The U.S. Securities and Exchange Commission (SEC) has adopted final rules directing U.S. stock exchanges (such as the NYSE or Nasdaq) to establish listing standards that will require their listed companies to implement a clawback policy for the recovery of incentive-based executive compensation received by current or former executive officers if the company has to restate its financial statements1. The SEC rules will also require U.S-listed companies to publicly file their clawback policy with their annual report and disclose how they have applied the policy, if relevant.
Subject to limited exceptions, the new rules will apply to all companies with equity, preferred or debt securities listed on a “national securities exchange”, such as the NYSE or Nasdaq (but not companies whose securities are merely quoted on an over-the-counter market in the U.S). There are no exceptions for foreign private issuers, Canadian companies reporting under the MJDS, controlled companies, emerging growth companies, smaller reporting companies, special purpose acquisition companies or business development companies.
Exceptions, however, will apply to U.S.-listed issuers of security futures products and standardized options, issuers of unit investment trust securities and certain issuers of registered investment company securities.
The SEC’s compensation clawback rules were adopted to implement Section 10D of the Securities Exchange Act of 1934, which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
Once the applicable U.S. listing standards take effect, every U.S.-listed company (including any U.S.-listed company that is a foreign private issuer and Canadian company reporting under the MJDS) subject to the rules must:
The required clawback policy will apply both to restatements that are required to correct a material error in previously-issued financial statements (so-called “Big R Restatements”) and restatements that are required in the current period only to avoid a material misstatement resulting from either an uncorrected error or the recognition of a corrected error in the current period (so-called “Little r Restatements”). Little r Restatements may include restatements that are sometimes required due to the cumulative effects of an error over multiple reporting periods. By contrast, clawbacks will not apply to out-of-period adjustments that are not “accounting restatements” or to changes in accounting principles, reclassifications due to discontinued operations and other retrospective revisions and adjustments that do not represent error corrections.
The mandated clawback policy will require a U.S.-listed company to recover the amount of pre-tax, incentive-based compensation received by its executive officers4 in excess of the amount that otherwise would have been received had that compensation been determined based on the restated financial measure. “Incentive-based compensation” means any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.
The SEC has defined “financial reporting measures” broadly to mean 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. As defined, this would include non-GAAP financial measures, as well as other measures, metrics and ratios that are not non-GAAP measures, such as same-store sales or turnover rates. In addition, the definition of “financial reporting measures” specifically includes stock price and total shareholder return (TSR).
Erroneously awarded incentive-based compensation must be clawed back regardless of whether:
The policy must also be applied to former executive officers who served as executive officers at any time during the applicable performance period.
U.S.-listed companies will be prohibited from indemnifying or insuring any current or former executive officer for the recovery of clawback amounts.
Once the rules come into effect, a U.S.-listed company may be subject to delisting if it does not adopt and disclose its clawback policy in accordance with the rules.
The requirement for U.S.-listed companies to recover incentive-based compensation from executive officers if there is a financial restatement is subject to the following impracticality exceptions:
The applicability of each of these exceptions must be confirmed by the company’s independent directors and is subject to review by the applicable U.S. stock exchange. We do not expect that Canadian companies will be able to rely on the home country law exception described above.
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