Inline XBRL preparation processes and expertise in
complying with the Inline XBRL tagging requirements under the final
rules.
---------------------------------------------------------------------------
\495\ An AICPA survey of 1,032 reporting companies with $75
million or less in market capitalization in 2018 found an average
cost of $5,850 per year, a median cost of $2,500 per year, and a
maximum cost of $51,500 per year for fully outsourced XBRL creation
and filing, representing a 45% decline in average cost and a 69%
decline in median cost since 2014. See Michael Cohn, AICPA Sees 45%
Drop in XBRL Costs for Small Companies, Acct. Today (Aug. 15, 2018),
available at https://www.accountingtoday.com/news/aicpa-sees-45-drop-in-xbrl-costs-for-small-reporting-companies (retrieved from
Factiva database). In addition, a 2018 NASDAQ survey of 151 listed
registrants found an average XBRL compliance cost of $20,000 per
quarter, a median XBRL compliance cost of $7,500 per quarter, and a
maximum XBRL compliance cost of $350,000 per quarter in XBRL costs.
See Letter from Nasdaq, Inc. (Mar. 21, 2019) (to the Request for
Comment on Earnings Releases and Quarterly Reports); see Request for
Comment on Earnings Releases and Quarterly Reports, Release No. 33-
10588 (Dec. 18, 2018) [83 FR 65601 (Dec. 21, 2018)].
\496\ See 17 CFR 229.601(b)(101), General Instruction C.4 of
Form N-CSR, and 17 CFR 232.405.
---------------------------------------------------------------------------
With the new disclosures, investors may 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 listed issuers will be required to
adopt and comply with a recovery policy satisfying the requirements of
the final rules, issuers will 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-back 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 marginally improve allocative
efficiency by allowing investors to make more informed investment
decisions based on a better understanding of the incentives of the
executive officers. The requirement to publish recovery policies may
make such variation more likely to emerge.\497\
---------------------------------------------------------------------------
\497\ 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 final rules may make the signal more credible
and allow issuers to differentiate themselves based on variation in
the scope of a recovery policy.
---------------------------------------------------------------------------
Further, if at any time during the last completed fiscal year a
listed issuer's recovery policy required an issuer to recover
erroneously awarded compensation, the final rules will require the
issuer to disclose details of the recovery efforts under Item 402(w) of
Regulation S-K. These disclosures will allow existing and prospective
shareholders to observe whether issuers are enforcing their recovery
policies consistent with Section 10D. This will 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
(e.g., because the expense of enforcing recovery rights would exceed
the amount of erroneously awarded compensation 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.
As a commenter noted, there are a number of direct costs for
issuers resulting from the disclosure requirements of the final
rules.\498\ First, issuers will incur direct costs to file their
compensation recovery policies as an exhibit to their Exchange Act
annual reports. For purposes of our Paperwork Reduction Act Analysis,
we estimate that the exhibit filing requirement would impose a minimal
burden of 0.4 hours per issuer. Second, if an issuer is required to
recover erroneously awarded compensation, or if there is an outstanding
balance from application of the recovery policy to a prior restatement,
the issuer would incur a direct cost to prepare and disclose the
information required by Item 402(w) of Regulation S-K, Item 6.F of Form
20-F, or paragraph B.19 of Form 40-F, as applicable (or, for registered
management investment companies, Item 18 to Form N-CSR and Item
22(b)(20) of Schedule 14A) and the corresponding narrative. For
purposes of our PRA, we estimate that the final disclosure requirement,
including costs to tag the required disclosure in Inline XBRL, as
described above, would impose a burden of 25 hours per issuer.\499\
---------------------------------------------------------------------------
\498\ See, e.g., comment letter from IBC (noting that the
``necessity for additional disclosures as well as the XBRL
requirement increase the administrative cost to the registrant due
to the substantial increase in the amount of information required
for disclosure and the complexity of formatting data in XBRL'')
\499\ See Section V.C., for a more extensive discussion of these
disclosure burdens, including the monetization and aggregation
across issuers of these direct costs.
---------------------------------------------------------------------------
7. Indemnification and Insurance
Many of the benefits discussed above would result from an executive
officer's changes in behavior as a result of incentive-based
compensation being at risk for recovery should a ``Big R'' or ``little
r'' restatement be required. These benefits would be substantially
undermined if the issuer were able to indemnify the executive officer
for the loss of compensation.\500\ Moreover, as a commenter noted,
shareholders would bear the cost of providing such
indemnification.\501\ Therefore, the indemnification provision
prohibits listed issuers from indemnifying current and former executive
officers against the loss of erroneously awarded compensation or paying
or reimbursing such executives for insurance premiums to cover losses
incurred under the recovery policy.\502\
---------------------------------------------------------------------------
\500\ Several commenters offered suggestions on this issue, see
Section II.E.2.
\501\ See, e.g., comment letter from Rosanne D. Balfour,
discussing this potential outcome.
\502\ As an example of the type of indemnification that is
prohibited, one commenter noted that when Wilmington Trust was
required to recover $2 million from an executive under the TARP
clawback rules, the company responded by increasing the executive's
base salary by 25%. See comment letter from Kovachev. See also the
discussion infra at note 368.
---------------------------------------------------------------------------
Although reimbursement of insurance premiums by issuers would be
prohibited, the insurance market may develop an insurance product that
would allow an executive officer, 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 officer would be able to hedge some of the risk
that results from a recovery policy. If an executive officer 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 officer'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 officer, then incentives would remain for the
executive to avoid inappropriate actions.
The development of this type of private insurance policy for
executive officers would also have implications for issuers. Overall,
it could make it less costly for an issuer to compensate an executive
officer after implementing a recovery policy. If an active insurance
[[Page 73126]]
market develops such that the executive officer 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 indemnification provision prohibits issuers from
reimbursing a current or former executive officer 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 officer's compensation. This increase may be less than
the increase in the market-determined compensation packages if an
insurance policy was unavailable because an insurance company may be
more willing to bear uncertainty than a risk-averse executive.
8. Effects May Vary for Different Types of Issuers
The effects of the final rules 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 have different compensation structures, financial
reporting complexity, or quality than other issuers. Analysis by
Commission staff indicates that SRCs, on average, use a lower
proportion of incentive-based compensation than non-SRCs, suggesting a
lower potential impact of the final rules on SRCs.\503\ On the other
hand, as discussed in Section IV.A., only 34% of SRCs currently have a
recovery policy in place in contrast to 71% of larger domestic issuers.
As a result, SRCs may experience more dramatic benefits as well as
larger costs, relative to the baseline. 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 restatements and recoveries at SRCs.\504\ Academic studies
suggest that the likelihood of reporting a material weakness in
internal control over financial reporting decreases as the size of the
issuer increases.\505\ This may imply that, relative to non-SRCs, the
final rules may cause executive officers at SRCs to devote
proportionately more resources to the production of high-quality
financial reporting. Finally, to the extent that implementation of the
final rules entails fixed costs, SRCs, because of their smaller size,
would incur a greater proportional compliance burden than larger
issuers.
---------------------------------------------------------------------------
\503\ 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 2021.
Staff found that, on average, SRCs pay 47% of total compensation in
base salary versus 20% for non-SRCs; SRCs pay 19% of total
compensation in stock awards versus 45% for non-SRCs; SRCs pay 7% of
total compensation in non-equity incentive plan compensation versus
18% for non-SRCs; SRCs pay 6% of total compensation as a bonus
versus 2% for non-SRCs; and SRCs pay 16% of total compensation in
option awards versus 8% 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 rule, these
differences should be taken as maximum estimated differences of
incentive-based compensation for named executive officers. Staff did
not find significant differences between SRCs and non-SRCs in the
percent of compensation paid in nonqualified deferred compensation,
or in other compensation. We also note that the final rule covers a
broader set of employees than the named executive officers required
to report within the Summary Compensation Table.
\504\ See Susan Scholz, Financial Restatement: Trends in the
United States 2003-2012, Ctr. Audit Quality, Washington, DC, (2013).
\505\ See, e.g., Jeffrey T. Doyle et al., Determinants of
Weaknesses in Internal Control Over Financial Reporting, 44 J. Acct.
& Econ. 193 (2007) available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=770465 (retrieved from SSRN Elsevier
database).
---------------------------------------------------------------------------
The final rules 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.\506\ 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 above, 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, including both ``Big R'' and ``little r''
restatements. This reduced incentive could have a greater impact for
EGCs, relative to non-EGCs, to the extent that executive officers at
EGCs are more likely to forgo value-enhancing growth opportunities as a
result of the final rules, 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,\507\ which may
imply that EGCs have a higher likelihood of an accounting restatement
and a higher likelihood of reporting a material weakness in internal
control over financial reporting. Similar to SRCs, this may imply that,
relative to non-EGCs, the final rules may cause executive officers at
EGCs to devote proportionately more resources to the production of
high-quality financial reporting. Also, as discussed in Section IV.A.,
only 19% of EGCs currently have a recovery policy in place compared to
71% of larger domestic issuers . As a result, EGCs may experience more
dramatic changes relative to the baseline.
---------------------------------------------------------------------------
\506\ In an analysis of 446 EGCs with fiscal year 2021 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. 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 above
that level; and staff restricted the analysis to companies that
issued common equity and were listed on NYSE, NYSE MKT, or NASDAQ.
\507\ Using the same dataset referenced in note 322, staff found
the average market capitalization of EGCs is approximately $1.5
billion while the average market capitalization of non-EGCs is
approximately $14.6 billion. Staff also found the smallest EGCs tend
to be relatively close 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 $40.6
million and $60.5 million, respectively. Conversely, staff found 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 $2.9 billion and $21.9 billion.
---------------------------------------------------------------------------
Some commenters have noted that SRCs and EGCs may face
disproportionate costs.\508\ One commenter noted that these companies
may benefit disproportionately,\509\ and another commenter indicated
that the benefits may be lower for companies immediately following the
IPO process.\510\ We acknowledge that SRCs and EGCs may face
disproportionate costs of compliance as compared to other companies,
but also note that our baseline analysis suggests that fewer of these
companies may have implemented compensation recovery policies \511\ and
[[Page 73127]]
consequently may realize disproportionate benefits.\512\
---------------------------------------------------------------------------
\508\ See, e.g., comment letter from ABA 1 (indicating that SRCs
and EGCs are likely to bear significant costs in enforcing a
mandatory compensation recovery policy and that the proposed rule
would create a costly incentive for newly public issuers to avoid
the use of incentive based compensation); CCMC 2 (indicating that
the costs would be disproportionate); Compensia (indicating that
SRCs and EGCs would face disproportionate costs); Mercer (indicating
that the rule could impede the facilitation of capital formation for
SRCs and EGCs); and NACD (suggesting the rule ``puts an inordinate
burden on smaller companies, which cannot always afford the kind of
compliance costs entailed by new rules'').
\509\ See, e.g., comment letter from Public Citizen 1
(suggesting that ``the chance for manipulation [at SRCs] is perhaps
even greater at such companies than at larger firms with a wider and
arguably more vigilant shareholder base'').
