United States: Is It Groundhog Day? SEC Reopens Comment Period For Clawback Proposal

Yesterday, the SEC announced that it is reopening the comment period for its 2015 proposal for listing standards for recovery of erroneously awarded compensation. Wait—didn't they just do that? Yes, in October 2021. (See this PubCo post.) But no, that's not Sonny and Cher on the radio. The SEC has decided to reopen the comment period AGAIN to allow further public comment in light of a new, just released DERA staff memorandum containing "additional analysis and data on compensation recovery policies and accounting restatements." The new comment period will be open until 30 days after publication of the reopening notice in the Federal Register.

These rules were first proposed way back in 2015 to implement Section 954 of Dodd-Frank, the clawback provision. But the proposal was relegated to the SEC's long-term agenda and never heard from again. Until, that is, the topic found a spot on the SEC's short-term agenda for spring 2021 (see this PubCo post) with a target date for a re-proposal of April 2022. Obviously, that didn't happen.

As you may recall, Section 954 required the SEC to direct the national securities exchanges to adopt listing standards obliging each listed company to adopt, disclose and enforce a policy for recouping executive compensation that was paid on the basis of erroneous financial information, the theory being that it was compensation to which the executives were never really entitled in the first place. Under the 2015 proposal, new Rule 10D-1 would require exchange-listed companies to adopt and implement clawback policies under which they must recover from current and former executive officers the amount of erroneously awarded "incentive-based compensation" received during the three years preceding the date of an accounting restatement that resulted from the company's material noncompliance with any financial reporting requirement under the securities laws. The "amount erroneously awarded" means the amount that exceeds the amount the executive would have received had the compensation instead been determined based on the restated amount.

In 2021, the SEC reopened the comment period on the original proposal, requesting comment on a number of specific areas. You may recall that the questions posed by the SEC when the comment period was reopened in 2021 indicated that, among other things, the SEC was considering a potential expansion of the concept of "restatement" to include not only "reissuance" ("Big R") restatements (which involve a material error and an 8-K), but also "revision" ("little r") restatements (or some version thereof). (See this PubCo post.)

The new memo from DERA addresses the increase in voluntary adoption of compensation recovery policies by issuers and estimates the number of additional restatements that would trigger a compensation recovery analysis if the rules were extended to include all required restatements, including "little r" restatements.

The memo indicates that "the number and percentage of filers that disclose a compensation recovery policy has roughly doubled relative to the estimates provided in the Proposing Release." However, studies have shown that these policies would result in compensation recovery analyses in more limited circumstances than under the proposed rules. For example, they may require misconduct, apply to fewer executives or have a shorter look-back. Nevertheless, DERA indicates, the increases in the number of policies would reduce the original estimated costs and benefits. (Check out the footnote, which describes how DERA modified its apparently incorrect original keyword search!)

With regard to restatements, the new DERA memo estimates "that 'little r' restatements may account for roughly three times as many restatements as 'Big R' restatements in 2021, after excluding restatements by SPACs."

As a result, if both types of restatement were covered by the rules, the total number of restatements that could potentially trigger a compensation recovery analysis would clearly increase. But that doesn't mean that the number of recoveries would jump proportionately. Rather, DERA found that "little r" restatements "may be less likely than 'Big R' restatements to trigger a potential recovery of compensation. For example, 'little r' restatements may be less likely to be associated with a decline in previously reported net income, and on average they are associated with smaller stock price reactions." So, if the contemplated change were adopted, the number of recoveries would likely not increase in proportion to the increase in the number of restatements, which "would mitigate the potential impact of including 'little r' restatements on the expected benefits and costs associated with the proposed rules."

Nevertheless, according to DERA, the potential inclusion of "little r" restatements could still increase both the benefits and the costs to the extent that companies recover additional erroneously awarded compensation and incur additional implementation costs associated with those recoveries. Notably, the memo suggests that, among other things, the inclusion of "little r" restatements "would likely mitigate the potential for the proposed rules to create an incentive for managers to report misstatements as 'little r' restatements rather than 'Big R' restatements." DERA also analyzes the different impact for different types of listed issuers.

In addition, the fact sheet indicates that the SEC is also still seeking comment on whether the proposed "reasonably should have concluded" standard for triggering a lookback should be revised. Under the original proposal, one prong of the trigger for the three-year lookback period was the date the issuer's board committee or authorized officer concludes, or "reasonably should have concluded," that the issuer's previously issued financial statements contain a material error. In the 2021 reopening, the SEC asked whether it should remove the "reasonably should have concluded" standard in light of concerns that the standard adds uncertainty to the determination. The SEC noted that, for material errors, the date would likely be included in the 8-K and, for other errors, evidence of the conclusion that a restatement is required is generally included in the issuer's materiality analysis. Apparently, the SEC continues to reconsider this issue.

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