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On July 1, the SEC proposed rules that would compel all U.S. securities exchanges to adopt listing standards directing every listed company to adopt a policy requiring recovery, on a no-fault basis, of any incentive compensation paid to an executive officer on the basis of accounting measures that were subsequently restated.  The 2010 Dodd-Frank Act directed the SEC to impose such listing requirements.  In a press release announcing the proposals, SEC Chair White stated that the rules “would result in increased accountability and greater focus on the quality of financial reporting.” Under proposed Securities Exchange Act Rule 10D-1, each listed company would be required to develop a compensation recovery policy.  That policy would have to provide that, in the event of an accounting restatement to correct a material error, the company will recover or “claw back” from current and former executive officers any incentive-based compensation received during the prior three fiscal years that exceeds the amount that would have been received under the restatement.  Recovery would be required regardless of whether the officers required to make the repayment were responsible for the errors that resulted in the restatement and regardless of whether the inaccurate financial reporting was the result of misconduct by anyone.  A company would be subject to delisting if it failed to adopt such a compensation recovery policy or to enforce the policy’s recovery provisions. Other features of the proposed rule include –

  • Current and former “executive officers”  would be subject to the clawback requirement.  For this purpose, “executive office” would be defined in a manner similar to the definition of an “officer” under the trade reporting and short-swing profit recovery provisions of Exchange Act Section 16.  That definition includes the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company.
  • Incentive-based compensation “granted, earned or vested” based on the attainment of any financial reporting measure would be subject to recovery.  A “financial reporting measure” is a measure that is based, in whole or in part, on the accounting principles that are used in preparing the company’s financial statements.  Incentive compensation based on stock price or on total shareholder return would be included.  For incentive-based compensation based on stock price or total shareholder return, companies could use a reasonable estimate of the effect of the restatement on the applicable measure to determine the recovery amount.
  • A company could decline to pursue recovery only if the compensation committee (or a majority of the independent directors) determined, after reasonable attempts to collect, that further recovery efforts would impose undue costs on the company or its shareholders.  A company would also be excused from collection if doing so would violate home country law.
  • Each listed company would be required to file its recovery policy as an exhibit to its annual Form 10-K report.  In addition, companies would be required to disclose actions taken to recover compensation in Form 10-K and in any proxy statement that requires executive compensation disclosure.  These disclosures would be triggered if, during the fiscal year, a restatement requiring recovery of excess incentive-based compensation occurred, or if there was an outstanding recovery balance from a prior restatement.

The proposal was published by a 3-2 SEC vote.   Among other things, dissenting Commissioner Gallagher stated that the definition of executive officer and the no-fault recovery feature went beyond the requirements of the Dodd-Frank Act and made the proposed rule unduly broad and not “equitable.”  He also argued that the rule should have afforded boards discretion whether to pursue a claw back and whether to settle a claim for less than the full amount.


Assuming it is adopted in the form proposed, the claw back rule will change the stakes when management and the audit committee face decisions regarding restatements, particularly in “close call” cases.  Engagement partner identification (discussed earlier in this Update) may also impact the restatement environment, if, as some have predicted, association with a restatement becomes a career-limiting event for the engagement partner.  As the disincentives to restate increase, audit committees will need to become more vigilant in making sure that they are fully and evenhandedly informed in situations in which a restatement is a possibility. The claw back rule is also likely to have an impact on compensation policy.  Executive officers may seek to receive more of their compensation as base salary or in other forms that are not linked to the attainment of financial reporting measures.


Daniel L. Goelzer has a strategic role in the Baker & McKenzie's global corporate, securities, and banking compliance practices. He has more than 35 years of securities law experience, including service in senior positions at both the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB). The SEC appointed him as a founding member of the PCAOB, and he served as the Board’s Acting Chairman from 2009 to 2011. He is also a former General Counsel of the SEC and a former Vice Chair of the International Forum of Independent Audit Regulators. He writes and speaks frequently on national and international securities laws and accounting industry issues.

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