\510\ See, e.g., comment letter from Compensia (suggesting that
for EGCs, ``the likelihood of a financial restatement in the period
immediately following an IPO would be minimal given the degree of
scrutiny the issuer must undergo during the offering process'').
\511\ See Section IV.A.
\512\ See supra note 413.
---------------------------------------------------------------------------
In addition, we recognize that there may be additional specific
costs and benefits for FPIs. While we believe the typical issuer is
unlikely to transfer listing in the short-term as a result of the final
rules, the potential response of FPIs is less clear. On one hand, by
virtue of listing on a U.S. exchange, an FPI 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.
Commenters have noted that the final rules would increase the
compliance burden on FPIs and could thereby potentially reduce the
advantage of listing on a U.S. market.\513\ One commenter noted that
the final rules would cause a competitive disadvantage for domestic
issuers as compared to foreign issuers,\514\ and others noted that they
may encourage foreign governments to pass laws that disadvantage or
penalize U.S. corporations.\515\ In addition, commenters noted that
U.S. corporations operating in jurisdictions outside the United States
would face similar compliance hurdles as FPIs.\516\
---------------------------------------------------------------------------
\513\ See, e.g., comment letters from CCMC 1; and Coalition. See
also, e.g., comment letter from Freshfields (noting that the rules
will require FPIs to identify and keep track of executive officers
consistent with Section 16, and stating that, as a result of such
requirements, the Economic Analysis in the Proposing Release
understates the compliance burden for FPIs, especially if the FPI
becomes subject to two clawback regimes); and Kaye Scholer (stating
that the proposal does not give due consideration to or address the
complications that would arise where an FPI is also required to
recover compensation under home country rules, such as situations
where the home country has a different definition of incentive-based
compensation). In addition, see comment letter from UBS (noting that
it may lose attractiveness as an employer as a result of the
proposed rules).
\514\ See comment letter from Bishop.
\515\ See comment letters from CCMC 1; and Coalition.
\516\ See, e.g., comment letters from CCMC 1; and Coalition.
---------------------------------------------------------------------------
We recognize that FPIs may bear additional compliance costs, as
noted by commenters, relative to non-FPI listed issuers. As a result,
FPIs could choose to delist from U.S. exchanges.\517\ Further, FPIs
that are not currently listed on U.S. exchanges, but are considering
listing on a non-home country exchange, may choose to list on another
non-home foreign exchange because of the increased burden of our final
rules. At the same time, we understand that one of the benefits of
listing on a U.S. exchange is that an issuer can signal the high
quality of its corporate governance, which is achieved by subjecting
itself to the rigorous corporate governance rules and regulations of a
U.S. exchange.\518\ By listing on U.S. exchanges, many FPIs may gain
the ability to raise capital at a reduced cost compared to their home
market. Hence, some FPIs seeking access to U.S. capital markets may
view the requirements as beneficial.
---------------------------------------------------------------------------
\517\ See supra note 261, describing feedback from commenters
who note that the rules may create potential disincentives for FPIs
to list on U.S. exchanges. See also comment letter from Davis Polk 1
(noting that ``adoption of Section 404 of the Sarbanes-Oxley Act of
2002 led 51.6% of foreign firms to consider delisting from U.S.
exchanges, and led 76.8% of small foreign firms to consider
delisting, with 98 foreign firms de-listing in 2002,'' citing SEC
Office of Economic Analysis, Study of the Sarbanes-Oxley Act of 2002
Section 404 Internal Control over Financial Reporting Requirements
(Sep. 2009), available at https://www.sec.gov/news/studies/2009/sox-404_study.pdf.)
\518\ See, e.g., Craig Doidge et al., Why do Foreign Firms Leave
U.S. Equity Markets?, 65 J. Fin., 1507 (2010), (noting that by
subjecting themselves to U.S. laws and institutions, insiders of
foreign firms credibly bond themselves to avoid some types of
actions that might decrease the wealth of minority shareholders.)
But see comment letter from Kaye Scholer (arguing that U.S.
standards for corporate governance may not be more rigorous than
other jurisdictions, and further that it is not clear that FPIs list
on a U.S. exchange to signal their high quality corporate governance
rather than to access U.S. capital markets or to provide more
liquidity for their stock).
---------------------------------------------------------------------------
We also recognize that the final rule may have different effects on
listed funds. One commenter noted that listed funds' financial
statements are less complex than operating company financial statements
and that accounting restatements are relatively rare for funds.\519\
The commenter also stated that the proposal could affect more than the
small number of internally managed listed funds that the Commission
estimated in the proposal, because some externally managed listed funds
may pay some or all of the funds' chief compliance officers'
compensation.
---------------------------------------------------------------------------
\519\ See comment letter from ICI.
---------------------------------------------------------------------------
We recognize that there is a wide range of complexity in issuer
financial reporting. Issuers with less complex financial reporting,
such as some listed funds, may realize fewer benefits from the final
rule. We also anticipate that such issuers may experience fewer costs,
as fewer compensation contracts may be affected, and potential trigger
events would be relatively rare. In addition, we recognize that listed
funds that pay for their chief compliance officers' compensation would
be affected by the final rule, and that as a result, the number of
affected funds likely exceeds the estimate provided in the Proposing
Release.
C. Alternatives
Below we discuss possible alternatives to the final rules 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 final
rules may impose certain disproportionate costs on SRCs and EGCs.
However, smaller issuers, SRCs and EGCs, may have an increased
likelihood of reporting an accounting error and may be more likely to
report a material weakness in internal control over financial
reporting.\520\ As more fully discussed in Section II.A.3, while the
Commission has the authority to exercise its discretion to exempt such
issuers, Congress did not direct the Commission to consider
differential treatment for recovery of incentive-based compensation
that was not earned and should not have been paid for SRCs or EGCs. As
such, we see no reason why shareholders of smaller issuers should not
benefit from recovery of erroneously awarded compensation in the same
manner as shareholders of larger issuers.
---------------------------------------------------------------------------
\520\ See, Choudhary et al., supra note 61 (finding that future
restatements are less likely for larger firms). See also comment
letter from Public Citizen 1 (arguing that the risk of manipulation
is greater at smaller companies).
---------------------------------------------------------------------------
A number of commenters suggested that we consider exempting FPIs,
arguing that home countries would generally have a greater interest in
determining whether issuers should have recourse against executive
officers.\521\ Another commenter suggested that some issuers may be
required to implement two different recovery policies, and also noted
that FPIs are not currently required to identify Section 16 officers.
As a result, the commenter stated that the economic analysis in the
Proposing Release understated the costs for FPIs.\522\
---------------------------------------------------------------------------
\521\ See, e.g., comment letters from the ABA 1; Bishop; and
Davis Polk 1.
\522\ See supra footnotes 32 through 37; see also comment letter
from Freshfields (``we expect all UK companies that are FPIs either
already have a clawback in place, or will implement one when their
directors' remuneration policy is next submitted for shareholder
approval,'' and ``we believe that the Economic Analysis in the
Release understates the compliance burden for FPIs especially if the
FPI becomes subject to two clawback regimes'').
---------------------------------------------------------------------------
As discussed previously in the context of FPIs generally, the
potential effect of the final rules on FPIs is difficult to predict. On
the one hand, due to the potential differences in home
[[Page 73128]]
country law, the final rule requirements may be especially burdensome
for FPIs relative to non-FPIs.\523\ On the other hand, there is
evidence that many FPIs may be listing on U.S. exchanges in part to
credibly signal to investors their willingness and ability to be
subjected to stricter governance standards.\524\ While FPIs may face a
relatively higher burden from the final rules, they also may experience
a relatively higher benefit. As more fully discussed in Section II.A.3,
while the Commission has the authority to exercise its discretion to
exempt such issuers, the concerns expressed by commenters do not in our
view justify exempting all FPIs from the obligation to recover
incentive-based compensation that was erroneously awarded. Moreover,
the recovery requirements will help to encourage reliable financial
reporting by listed issuers, which is as important for investors in
FPIs as for other issuers. Studies have shown that foreign companies
present a similar risk of restatement as other companies \525\ and that
U.S. issuers who are non-accelerated filers accounted for approximately
53% of restatements.\526\ To the extent that recovery under Rule 10D-1
would be wholly inconsistent with a foreign regulatory regime, we have
included an impracticability accommodation, as discussed in Section
II.C.3.b., which may alleviate some of the implementation challenges
faced by FPIs.
---------------------------------------------------------------------------
\523\ We note that if recovery of erroneously awarded
compensation would violate home country laws that were in effect as
of the date of publication of Rule 10D-1 in the Federal Register,
the final rules may permit the board of directors discretion to
forgo recovery as impracticable, subject to certain conditions.
\524\ See Craig Doidge et al., supra note 518.
\525\ See supra note 56.
\526\ See A Twenty-Year Review.
---------------------------------------------------------------------------
Certain commenters also suggested we unconditionally exempt listed
funds, rather than the conditional exemption we are adopting. Listed
funds, unlike most other issuers, are generally externally managed and
often have few, if any, employees that are compensated by the fund
(i.e., the issuer). As discussed above, the final rules are designed to
reflect the structure and compensation practices of listed funds by
requiring funds to implement compensation recovery policies only when
they in fact award incentive-based compensation covered by Section 10D.
As such, we believe the rules are appropriately tailored as applied to
funds in that they will only apply to the small subset of listed funds
that award incentive-based compensation covered by Section 10D.
2. Excluding Incentive-Based Compensation Tied to Stock Price
The final rule encompasses incentive-based compensation tied to
measures such as stock price and TSR because improper accounting
affects such financial reporting measures and in turn results in excess
compensation. As discussed above, the final rules may result in 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 final rules, 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 final rules 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.\527\ To this end, accounting-based measures of performance--
although not directly tied to issuer value enhancement--may better
capture the effect of an executive officer's actions during the
relevant performance period. Therefore, if incentive-based compensation
tied to stock price were 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 officer's actions during the performance period. Since
changes in compensation practices away from the current market
practices may be either beneficial to issuers or not, depending on
whether current practices are optimal, it is unclear that shifting
compensation toward forms tied to market-based metrics would be
beneficial.
---------------------------------------------------------------------------
\527\ All of the seven most frequently used metrics to award
compensation in short-term incentive plans were accounting-based
measures. Those measures are operating income, revenue, cash flow,
EPS, return measures, operating income margin, and net income. See
Meridian Report. See also supra note 356.
---------------------------------------------------------------------------
The optimal compensation package may contain 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.\528\ Using market-based measures of performance in
short-term incentive plans may be undesirable for the executive officer
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
officer'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 officer'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 consequently may
adversely affect the incentives of the executive officer.
---------------------------------------------------------------------------
\528\ See Meridian Report.
---------------------------------------------------------------------------
3. Including Only ``Big R'' Restatements as Trigger Events
The Commission considered adopting final rules that would provide
that recovery is required with respect to only ``Big R'' restatements
that correct errors that are material to previously issued financial
statements. Under that alternative, ``little r'' restatements would not
trigger a potential recovery.
As discussed above, some commenters have provided feedback
[[Page 73129]]
indicating that there are substantial benefits associated with
including ``little r'' restatements as trigger events, including the
likelihood that the final rules will provide stronger incentives for
managers to monitor the accuracy of financial statements.\529\ Were we
to include only ``Big R'' restatements, those benefits would not be
realized. However, other commenters have noted that the inclusion of
``little r'' restatements as trigger events may increase the costs of
compliance with the final rules compared to an alternative of including
only ``Big R'' restatements.\530\ Although it is possible that certain
compliance costs may be higher as a result of the inclusion of ``little
r'' restatements in the scope of potential trigger events, as discussed
above, not every restatement would trigger a recovery of compensation
that was earned as a result of meeting performance measures.\531\ In
addition, issuers are already required to perform a materiality
analysis on each error that is identified in order to determine how to
account for and report the correction of that error, and in that
context, issuers may have already calculated the impact of the error on
executive compensation. Furthermore, the broader scope of encompassing
``little r'' restatements addresses concerns that issuers could
manipulate materiality and restatement determinations to avoid
application of the compensation recovery policy.\532\
---------------------------------------------------------------------------
\529\ See supra note 84.
\530\ See supra note 88. Also, as noted in the Second Reopening
Release, the inclusion of ``little r'' restatements as potential
trigger events increases the number of potential trigger events.
\531\ We expect that recovery of incentive-based compensation
that is tied to TSR would be relatively small and infrequent as a
result of ``little r'' restatements, since these restatements are
less likely to be associated with significant stock price reactions.
See Choudhary et al., supra note 61 (finding an average stock price
reaction of -3.3% to ``Big R'' restatements and -0.3% for ``little
r'' restatements); Thompson, supra note 79 (finding an average stock
price reaction of -1.5% to ``Big R'' restatements and -0.3% for
``little r'' restatements).
\532\ See supra note 107.
---------------------------------------------------------------------------
4. Other Alternatives Considered
Some commenters suggested that issuers may choose to implement a
nonqualified deferred compensation plan (e.g., a ``holdback plan'') to
aid in the recovery of erroneously awarded incentive-based
compensation.\533\ One commenter suggested that the Commission
specifically require the use of a holdback plan,\534\ and another
commenter noted that such a plan may raise significant tax issues and
recommended that the Commission provide the board of directors with
broad discretion.\535\ A holdback plan would likely reduce the costs of
recovering erroneously awarded incentive-based compensation. On the
other hand, a holdback plan may further augment any increase in
compensation necessary to offset the expected cost to the executive
officer of a recovery policy. This is due to the executive officer not
having access to the funds she has earned and having to delay
consumption that would otherwise be possible. These considerations
suggest that a holdback plan could be efficient at some issuers but
inefficient at others. We note that the rule does not mandate a
holdback plan, but also does not prevent issuers from adopting a
holdback plan if they so choose.
---------------------------------------------------------------------------
\533\ See comment letter from Compensia; NACD; and Bhagat and
Elson. See also Stuart Gillan and Nga Nguyen, Clawbacks, Holdbacks,
and CEO Contracting, 30 J. Appl. Corp. Fin., 53 (2018).
\534\ See comment letter from Bhagat and Elson.
\535\ See comment letter from ABA 1.
---------------------------------------------------------------------------
One commenter suggested that the Commission consider also requiring
recovery of proportional incentive compensation, whether or not it is
numerically connected to the restated financial results. This
suggestion would require issuers, in the event of a restatement, to
recover a proportionate amount of the compensation tied to qualitative
variables or board judgment.\536\ Relative to the final amendments,
this alternative implementation would reduce the incentive to alter the
composition of an executive officer'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, as suggested by the commenter, we agree that 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 could also
increase the amount of expected compensation the executive officer
would require in order to voluntarily bear the increased uncertainty.
---------------------------------------------------------------------------
\536\ See comment letter from Public Citizen 1.
---------------------------------------------------------------------------
V. Paperwork Reduction Act
A. Summary of the Collection of Information
Certain provisions of our rules, schedules, and forms that will be
affected by the final rules contain ``collection of information''
requirements within the meaning of the Paperwork Reduction Act. The
Commission published a notice requesting comment on changes to these
collections of information in the Proposing Release and submitted these
requirements to the Office of Management and Budget (``OMB'') for
review in accordance with the PRA.\537\ While a number of commenters
provided comments on the potential costs of the proposed rules, as well
as factors that could affect the scope of entities covered by the
proposal, commenters did not specifically address our PRA
analysis.\538\
---------------------------------------------------------------------------
\537\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\538\ See supra Section II. One commenter contended that the
Reopening Release should have included an updated PRA analysis. See
comment letter from Toomey/Shelby, supra note 14.
---------------------------------------------------------------------------
The hours and costs associated with preparing, filing, and
distributing the schedules and forms constitute reporting and cost
burdens imposed by each collection of information. 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. Compliance with the information collections is
mandatory. Responses to the information collections are not
confidential and there is no mandatory retention period for the
information disclosed. The titles for the affected collections of
information are:
``Form 10-K'' (OMB Control No. 3235-0063);
``Form 20-F'' (OMB Control No. 3235-0288);
``Form 40-F'' (OMB Control No. 3235-0381); and
``Form N-CSR'', Certified Shareholder Report of Registered
Management Investment Companies'' (OMB Control No. 3235-0570).\539\
---------------------------------------------------------------------------
\539\ The amendments also affect the following collections of
information: ``Regulation 14A and Schedule 14A'' (OMB Control No.
3235-0059); ``Regulation 14C and Schedule 14C'' (OMB Control No.
3235-0057); and ``Rule 20a-1 under the Investment Company Act of
1940, Solicitations of Proxies, Consents, and Authorizations'' (OMB
Control No. 3235-0158). Regulations 14A and 14C and the related
schedules require the new disclosure to be included in proxy and
consent solicitations. Rule 20a-1 requires funds to comply with
Regulation 14A, Schedule 14A, and all other rules and regulations
adopted pursuant to Section 14(a) of the Exchange Act that would be
applicable to a proxy solicitation if it were made in respect of a
security registered pursuant to Section 12 of the Exchange Act. As
noted below, for purposes of the PRA and in order to avoid the PRA
inventory reflecting duplicative burdens, we assume the disclosure
will be incorporated by reference into Form 10-K and Form N-CSR from
proxy and information statements and do not include a separate
burden for these collections of information. See notes 543 and 544.
---------------------------------------------------------------------------
[[Page 73130]]
The Commission adopted Form 10-K, Form 20-F and Form 40-F under the
Exchange Act. Form N-CSR was adopted under the Exchange Act and
Investment Company Act. The forms set forth the disclosure requirements
to help shareholders make informed voting and investment decisions.
B. Summary of the Final Amendments and Effect of the Final Amendments
on Existing Collections of Information
To implement the provisions of Section 954 of the Dodd-Frank Act,
which added Section 10D to the Exchange Act we are adopting Rule 10D-1
under the Exchange Act as well as amendments to Items 402, 404, and 601
of Regulation S-K; Rule 405 of Regulation S-T; Schedule 14A; Form 20-F;
Form 40-F; Form 10-K; and Form N-CSR. Rule 10D-1 directs national
securities exchanges and associations to establish listing standards
that require listed issuers to adopt and comply with written policies
for recovery of erroneously awarded 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. As described in more detail above, we are also
adopting new disclosure requirements in Schedule 14A, Form 10-K, Form
20-F, Form 40-F, and Form N-CSR to require issuers listed on an
exchange to file their written compensation recovery policy as an
exhibit to their annual reports. Form 10-K, Form 20-F, Form 40-F
additionally require issuers listed on an exchange to indicate by a
check box on the cover page of their annual reports whether the
financial statements of the registrant included in the filing reflect
correction of an error to previously issued financial statements and
whether any of those error corrections are restatements that required a
recovery analysis; and disclose actions an issuer has taken pursuant to
such recovery policy. These disclosures will also be required to be
provided in tagged data language using Inline XBRL.\540\
---------------------------------------------------------------------------
\540\ While paperwork burdens associated with investment company
interactive data requirements are generally accounted for in the
Information Collection titled ``Registered Investment Company
Interactive Data,'' any burdens associated with interactive data for
investment companies associated with the final rules are estimated
to be negligible. For administrative simplicity, these burdens
therefore are incorporated into the burdens associated with the Form
N-CSR Information Collection, discussed below.
---------------------------------------------------------------------------
The additional information a listed U.S. issuer is required to
compile and disclose regarding its policy on incentive-based
compensation pursuant to Item 402(w) supplements information that U.S.
issuers often provide elsewhere in their executive compensation
disclosure.\541\ Similarly, for a listed FPI filing an annual report on
Form 20-F or, if a FPI elects to use domestic registration and
reporting forms, on Form 10-K, the amendments supplement existing
disclosures.\542\ We anticipate that new disclosure and submission
requirements will increase the amount of information that listed U.S.
issuers and listed FPIs must compile and disclose and therefore
increase the burdens and costs for the affected registrants.
---------------------------------------------------------------------------
\541\ These issuers are required to provide information relating
to the compensation of their named executive officers that may
include 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. See 17 CFR
229.402(b)(2)(viii). SRCs and EGCs generally are subject to scaled
executive compensation disclosure requirements in Item 402 of
Regulation S-K. See 17 CFR 229.402(l) and Section 102(c) of the JOBS
Act. However, the requirements of new Item 402(w) are not scaled and
thus SRCs and EGCs will be required to provide all of the
disclosures called for by this item. Accordingly, we have not
calculated separate or different paperwork burdens with respect to
Item 402(w) for these classes of issuers. With respect to registered
management investment companies, under the final rules, information
mirroring Item 402(w) disclosure must be included in annual reports
on Form N-CSR and in proxy statements and information statements
relating to the election of directors.
\542\ See Item 6.B and Item 7.B. of Form 20-F.
---------------------------------------------------------------------------
For listed U.S. issuers, other than registered management
investment companies, the amendments require additional Item 402
disclosure in certain required reports and will increase the burden
hour and cost estimates associated with Form 10-K.\543\ For listed
registered management investment companies, the amendments to Form N-
CSR and Schedule 14A require additional disclosure and will increase
the associated burden hour and cost estimates, if the registered
investment company pays incentive-based compensation, for Form N-
CSR.\544\ For listed FPIs filing an annual report on Form 20-F, Form
40-F or, if a FPI elects to use U.S. registration and reporting forms,
on Form 10-K, the amendments require additional disclosure in annual
reports and will increase the burden hour and costs estimates for each
of these forms.
---------------------------------------------------------------------------
\543\ For purposes of our PRA estimates, consistent with past
amendments to Item 402, we assume that all of the burden relating to
the new narrative disclosure requirements in Schedule 14A and
Schedule 14C 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. We are therefore not allocating a
separate burden estimates for Regulation 14A/Schedule 14A and
Regulation 14C/Schedule 14C. 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
(Aug. 29, 2006) [71 FR 53158].
\544\ 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 will be
associated with Form N-CSR, and therefore, we are not allocating a
separate burden estimate for Schedule 14A or Rule 20a-1 under the
Investment Company Act with respect to disclosure by such funds.
---------------------------------------------------------------------------
C. Burden and Cost Estimates Related to the Final Amendments
The following table summarizes the estimated paperwork burdens
associated with the amendments to the affected forms filed by listed
issuers.
[[Page 73131]]
PRA Table 1--Estimated Paperwork Burden of Final Amendments
------------------------------------------------------------------------
Brief explanation
Estimated burden of estimated
increase burden increase
------------------------------------------------------------------------
Amendments to Reg. S-K Items 402, 404, and 601, Reg. S-T Item 405, Form
20-F, Form 40-F, Schedule 14A, Form 10-K, and Rule 10D-1
------------------------------------------------------------------------
(1) Require the filing of an (1) An increase of These increases
issuer's recovery policy as an 0.4 burden hours are the estimated
exhibit to its Exchange Act for Form 10-K, effect on the
annual report. Form 20-F, and affected forms by
Form 40-F. the amendments to
(2) An increase of implement Section
25 burden hours 10D, including
for each of the the filing of the
affected forms: recovery policy,
Form 10-K, Form recovery policy
20-F, and Form 40- and policy
F. implementation
disclosures, and
the use of
structured data
for this
information.
(2) Require:
[cir] Disclosure regarding
the issuer's conclusion
that recovery was not
required under the recovery
policy or disclosure
regarding how the issuer
applied its recovery policy
after the issuer was
required to prepare an
accounting restatement that
required recovery under the
policy, or there was an
outstanding balance to be
recovered;
[cir] Disclosure of the
effects of the recovery on
the Summary Compensation
Table;
[cir] New check boxes to
indicate on the cover page
of issuers' annual reports
whether the financial
statements included in the
filing reflect correction
of an error to previously
issued financial statements
and whether such
corrections are
restatements that required
a recovery analysis; and
[cir] The above information
to be tagged using Inline
XBRL.
------------------------------------------------------------------------
Amendments to Form N-CSR, and Rule 10D-1
------------------------------------------------------------------------
(1) Require the filing of a (1) An increase of These increases
fund's recovery policy as an 0.4 burden hours are the estimated
exhibit to its Form N-CSR for the affected effect on the
annual report. form: Form N-CSR. affected form by
(2) An increase of the amendments to
25 burden hours implement Section
for the affected 10D, including
form: Form N-CSR. the filing of the
recovery policy,
recovery policy
and policy
implementation
disclosures, and
the use of
structured data
for this
information.
(2) Require:
[cir] Disclosure regarding
the fund's conclusion that
recovery was not required
under the recovery policy
or disclosure regarding how
the fund applied its
recovery policy after the
fund was required to
prepare an accounting
restatement that required
recovery under the policy,
or there was an outstanding
balance to be recovered;
and
[cir] The above information
to be tagged using Inline
XBRL.
------------------------------------------------------------------------
In the Proposing Release, we derived our burden hour and cost
estimates by reviewing our burden estimates for similar disclosure and
considering our experience with other tagged data initiatives. In
particular, we noted that the preparation of the information required
by Item 402(w) and the corresponding narrative disclosure provisions
would be comparable to an issuer's preparation of the disclosure
required by the Commission's 2009 amendments to enhance certain aspects
of proxy disclosure, which were also largely designed to enhance
existing disclosure requirements.\545\ In addition, 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 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.
---------------------------------------------------------------------------
\545\ See Proxy Disclosure Enhancements Release No. 33-9089
(Dec. 16, 2009) [74 FR 68334 (Dec. 23, 2009)] (``Proxy Disclosure
Enhancements''), which 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.
---------------------------------------------------------------------------
[[Page 73132]]
In the Proposing Release, the Commission estimated that the average
incremental burden for an issuer to prepare the new narrative
disclosure would be 21 hours. The proposed estimate included the time
and cost of preparing disclosure, as well as tagging the data in XBRL
format. We continue to believe that these are the primary cost elements
for issuers preparing the disclosure and that the elements account for
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, disclosing information
regarding the application and implementation of this recovery policy if
required by a restatement.
While the cost elements remain the same, we recognize that there
may be some additional burden in tagging the information using Inline
XBRL, using the check boxes, and providing the expanded disclosure
regarding the application of the recovery policy, including disclosure
analyzing how the amount of erroneously awarded compensation was
calculated and explaining why an issuer concluded that a recovery of
compensation was not required. As a result, we are increasing our
estimate of the average incremental burden for an issuer to prepare the
disclosure from 21 hours to 25 hours. We note that this estimate should
represent an upward bound, as the incremental additional disclosure
associated with ``little r'' restatements should be lower than for
``Big R'' restatements because we anticipate that it will be less
likely that a ``little r'' restatement will result in erroneously
awarded compensation, and where no recovery is required the rules
require less disclosure. As we noted in Section IV, we estimate that
``little r'' restatements may account for roughly three times as many
restatements as ``Big R'' restatements.\546\
---------------------------------------------------------------------------
\546\ See note 396 and accompanying text.
---------------------------------------------------------------------------
In addition, consistent with the Proposing Release, we separately
estimate the burden of filing a listed issuer's or listed registered
investment company's recovery policy as an exhibit to its annual
report. In a modification from the proposal, we are reducing the
estimate of the burden from approximately one hour to 0.4 hours. We
estimate that the initial burden of filing the recovery policy as an
exhibit will be one hour, but the ongoing burden for filing in
subsequent years will be minimal, which we estimate as a burden of 0.1
hours. In order to form our estimate, we averaged the initial one hour
burden with the 0.1 hour burden in subsequent years to determine the
average burden over three years of 0.4 hours.
Because these estimates are 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 the overall effect of the
restatement on the issuer's incentive-based compensation. Issuers
subject to Item 402(w) will provide the required disclosures by either
including the information directly in their Exchange Act annual reports
or incorporating the information by reference from a proxy statement on
Schedule 14A or information statement on Schedule 14C.
The amendments described in Section II will increase the paperwork
burden for filings on the affected forms that include recovery policy
exhibit filings and recovery policy disclosure. However, not all
filings on the affected forms include these disclosures, either because
they are not listed issuers or they are not required to provide the
disclosure because they have not had to seek recovery pursuant to their
recovery policy. Therefore, to estimate the increase in overall
paperwork burden from the amendments, we first estimate the number of
listed issuers and then estimate the number of issuers that may be
required to include the recovery disclosure. Based on the staff's
findings, the table below sets forth our estimates of the number of
filings on these forms \547\ and the number of such filings that will
be required to include the recovery disclosure.\548\
---------------------------------------------------------------------------
\547\ Of the 2,710 listed issuers that file Form N-CSR, 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, and thus may be
required to file a recovery policy exhibit. 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 new Item 18 of Form N-CSR. One commenter
suggested that a greater number of investment companies could be
affected by the proposal, but as this commenter did not include data
addressing the compensation arrangements that would fall within the
scope of the proposed requirements, and because we have no other
reason to believe that our estimates should be adjusted, we are not
adjusting our methods of estimating the number of investment
companies that the final rules would affect. See comment letter from
ICI.
\548\ See Section IV. In Section IV.A, we note that the report,
A Twenty-One Year Review, indicated that 4.9% of issuers disclosed a
restatement in 2020. In developing our estimates, we used the
current annual responses in the OMB inventory for the forms as a
starting point when determining the number of affected issuers.
Issuers are generally only required to file one annual report on
Form 10-K, Form 20-F, Form 40-F, or Form N-CSR per year. We expect,
as noted above, that for purposes of the PRA, to the extent issuers
provide the required information in other filings, the information
will be incorporated by reference. See notes 543 and 544. Further,
while issuers are generally required to file one annual report, the
rules do not apply to all issuers, rather they only apply to listed
issuers. As PRA Table 2 reflects, we estimate, based on Audit
Analytics restatement data for 2021, that approximately five% of
listed issuers restated their financial statements in 2020 and 2021.
While recognizing that not all issuers that file restatements will
be required to provide recovery disclosure, for purposes of the PRA,
we use the five% figure as an upward bound, and estimate that all
such issuers will provide the required disclosure.
PRA Table 2--Estimated Number of Affected Filings
----------------------------------------------------------------------------------------------------------------
Number of
estimated Number of
Current annual recovery estimated filings
Form responses in policy that include
OMB Inventory exhibit recovery
filings disclosure
----------------------------------------------------------------------------------------------------------------
10-K......................................................... 8,292 4,513 226
20-F......................................................... 729 722 36
40-F......................................................... 132 132 7
N-CSR........................................................ 6,898 7 1
----------------------------------------------------------------------------------------------------------------
We calculated the burden estimates by adding the estimated
additional burden to the existing estimated responses and multiplying
the estimated number of responses by the estimated average amount of
time it would take an issuer to prepare and review disclosure required
under the final amendments. For purposes of the PRA, the burden is
[[Page 73133]]
to be allocated between internal burden hours and outside professional
cost. PRA Table 3 sets forth the percentage estimates we typically use
for the burden allocation for each collection of information and the
estimated burden allocation for the proposed new collection of
information. We also estimate that the average cost of retaining
outside professionals is $600 per hour.\549\
---------------------------------------------------------------------------
\549\ We recognize that the costs of retaining outside
professionals may vary depending on the nature of the professional
services, but for purposes of this PRA analysis, we estimate that
such costs would be an average of $600 per hour. At the proposing
stage, we used an estimated cost of $400 per hour. We are increasing
this cost estimate to $600 per hour to adjust the estimate for
inflation from August 2006 to the present. The inflation-adjusted
amount is $583.88, which we have rounded up to $600.
PRA Table 3--Estimated Burden Allocation for the Affected Collections of
Information
------------------------------------------------------------------------
Outside
Collection of information Internal professionals
(percent) (percent)
------------------------------------------------------------------------
Forms 10-K, N-CSR....................... 75 25
Form 20-F, 40-F......................... 25 75
------------------------------------------------------------------------
PRA Table 4 illustrates the incremental change to the total annual
compliance burden of affected forms, in hours and in costs, as a result
of the amendments' estimated effect on the paperwork burden per
response.\550\ We note that the table includes one line for the exhibit
filing requirements and a separate line for the recovery disclosure
requirement, to account for the differences in the number of estimated
responses.
---------------------------------------------------------------------------
\550\ These estimates represent the average burden for all
issuers, both large and small. In deriving our estimates, we
recognize that the burdens will likely vary among individual issuers
based on a number of factors, including the size and complexity of
their organizations. The OMB PRA filing inventories represent a
three-year average. Some issuers may 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. Averages
also may not align with the actual number of filings in any given
year.
PRA Table 4--Calculation of the Incremental Change in Burden Estimates of Current Responses Resulting From the Final Amendments
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of
estimated Burden hour Change in Change in Change in Change in
Collection of information affected increase per burden hours company hours professional professional
responses response hours costs
(A) \a\ (B) (C) = (D) = (E) = (F) =
(A) x (B) (C) x 0.75 (C) x 0.25 (E) x $600
or 0.25 or 0.75
--------------------------------------------------------------------------------------------------------------------------------------------------------
10-K Exhibit............................................ 4,513 0.4 1,805 1,354 451 $270,600
10-K.................................................... 226 25 5,650 4,238 1,412 847,200
20-F Exhibit............................................ 722 0.4 289 72 217 130,200
20-F.................................................... 36 25 900 225 675 405,000
40-F Exhibit............................................ 132 0.4 52.8 13 40 24,000
40-F.................................................... 7 25 175 44 131 78,600
N-CSR Exhibit........................................... 7 0.4 3 2 1 600
N-CSR................................................... 1 25 25 19 6 3,600
--------------------------------------------------------------------------------------------------------------------------------------------------------
PRA Table 5 illustrates the incremental change to the total annual
compliance burden of affected forms, in costs, as a result of the
adjustment to the average cost of retaining outside professionals from
$400 to $600 per hour.\551\
---------------------------------------------------------------------------
\551\ See note 549. The table adjusts the average cost of
retaining outside professionals from $400 to $600 per hour for the
affected Exchange Act forms. The aggregate burden of Form N-CSR was
last estimated, including to adjust for inflation, in 2021.
PRA Table 5--Calculation of the Incremental Change in Costs of Current Responses Resulting From the Average Cost
Adjustment
----------------------------------------------------------------------------------------------------------------
Current cost Adjusted cost
Collection of information Number of affected burden at $400 per burden at $600 per
responses hour hour
----------------------------------------------------------------------------------------------------------------
10-K................................................ 8,292 $1,840,481,319 $2,760,721,978
20-F................................................ 729 576,824,025 865,236,038
40-F................................................ 132 17,084,560 25,626,840
----------------------------------------------------------------------------------------------------------------
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. The
following table summarizes the requested paperwork burden, including
the estimated total reporting burdens and costs, under the amendments.
For purposes of the PRA, the requested change in burden hours in column
H of PRA Table 6 is rounded to the nearest whole number.
[[Page 73134]]
PRA Table 6--Requested Paperwork Burden Under the Final Amendments
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Current burden Program change Revised burden
--------------------------------------------------------------------------------------------------------------------------------------
Form Current Current Number of Change in Change in
annual burden Adjusted cost affected company professional Annual Burden hours Cost burden
responses hours burden responses hours costs responses
(A) (B) (C) (D) (E) (F) (G) (H) = (B) + (E) (I) = (C) + (F)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Form 10-K................................................ 8,292 14,025,462 $2,760,721,978 4,513 5,592 $1,117,800 8,292 14,031,054 $2,761,839,778
Form 20-F................................................ 729 479,261 865,236,038 722 297 535,200 729 479,558 865,771,238
Form 40-F................................................ 132 14,237 25,626,840 132 57 102,600 132 14,294 25,729,440
Form N-CSR............................................... 6,898 181,167 5,199,584 2,710 21 4,200 6,898 181,188 5,203,784
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
VI. Final Regulatory Flexibility Act Analysis
The Regulatory Flexibility Act requires the Commission, in
promulgating rules under Section 553 of the Administrative Procedure
Act,\552\ to consider the impact of those rules on small entities. We
have prepared this Final Regulatory Flexibility Analysis (``FRFA'') in
accordance with Section 604 of the RFA.\553\ An Initial Regulatory
Flexibility Analysis (``IRFA'') was prepared in accordance with the RFA
and was included in the Proposing Release.
---------------------------------------------------------------------------
\552\ 5 U.S.C. 553.
\553\ 5 U.S.C. 604.
---------------------------------------------------------------------------
A. Need for, and Objectives of, the Final Amendments
We are adopting amendments to implement the provisions of Section
954 of the Dodd-Frank Act, which added Section 10D to the Exchange Act.
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 final rules direct the exchanges to
establish listing standards that require each issuer to adopt and
comply with a policy providing for the recovery of erroneously awarded
incentive-based compensation based on financial information required to
be reported under the securities laws that is received by current or
former executive officers. The final rules also require listed issuers
to file their policies as an exhibit to their annual reports and to
include other disclosures in the event a recovery analysis is triggered
under the policy
As discussed in Section I, we read Section 954 to be motivated by a
simple proposition: executives of listed issuers should not be entitled
to retain incentive-based compensation that was erroneously awarded on
the basis of misreported financial information. The statute thus
mandates that listed issuers have policies in place to recover such
compensation for the benefit of the issuer's owners--its shareholders.
The language and legislative history of Section 954 makes clear that
the provision is premised on the notion that an executive officer
should not retain incentive-based compensation that, had the issuer's
accounting been correct in the first instance, would not have been
received by the executive, regardless of any fault of the executive
officer for the accounting errors. Accordingly, under the final rules,
listed issuers will be required to adopt a policy to recover
erroneously awarded incentive-based compensation from current or former
executive officers regardless of whether those officers caused the
material noncompliance or have direct responsibility for financial
reporting matters. The disclosure requirements in the rules 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. The need for, and objectives
of, the amendments are discussed in more detail in Sections I and II.
We discuss the economic impact, including the estimated compliance
costs and burdens, of the amendments in Sections IV and V.
B. Significant Issues Raised by Public Comments
In the Proposing Release, we requested comment on all aspects of
the IRFA, including how the proposed rules could further lower the
burden on small entities, the number of small entities that would be
affected by the proposed rules, the existence or nature of the
potential impact of the proposals on small entities discussed in the
analysis, and how to quantify the impact of the proposed rules. We did
not receive any comments specifically addressing the IRFA.\554\
However, we received a number of comments on the proposed rules
generally,\555\ and have considered these comments in developing the
FRFA. As noted in Section II.A.2., a number of commenters recommended
that the Commission exempt or defer compliance for SRCs and EGCs citing
the costs and burdens associated with imposing compensation recovery
policies containing the detail and scope contemplated by the
proposal.\556\ Other commenters expressed support for requiring
recovery by SRCs and EGCs as proposed.\557\
---------------------------------------------------------------------------
\554\ As discussed in supra note 14, one comment letter noted
that the Commission did not update the RFA analysis in the Reopening
Release, and urged the Commission to re-propose with an updated RFA
analysis. See comment letter from Toomey/Shelby.
\555\ See Sections II and IV.
\556\ See, e.g., comment letters from ABA 1; CCMC 2; Compensia;
Hunton; Mercer; and NACD. Some commenters additionally recommended
exempting SRCs and EGCs from the XBRL tagging requirements in view
of the burden of preparing disclosure in XBRL format. See Section
II.D.2. and comment letters from ABA 1; and Hay Group.
\557\ See, e.g., comment letters from Better Markets 1; CalPERS
1; CFA Institute 1; Public Citizen 1; and SBA.
---------------------------------------------------------------------------
C. Small Entities Subject to the Final Amendments
The final amendments will affect, among other entities, small
entities that list securities on U.S.-registered securities exchanges.
The RFA defines ``small entity'' to mean ``small business,'' ``small
organization,'' or ``small governmental jurisdiction.'' \558\ For
purposes of the RFA, under our rules, an issuer, other than an
investment company, is 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.\559\ The final
[[Page 73135]]
amendments will 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 126 listed issuers, other than
registered investment companies, that may be considered small
entities.\560\ Under 17 CFR 270.0-10, an investment company, including
a business development company, is considered to be a small entity 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. We estimate that there are
approximately three listed investment companies, including business
development companies, that may be considered small entities that may
be affected by the final amendments.
---------------------------------------------------------------------------
\558\ 5 U.S.C. 601(6).
\559\ See 17 CFR 230.157 under the Securities Act and 17 CFR
240.0-10(a) under the Exchange Act. When referring to an exchange,
the term ``small business'' or ``small organization'' means any
exchange that: (1) has been exempted from the reporting requirements
of 17 CFR 242.601; and is not affiliated with any person (other than
a natural person) that is not a small business or small
organization. See 17 CFR 240.0-10(e). No exchanges meet these
criteria.
\560\ These estimates are based on staff analysis of issuers
potentially subject to the final amendments, excluding co-
registrants, with EDGAR filings on Form 10-K, or amendments thereto,
filed during the calendar year of Jan. 1, 2020 to Dec. 31, 2020, or
filed by Sept. 1, 2021, that, if timely filed by the applicable
deadline, would have been filed between Jan. 1 and Dec. 31, 2020.
Analysis is based on data from XBRL filings, Compustat, Ives Group
Audit Analytics, and manual review of filings submitted to the
Commission. We further note that in the Proposing Release we
estimated that there were 61 listed issuers. While the number of
issuers in our current estimate reflects an increase from 61 to 126
listed issuers, we further estimate that 89 of the 126 listed
issuers are SPACs. In the past two years, the U.S. securities
markets have experienced an unprecedented surge in the number of
initial public offerings by SPACs, with SPACs initially raising more
than $83 billion in 2020 and more than $160 billion in 2021,
compared to $13.6 billion in in 2019 and $10.8 billion in 2018. Some
of these small entities that are SPACs are unlikely to remain small
entities once the SPAC has completed its intended business
combination and becomes an operating rather than a shell company.
---------------------------------------------------------------------------
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
As noted above, the purpose of the final rules is to implement
Section 10D of the Exchange Act by directing the exchanges to prohibit
the listing of any security of an issuer that does not comply with
listing standards regarding the development and implementation of a
policy requiring recovery of erroneously awarded incentive-based
compensation, and to require issuers to file all disclosure with
respect to that policy in accordance with Commission rules. Rule 10D-1
requires exchanges to adopt listing standards that 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. As described in more detail above, the final
rules also require issuers listed on an exchange to: file their written
erroneously awarded compensation recovery policy as an exhibit to their
annual reports; indicate by check boxes on the cover page of their
annual reports whether the financial statements of the registrant
included in the filing reflect correction of an error to previously
issued financial statements and whether any of those error corrections
are restatements that required a recovery analysis; and disclose
actions an issuer has taken pursuant to such recovery policy. These
disclosures will also be required to be provided in tagged data
language using Inline XBRL.
Small entities that are listed issuers will be subject to the same
recovery and disclosure requirements as other listed issuers. These
requirements are discussed in detail in Section II.
Developing and implementing the recovery policy mandated by the
final amendments will impose compliance costs on small entities. The
amendments may also involve the use of professional skills, such as
legal, accounting, or technical skills. For example, listed issuers may
engage the professional services of attorneys, accountants, and/or
executive compensation consultants to develop their recovery policies
and may use the services of those professionals to implement those
policies in the event of an accounting restatement. Such services may
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 in connection with the
collection, recording, and reporting of disclosures required under the
rules. In addition, these entities will incur costs to tag the required
disclosures in Inline XBRL and may engage the services of outside
professionals to assist with this process. We discuss the economic
effects, including the estimated costs and burdens, of the final
amendments on all registrants, including small entities, in Sections IV
and V.
As noted in Section IV, there is evidence that companies that are
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
listed issuers that are small entities.\561\ This may imply that,
relative to other issuers, the final rules may cause executive officers
at small entities to devote proportionately more internal resources to
financial reporting and incur a greater proportional compliance burden
than larger issuers. In addition, to the extent that a recovery policy
reduces the incentive of an executive officer of a small entity to
invest in certain value-enhancing projects that may increase the
likelihood of a material accounting error, this may have a larger
impact on the market value of equity of smaller entities whose
valuation may be driven more by future prospects than by the value of
current assets.\562\
---------------------------------------------------------------------------
\561\ See note 504 and accompanying text.
\562\ See note 506 and accompanying text.
---------------------------------------------------------------------------
However, we believe that the impact of the amendments on small
entities overall will be mitigated because the rules 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 affected small entities. Further, as
noted in Section IV, the effects of implementing a recovery policy
could be lower on small entities relative to other issuers to the
extent that small entities use a lower proportion of incentive-based
compensation than other issuers. Analysis by Commission staff finds
evidence that SRCs (and small entities that are SRCs), on average, use
a lower proportion of incentive-based compensation than non-SRCs,
suggesting a lower potential impact of the final rules on SRCs and
small entities.\563\
---------------------------------------------------------------------------
\563\ See supra note 503 and accompanying text.
---------------------------------------------------------------------------
E. Agency Action To Minimize Effect on Small Entities
The RFA directs us to consider alternatives that would accomplish
our stated objectives, while minimizing any significant adverse impact
on small entities. Accordingly, 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;
Using performance rather than design standards; and
[[Page 73136]]
Establishing different compliance or reporting
requirements or timetables that take into account the resources
available to small entities.
The amendments do not provide simplified compliance and reporting
requirements, an exemption, or otherwise establish alternative
compliance, reporting requirements, or timetables for small entities.
As noted in Section I, Section 10D's purpose is straightforward: to
recover incentive-based compensation that was erroneously awarded to
executives at listed companies on the basis of misreported financial
information. We see no reason why the shareholders of listed issuers
that are small entities should not be entitled to recover compensation
that was erroneously awarded to executives on the basis of such
misreported information. Like other listed issuers, these entities will
have flexibility to forgo recovery in circumstances where the direct
expense paid to a third party to assist in enforcing recovery would
exceed the recoverable amounts and will not be required to have a
recovery policy in place until more than a year after the final
amendments are published in the Federal Register. Moreover, while the
final rules may impose a greater proportional compliance burden on
small entities, as discussed in Section IV, the benefits of the final
rules may be particularly salient for small entities as evidence
suggests that they may have an increased likelihood of reporting an
accounting error and may be more likely to report a material weakness
in internal control over financial reporting.
The recovery requirement may also provide executive officers with
an increased incentive to improve the overall quality and reliability
of the issuer's financial reporting. As noted in Section IV, small
entities may have an increased likelihood of reporting an accounting
error and may be more likely to report a material weakness in internal
control over financial reporting, due to their smaller size relative to
larger entities.\564\ For all of these reasons, we do not believe it
would be appropriate to establish alternative compliance requirements
or exempt small entities from the scope of the mandatory recovery
provisions.
---------------------------------------------------------------------------
\564\ See note 520.
---------------------------------------------------------------------------
The final amendments further require the filing of a listed
issuer's policy on recovery of incentive-based compensation, and clear
disclosure to provide shareholders with useful information regarding
the application of that policy. By requiring such disclosure, the final
amendments will help promote consistent compliance with recovery
obligations and related disclosure across all listed issuers. Because
the filing of the recovery policy is not costly for issuers and
provides a way for investors to understand the means by which an issuer
is complying with the requirements, we do not believe the marginal cost
savings to small entities warrants an exemption from this requirement.
Further, we note that the additional disclosures with respect to the
application of the policy would only be required in the event of a
restatement due to material noncompliance with financial reporting
requirements, and we believe it is necessary in these circumstances for
investors to understand the implications of the restatement and the
issuer's application of its policy, regardless of the size of the
entity.
Finally, some aspects of the final rules use performance standards.
Specifically, Rule 10D-1 uses a principles-based definition of
``incentive-based compensation,'' provides boards of directors with
discretion in determining the means of recovery, and uses a principles-
based approach to determining the amount of incentive-based
compensation subject to recovery. These aspects of the final rules may
make it easier for small entities to apply the mandatory recovery
policy in the context of their own facts and circumstances. However,
many other aspects of the final rules, in particular the disclosure
requirements, use design standards in order to promote consistent
information and recovery practices across listed issuers, in keeping
with what we understand to be Congress's objective in enacting Section
10D.
Statutory Authority
The amendments contained in this release are being adopted under
the authority set forth in Sections 6, 7, 10, and 19(a) of the
Securities Act; Sections 3(b), 10D, 12, 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, 232, 240, 249, 270, and 274
Reporting and recordkeeping requirements, Securities, Investment
companies.
Text of Rule Amendments
In accordance with the foregoing, the Commission amends 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 authority citation for part 229 continues 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; sec. 953(b), Pub. L. 111-203, 124 Stat. 1904 (2010);
and sec. 102(c), Pub. L. 112-106, 126 Stat. 310 (2012).
0
2. Amend Sec. 229.402 by:
0
a. Revising paragraph (a)(1);
0
b. In paragraph (c), adding Instruction 5 under the heading
``Instructions to Item 402(c)'';
0
c. In paragraph (n), adding Instruction 5 under the heading
``Instructions to Item 402(n)''; and
0
d. Adding paragraph (w).
The revision and additions read as follows:
Sec. 229.402 (Item 402) Executive compensation.
(a) General. (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 249.220f), 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 (19) of General Instruction B of Form 40-F (17 CFR
249.240f), as applicable. A foreign private issuer that elects to
provide domestic Item 402 disclosure must provide the disclosure
required by Item 402(w) in its annual report or registration statement,
as applicable.
* * * * *
(c) * * *
Instructions to Item 402(c). * * *
5. 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 by any amounts
recovered pursuant to a registrant's compensation recovery policy
required by the listing standards adopted pursuant to 17 CFR 240.10D-1,
and identify such amounts by footnote.
* * * * *
(n) * * *
[[Page 73137]]
Instructions to Item 402(n). * * *
5. 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 by any amounts
recovered pursuant to the compensation recovery policy required by the
listing standards adopted pursuant to 17 CFR 240.10D-1, and identify
such amounts by footnote.
* * * * *
(w) Disclosure of a registrant's action to recover erroneously
awarded compensation.
(1) If at any time during or after the last completed fiscal year
the registrant was required to prepare an accounting restatement that
required recovery of erroneously awarded compensation pursuant to the
registrant's compensation recovery policy required by the listing
standards adopted pursuant to 17 CFR 240.10D-1, or there was an
outstanding balance as of the end of the last completed fiscal year of
erroneously awarded compensation to be recovered from the application
of the policy to a prior restatement, the registrant must provide the
following information:
(i) For each restatement:
(A) The date on which the registrant was required to prepare an
accounting restatement;
(B) The aggregate dollar amount of erroneously awarded compensation
attributable to such accounting restatement, including an analysis of
how the amount was calculated;
(C) If the financial reporting measure as defined in 17 CFR
240.10D-1(d) related to a stock price or total shareholder return
metric, the estimates that were used in determining the erroneously
awarded compensation attributable to such accounting restatement and an
explanation of the methodology used for such estimates;
(D) The aggregate dollar amount of erroneously awarded compensation
that remains outstanding at the end of the last completed fiscal year;
and
(E) If the aggregate dollar amount of erroneously awarded
compensation has not yet been determined, disclose this fact, explain
the reason(s) and disclose the information required in paragraphs
(w)(1)(i)(B) through (D) of this section in the next filing that is
required to include disclosure pursuant to Item 402 of Regulation S-K;
(ii) If recovery would be impracticable pursuant to 17 CFR 240.10D-
1(b)(1)(iv), for each current and former named executive officer and
for all other current and former executive officers as a group,
disclose the amount of recovery forgone and a brief description of the
reason the listed registrant decided in each case not to pursue
recovery; and
(iii) For each current and former named executive officer from
whom, as of the end of the last completed fiscal year, erroneously
awarded compensation had been outstanding for 180 days or longer since
the date the registrant determined the amount the individual owed,
disclose the dollar amount of outstanding erroneously awarded
compensation due from each such individual.
(2) If at any time during or after its last completed fiscal year
the registrant was required to prepare an accounting restatement, and
the registrant concluded that recovery of erroneously awarded
compensation was not required pursuant to the registrant's compensation
recovery policy required by the listing standards adopted pursuant to
17 CFR 240.10D-1, briefly explain why application of the recovery
policy resulted in this conclusion.
(3) The information must appear with, and in the same format as,
the rest of the disclosure required to be provided pursuant to this
Item 402. The information is required only in proxy or information
statements that call for Item 402 disclosure and the registrant's
annual report on Form 10-K, and 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.
(4) The disclosure must be provided in an Interactive Data File in
accordance with Rule 405 of Regulation S-T and the EDGAR Filer Manual.
* * * * *
0
3. Amend Sec. 229.404 by:
0
a. Under the heading ``Instructions to Item 404(a),'' removing ``or''
at the end of Instruction 5.a.i.;
0
b. Under the heading ``Instructions to Item 404(a),'' removing the
``.'' and adding in its place ``; or'' in Instruction 5.a.ii.; and
0
c. Under the heading ``Instructions to Item 404(a),'' adding
Instruction 5.a.iii.
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 erroneously awarded
compensation computed as provided in 17 CFR 240.10D-1(b)(1)(iii) and
the applicable listing standards for the registrant's securities, that
is disclosed pursuant to Item 402(w) (Sec. 229.402(w)).
* * * * *
0
4. Amend Sec. 229.601 by:
0
a. In paragraph (a), amend the ``Exhibit table'' by adding paragraph
(97); and
0
b. Adding paragraph (b)(97).
The additions to read as follows:
Sec. 229.601 (Item 601) Exhibits.
(a) * * *
Exhibit Table
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Securities act forms Exchange act forms
--------------------------------------------------------------------------------------------------------------------------------------------
S-1 S-3 SF-1 SF-3 S-4 \1\ S-8 S-11 F-1 F-3 F-4 \1\ 10 8-K \2\ 10-D 10-Q 10-K ABS-EE
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
* * * * * * *
(97) Policy Relating to Recovery of Erroneously ...... ...... ....... ....... ....... ...... ....... ...... ...... ....... ...... ....... ....... ....... X ..........
Awarded Compensation..............................
* * * * * * *
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\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) * * *
(97) Policy relating to recovery of erroneously awarded
compensation. A registrant that at any time during its last completed
fiscal year had a class of
[[Page 73138]]
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) must file as an exhibit to its annual
report the compensation recovery policy required by the applicable
listing standards adopted pursuant to 17 CFR 240.10D-1.
* * * * *
PART 232--REGULATION S-T--GENERAL RULES AND REGULATIONS FOR
ELECTRONIC FILINGS
0
5. The general authority citation for part 232 continues to read in
part as follows:
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s(a), 77z-3,
77sss(a), 78c(b), 78l, 78m, 78n, 78o(d), 78w(a), 78ll, 80a-6(c),
80a-8, 80a-29, 80a-30, 80a-37, 80b-4, 80b-6a, 80b-10, 80b-11, 7201
et seq.; and 18 U.S.C. 1350, unless otherwise noted.
* * * * *
0
6. Amend Sec. 232.405 by:
0
a. Removing the word ``or'' at the end of paragraph (b)(2)(iii);
0
b. Removing the period at the end of paragraph (b)(2)(iv) and adding
``; or'' in its place;
0
c. Adding paragraph (b)(2)(v);
0
d. Removing paragraph (b)(3)(i)(C);
0
e. Removing the word ``and'' at the end of paragraph (b)(3)(ii);
0
f. Removing the period at the end of paragraph (b)(3)(iii) and adding
``; and'' in its place;
0
g. Adding paragraph (b)(3)(iv);
0
h. Removing the period at the end of paragraph (b)(4)(i) and adding
``and'' in its place; and
0
i. Adding paragraph (b)(4)(ii).
The revisions and additions read as follows:
Sec. 232.405 Interactive Data File Submissions.
* * * * *
(b) * * *
(2) * * *
(v) Any disclosure provided in response to Item 18 of Sec. Sec.
249.331 and 274.128 of this chapter (Form N-CSR), as applicable.
(3) * * *
(iv) As applicable, the disclosure set forth in paragraph (b)(4) of
this section.
(4) * * *
(ii) Any disclosure provided in response to: Sec. 229.402(w) of
this chapter (Item 402(w) of Regulation S-K); Item 6.F of Sec.
249.220f of this chapter (Form 20-F); paragraph (19) of General
Instruction B of Sec. 249.240f of this chapter (Form 40-F); and Item
18 of Sec. Sec. 249.331 and 274.128 of this chapter (Form N-CSR).
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
7. The general 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, 78dd, 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); and Pub. L.
112-106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise
noted.
* * * * *
0
8. Add an undesignated center heading and Sec. 240.10D-1 after Sec.
240.10C-1 to read as follows:
Requirements Under Section 10D
Sec. 240.10D-1 Listing standards relating to recovery of erroneously
awarded compensation.
(a) 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 exchange or association
lists securities, must:
(1) In accordance with the provisions of this section, prohibit the
initial or continued listing of any security of an issuer that is not
in compliance with the requirements of any portion of this section;
(2) No later than February 27, 2023, propose rules or rule
amendments that comply with this section. Such rules or rule amendments
that comply with this section must be effective no later than one year
after November 28, 2022;
(3) Require that each listed issuer:
(i) 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) of this section to which the issuer is
subject;
(ii) Comply with that recovery policy for all incentive-based
compensation received (as defined in paragraph (d) of this section) by
executive officers on or after the effective date of the applicable
listing standard;
(iii) Provide the disclosures required by this section and in the
applicable Commission filings required on or after the effective date
of the listing standard referenced in paragraph (a)(2) of this section
to which the issuer is subject.
(b) Recovery of Erroneously Awarded Compensation. The issuer must:
(1) Adopt and comply with a written policy providing that the
issuer will recover reasonably promptly the amount of erroneously
awarded incentive-based compensation 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, including any required accounting
restatement to correct an error in previously issued financial
statements that is material to the previously issued financial
statements, or that would result in a material misstatement if the
error were corrected in the current period or left uncorrected in the
current period.
(i) The issuer's recovery policy must apply to all incentive-based
compensation received by a person:
(A) After beginning service as an executive officer;
(B) Who served as an executive officer at any time during the
performance period for that incentive-based compensation;
(C) While the issuer has a class of securities listed on a national
securities exchange or a national securities association; and
(D) During the three completed fiscal years immediately preceding
the date that the issuer is required to prepare an accounting
restatement as described in paragraph (b)(1) of this section. In
addition to these last three completed fiscal years, the recovery
policy must 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 between the
last day of the issuer's previous fiscal year end and the first day of
its new fiscal year that comprises a period of nine to 12 months would
be deemed a completed fiscal year. An issuer's obligation to recover
erroneously awarded compensation is not dependent on if or when the
restated financial statements are filed.
(ii) For purposes of determining the relevant recovery period, the
date that an issuer is required to prepare an accounting restatement as
described in paragraph (b)(1) of this section is the earlier to occur
of:
(A) 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 is required to
prepare an accounting restatement as described in paragraph (b)(1) of
this section; or
[[Page 73139]]
(B) The date a court, regulator, or other legally authorized body
directs the issuer to prepare an accounting restatement as described in
paragraph (b)(1) of this section.
(iii) The amount of incentive-based compensation that must be
subject to the issuer's recovery policy (``erroneously awarded
compensation'') is 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 restated
amounts, and must 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 must 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 must 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 the
conditions of paragraphs (b)(1)(iv)(A), (B), or (C) of this section are
met, and 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, has made a determination that recovery would be impracticable.
(A) The direct expense paid to a third party to assist in enforcing
the policy would exceed the amount to be recovered. Before concluding
that it would be impracticable to recover any amount of erroneously
awarded compensation based on expense of enforcement, the issuer must
make a reasonable attempt to recover such erroneously awarded
compensation, document such reasonable attempt(s) to recover, and
provide that documentation to the exchange or association.
(B) Recovery would violate home country law where that law was
adopted prior to November 28, 2022. 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, acceptable to the applicable national
securities exchange or association, that recovery would result in such
a violation, and must provide such opinion to the exchange or
association.
(C) Recovery would likely cause an otherwise tax-qualified
retirement plan, under which benefits are broadly available to
employees of the registrant, to fail to meet the requirements of 26
U.S.C. 401(a)(13) or 26 U.S.C. 411(a) and regulations thereunder.
(v) The issuer is prohibited from indemnifying any executive
officer or former executive officer against the loss of erroneously
awarded compensation.
(2) File all disclosures with respect to such recovery policy in
accordance with the requirements of the Federal securities laws,
including the disclosure required by the applicable Commission filings.
(c) General Exemptions. The requirements of this section do not
apply to the listing of:
(1) 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));
(2) A standardized option, as defined in 17 CFR 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);
(3) Any security issued by a unit investment trust, as defined in
15 U.S.C. 80a-4(2);
(4) 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.
(d) Definitions. Unless the context otherwise requires, the
following definitions apply for purposes of this section:
Executive Officer. 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 are 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. Policy-making function is not intended to
include policy-making functions that are not significant.
Identification of an executive officer for purposes of this section
would include at a minimum executive officers identified pursuant to 17
CFR 229.401(b).
Financial reporting measures. Financial reporting measures are
measures that are determined and presented in accordance with the
accounting principles used in preparing the issuer's financial
statements, and any measures that are derived wholly or in part from
such measures. Stock price and total shareholder return are also
financial reporting measures. A financial reporting measure need not be
presented within the financial statements or included in a filing with
the Commission.
Incentive-based compensation. 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.
Received. 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
9. Amend Section 240.14a-101, by adding Item 22(b)(20) 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 the Fund
[[Page 73140]]
was required to prepare an accounting restatement that required
recovery of erroneously awarded compensation pursuant to the Fund's
compensation recovery policy required by the listing standards adopted
pursuant to 240.10D-1, or there was an outstanding balance as of the
end of the last completed fiscal year of erroneously awarded
compensation to be recovered from the application of the policy to a
prior restatement, the Fund must provide the information required by
Item 18 of Form N-CSR, as applicable.
* * * * *
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
10. The authority citation for part 249 continues to read, in part, as
follows:
Authority: 15 U.S.C. 78a et seq., and 7201 et seq.; 12 U.S.C.
5461 et seq.; 18 U.S.C. 1350; Sec. 953(b) Pub. L. 111-203, 124 Stat.
1904; Sec. 102(a)(3) Pub. L. 112-106, 126 Stat. 309 (2012), Sec. 107
Pub. L. 112-106, 126 Stat. 313 (2012), Sec. 72001 Pub. L. 114-94,
129 Stat. 1312 (2015), and secs. 2 and 3 Pub. L. 116-222, 134 Stat.
1063 (2020), unless otherwise noted.
* * * * *
Section 249.220f is also issued under secs. 3(a), 202, 208, 302,
306(a), 401(a), 401(b), 406 and 407, Pub. L. 107-204, 116 Stat. 745,
and secs. 2 and 3, Pub. L. 116-222, 134 Stat. 1063.
Section 249.240f is also issued under secs. 3(a), 202, 208, 302,
306(a), 401(a), 406 and 407, Pub. L. 107-204, 116 Stat. 745.
* * * * *
Section 249.310 is also issued under secs. 3(a), 202, 208, 302,
406 and 407, Pub. L. 107-204, 116 Stat. 745.
* * * * *
Note: The text of Form 20-F does not, and this amendment will
not, appear in the Code of Federal Regulations.
0
11. Amend Form 20-F (referenced in Sec. 249.220f) by:
0
a. Adding the text and check boxes to the cover page immediately before
the text ``Indicate by check mark which basis of accounting the
registrant has used to prepare the financial statements included in
this filing'';
0
b. Adding Item 6.F.;
0
c. Adding Instruction 4. to the Instructions to Item 7.B.; and
0
d. Adding Instruction 97 to the Instructions as to Exhibits.
The revisions and additions to read as follows:
Form 20-F
* * * * *
If securities are registered pursuant to Section 12(b) of the Act,
indicate by check mark whether the financial statements of the
registrant included in the filing reflect the correction of an error to
previously issued financial statements. [squ]
Indicate by check mark whether any of those error corrections are
restatements that required a recovery analysis of incentive-based
compensation received by any of the registrant's executive officers
during the relevant recovery period pursuant to Sec. 240.10D-1(b).
[squ]
* * * * *
Item 6. Directors, Senior Management and Employees
* * * * *
F. Disclosure of a registrant's action to recover erroneously
awarded compensation.
(1) If at any time during or after the last completed fiscal year
the registrant was required to prepare an accounting restatement that
required recovery of erroneously awarded compensation pursuant to the
registrant's compensation recovery policy required by the listing
standards adopted pursuant to 17 CFR 240.10D-1, or there was an
outstanding balance as of the end of the last completed fiscal year of
erroneously awarded compensation to be recovered from the application
of the policy to a prior restatement, the registrant must, in its
annual report on Form 20-F, provide the following information:
(i) For each restatement:
(A) The date on which the registrant was required to prepare an
accounting restatement;
(B) The aggregate dollar amount of erroneously awarded compensation
attributable to such accounting restatement, including an analysis of
how the amount was calculated;
(C) If the financial reporting measure as defined in 17 CFR
240.10D-1(d) related to a stock price or total shareholder return
metric, the estimates that were used in determining the erroneously
awarded compensation attributable to such accounting restatement and an
explanation of the methodology used for such estimates;
(D) The aggregate dollar amount of erroneously awarded compensation
that remains outstanding at the end of the last completed fiscal year;
and
(E) If the aggregate dollar amount of erroneously awarded
compensation has not yet been determined, disclose this fact, explain
the reason(s) and disclose the information required in (B) through (D)
in the next filing that is subject to this Item;
(ii) If recovery would be impracticable pursuant to 17 CFR 240.10D-
1(b)(1)(iv), for each current and former named executive officer and
for all other current and former executive officers as a group,
disclose the amount of recovery forgone and a brief description of the
reason the listed registrant decided in each case not to pursue
recovery; and
(iii) For each current and former named executive officer from
whom, as of the end of the last completed fiscal year, erroneously
awarded compensation had been outstanding for 180 days or longer since
the date the registrant determined the amount the individual owed,
disclose the dollar amount of outstanding erroneously awarded
compensation due from each such individual.
(2) If at any time during or after its last completed fiscal year
the registrant was required to prepare an accounting restatement, and
the registrant concluded that recovery of erroneously awarded
compensation was not required pursuant to the registrant's compensation
recovery policy required by the listing standards adopted pursuant to
17 CFR 240.10D-1, briefly explain why application of the recovery
policy resulted in this conclusion;
(3) The information must appear with, and in the same format as,
the rest of the disclosure required to be provided pursuant to this
Item 6, is required only in annual reports and does not apply to
registration statements on Form 20-F, and 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; and
(4) The disclosure must be provided in an Interactive Data File in
accordance with Rule 405 of Regulation S-T and the EDGAR Filer Manual.
* * * * *
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
* * * * *
97. A registrant that at any time during its last completed fiscal
year 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) must file as an exhibit to
[[Page 73141]]
its annual report on Form 20-F the compensation recovery policy
required by the applicable listing standards adopted pursuant to 17 CFR
240.10D-1.
17 through 96 and 98 through 99 [Reserved]
* * * * *
Note: The text of Form 40-F does not, and this amendment will
not, appear in the Code of Federal Regulations.
0
12. Amend Form 40-F (referenced in Sec. 249.240f) by adding the text
and check boxes to the cover page immediately before the heading
``General Instructions'' and adding paragraph (19) to General
Instruction B to read as follows:
Form 40-F
* * * * *
If securities are registered pursuant to Section 12(b) of the Act,
indicate by check mark whether the financial statements of the
registrant included in the filing reflect the correction of an error to
previously issued financial statements. [squ]
Indicate by check mark whether any of those error corrections are
restatements that required a recovery analysis of incentive-based
compensation received by any of the registrant's executive officers
during the relevant recovery period pursuant to Sec. 240.10D-1(b).
[square]
* * * * *
B. Information To Be Filed on This Form
* * * * *
(19) Recovery of erroneously awarded compensation.
(a) A registrant that at any time during its last completed fiscal
year 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) must file as exhibit 97 to its
annual report on Form 40-F the compensation recovery policy required by
the applicable listing standards adopted pursuant to 17 CFR 240.10D-1.
(b) If at any time during or after the last completed fiscal year
the registrant was required to prepare an accounting restatement that
required recovery of erroneously awarded compensation pursuant to the
registrant's compensation recovery policy required by the listing
standards adopted pursuant to 17 CFR 240.10D-1, or there was an
outstanding balance as of the end of the last completed fiscal year of
erroneously awarded compensation to be recovered from the application
of the policy to a prior restatement, the registrant must, in its
annual report on Form 40-F, provide the following information:
(1) For each restatement:
(i) The date on which the registrant was required to prepare an
accounting restatement;
(ii) The aggregate dollar amount of erroneously awarded
compensation attributable to such accounting restatement, including an
analysis of how the amount was calculated;
(iii) If the financial reporting measure as defined in 17 CFR 10D-
1(d) related to a stock price or total shareholder return metric, the
estimates that were used in determining the erroneously awarded
compensation attributable to such accounting restatement and an
explanation of the methodology used for such estimates;
(iv) The aggregate dollar amount of erroneously awarded
compensation that remains outstanding at the end of the last completed
fiscal year; and
(v) If the aggregate dollar amount of erroneously awarded
compensation has not yet been determined, disclose this fact, explain
the reason(s) and disclose the information required in (ii) through(iv)
in the next filing that is subject to this paragraph 19;
(2) If recovery would be impracticable pursuant to 17 CFR 240.10D-
1(b)(1)(iv), for each current and former named executive officer and
for all other current and former executive officers as a group,
disclose the amount of recovery forgone and a brief description of the
reason the listed registrant decided in each case not to pursue
recovery; and
(3) For each current and former named executive officer from whom,
as of the end of the last completed fiscal year, erroneously awarded
compensation had been outstanding for 180 days or longer since the date
the registrant determined the amount the individual owed, disclose the
dollar amount of outstanding erroneously awarded compensation due from
each such individual.
(c) If at any time during or after its last completed fiscal year
the registrant was required to prepare an accounting restatement, and
the registrant concluded that recovery of erroneously awarded
compensation was not required pursuant to the registrant's compensation
recovery policy required by the listing standards adopted pursuant to
17 CFR 240.10D-1, briefly explain why application of the recovery
policy resulted in this conclusion;
(d) The information must appear with, and in the same format as
generally required for, the rest of the disclosure required to be
provided pursuant to General Instruction B, is required only in annual
reports and does not apply to registration statements on Form 40-F, and
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; and
(e) The disclosure must be provided in an Interactive Data File in
accordance with Rule 405 of Regulation S-T and the EDGAR Filer Manual.
* * * * *
Note: The text of Form 10-K does not, and this amendment will
not, appear in the Code of Federal Regulations.
0
13. Amend Form 10-K (referenced in Sec. 249.310) by adding a field to
the cover page to include the text and check boxes immediately before
the text ``Indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Act)'' to read as follows:
Form 10-K
* * * * *
If securities are registered pursuant to Section 12(b) of the Act,
indicate by check mark whether the financial statements of the
registrant included in the filing reflect the correction of an error to
previously issued financial statements. [squ]
Indicate by check mark whether any of those error corrections are
restatements that required a recovery analysis of incentive-based
compensation received by any of the registrant's executive officers
during the relevant recovery period pursuant to Sec. 240.10D-1(b).
[squ]
* * * * *
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
0
14. The authority citation for part 270 continues to read, in part, as
follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
* * * * *
Section 270.30a-2 is also issued under 15 U.S.C. 78m, 78o(d),
80a-8, 80a-29, 7202, and 7241; and 18 U.S.C. 1350, unless otherwise
noted.
* * * * *
0
15. Amend Sec. 270.30a-2 by revising it to read as follows:
Sec. 270.30a-2 Certification of Form N-CSR.
(a) Each report filed on Form N-CSR (Sec. Sec. 249.331 and 274.128
of this chapter) by a registered management investment company must
include certifications in the form specified in Item 19(a)(3) of
[[Page 73142]]
Form N-CSR, and such certifications must be filed as an exhibit to such
report. Each principal executive and principal financial officer of the
investment company, or persons performing similar functions, at the
time of filing of the report must sign a certification.
(b) Each report on Form N-CSR filed by a registered management
investment company under Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and that contains
financial statements must be accompanied by the certifications required
by Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350) and such certifications must be furnished as an exhibit to
such report as specified in Item 19(b) of Form N-CSR. Each principal
executive and principal financial officer of the investment company (or
equivalent thereof) must sign a certification. This requirement may be
satisfied by a single certification signed by an investment company's
principal executive and principal financial officers.
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
16. The authority citation for part 274 is revised to read as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and 80a-37 unless
otherwise noted.
Section 274.128 is also issued under 15 U.S.C. 78j-1, 7202, 7233,
7241, 7264, and 7265; and 18 U.S.C. 1350.
Note: The text of Form N-CSR does not, and this amendment will
not, appear in the Code of Federal Regulations.
0
18. Amend Form N-CSR (referenced in 17 CFR 274.128) by:
0
a. Revising General Instruction D;
0
b. Redesignating Item 18 as Item 19;
0
c. Redesignating the instructions to Item 18 as instructions to Item
19;
0
d. Adding new Item 18;
0
e. Redesignating paragraph (a)(2) of newly designated Item 19
(Exhibits) as paragraph (a)(3);and
0
f. Adding paragraph (a)(2) to newly designated Item 19 (Exhibits).
The revisions and additions read as follows:
Form N-CSR
* * * * *
D. Incorporation by Reference
A registrant may incorporate by reference information required by
Items 4, 5, 18, 19(a)(1), and 19(a)(2). No other Items of the Form
shall be answered by incorporating any information by reference. The
information required by Items 4, 5, and 18 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.)) involving 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 303 of Regulation S-T (17 CFR 232.303) (specific
requirements for electronically filed documents); Rule 12b-23 under the
Exchange Act (17 CFR 240.12b-23) (additional rules on incorporation by
reference for reports filed pursuant to Sections 13 and 15(d) of the
Exchange Act); and Rule 0-4 under the Investment Company Act of 1940
(17 CFR 270.0-4) (additional rules on incorporation by reference for
investment companies).
* * * * *
Item 18. Recovery of Erroneously Awarded Compensation
(a) If at any time during or after the last completed fiscal year
the registrant was required to prepare an accounting restatement that
required recovery of erroneously awarded compensation pursuant to the
registrant's compensation recovery policy required by the listing
standards adopted pursuant to 17 CFR 240.10D-1, or there was an
outstanding balance as of the end of the last completed fiscal year of
erroneously awarded compensation to be recovered from the application
of the policy to a prior restatement, the registrant must provide the
following information:
(1) For each restatement:
(i) The date on which the registrant was required to prepare an
accounting restatement;
(ii) The aggregate dollar amount of erroneously awarded
compensation attributable to such accounting restatement, including an
analysis of how the amount was calculated;
(iii) If the financial reporting measure defined in 17 CFR 10D-1(d)
related to a stock price or total shareholder return metric, the
estimates that were used in determining the erroneously awarded
compensation attributable to such accounting restatement and an
explanation of the methodology used for such estimates;
(iv) The aggregate dollar amount of erroneously awarded
compensation that remains outstanding at the end of the last completed
fiscal year; and
(v) If the aggregate dollar amount of erroneously awarded
compensation has not yet been determined, disclose this fact, explain
the reason(s) and disclose the information required in (ii) through
(iv) in the next annual report that the registrant files on this Form
N-CSR;
(2) If recovery would be impracticable pursuant to 17 CFR 10D-
1(b)(1)(iv), for each named executive officer and for all other
executive officers as a group, disclose the amount of recovery forgone
and a brief description of the reason the registrant decided in each
case not to pursue recovery; and
(3) For each named executive officer from whom, as of the end of
the last completed fiscal year, erroneously awarded compensation had
been outstanding for 180 days or longer since the date the registrant
determined the amount the individual owed, disclose the dollar amount
of outstanding erroneously awarded compensation due from each such
individual.
(b) If at any time during or after its last completed fiscal year
the registrant was required to prepare an accounting restatement, and
the registrant concluded that recovery of erroneously awarded
compensation was not required pursuant to the registrant's compensation
recovery policy required by the listing standards adopted pursuant to
17 CFR 240.10D-1, briefly explain why application of the recovery
policy resulted in this conclusion.
Item 19. 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).
Instruction to paragraph (a)(2).
The exhibit required by this paragraph (a)(2) is only required in
an annual report on Form N-CSR.
* * * * *
By the Commission.
Dated: October 26, 2022.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2022-23757 Filed 11-25-22; 8:45 am]
BILLING CODE 8011-01-P