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The SEC has proposed new rules to implement Section 954 of the Dodd-Frank Act, which added Section 10D to the Securities Exchange Act of 1934. Section 10D requires the Commission to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with Section 10D’s requirements for disclosure of the issuer’s policy on incentive-based compensation and recovery of incentive-based compensation that is received in excess of what would have been received under an accounting restatement.

The proposed rules direct the exchanges to establish listing standards that require listed issuers to:

  • adopt and comply with written policies for recovery of incentive-based compensation based on financial information required to be reported under the securities laws, applicable to the listed issuers’ executive officers, over a period of three years; and
  • disclose those recovery policies in accordance with Commission rules.

To assure that issuers listed on different exchanges are subject to the same disclosure requirements regarding compensation recovery policies, the SEC is proposing amendments to the disclosure rules that would require all issuers listed on any exchange to file their written recovery policy as an exhibit to their annual reports and, if they have taken actions pursuant to that policy, to disclose those actions.

Issuers and Securities Subject to the Rule

The proposal would require exchanges to apply the disclosure and recovery policy requirements to all listed issuers, with only limited exceptions. The limited exceptions apply only to security futures products, standardized options, and the securities of certain registered investment companies. The SEC does not propose to exempt categories of listed issuers, such as emerging growth companies, smaller reporting companies, foreign private issuers, and controlled companies, because the SEC believes the objective of recovering excess incentive-based compensation is as relevant for these categories of listed issuers as for any other listed issuer.


Restatements Triggering Application of a Recovery Policy

Proposed Rule 10D-1 provides that issuers adopt and comply with a written policy providing that in the event the issuer is required to prepare a restatement to correct an error that is material to previously issued financial statements, the obligation to prepare the restatement would trigger application of the recovery policy. In connection with this, the proposed rule defines an accounting restatement as the result of the process of revising previously issued financial statements to reflect the correction of one or more errors that are material to those financial statements. The SEC believes an issuer 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.

The SEC recognizes the following types of changes to an issuer’s financial statements do not represent error corrections, and therefore would not trigger application of the issuer’s recovery policy under the proposed listing standards:

  • retrospective application of a change in accounting principle;
  • retrospective revision to reportable segment information due to a change in the structure of an issuer’s internal organization;
  • retrospective reclassification due to a discontinued operation;
  • retrospective application of a change in reporting entity, such as from a reorganization of entities under common control;
  • retrospective adjustment to provisional amounts in connection with a prior business combination; and
  • retrospective revision for stock splits.

Date the Issuer Is Required to Prepare an Accounting Restatement

The proposed rule states 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 indicates that the first proposed date generally is expected to coincide with the occurrence of the event described in Item 4.02(a) of Exchange Act Form 8-K, although neither proposed date is predicated on a Form 8-K having been filed. For the first proposed date to occur, the issuer merely needs to have concluded that previously issued financial statements contain a material error, which the SEC expects may occur before the precise amount of the error has been determined.

Application of Recovery Policy

Executive Officers Subject to Recovery Policy

Section 10D of the Exchange Act does not define “executive officer” for purposes of the recovery policy. The proposed listing standards would include a definition of “executive officer” in Rule 10D-1 that is modeled on the definition of “officer” in Rule 16a-1(f) of the Exchange Act. For purposes of Section 10D, an “executive officer” would be the issuer’s president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division or function (such as sales administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer. Executive officers of the issuer’s parents or subsidiaries would be deemed executive officers of the issuer if they perform such policy making functions for the issuer.

Section 10D(b)(2) calls for the recovery policy to apply to “any current or former executive officer of the issuer who received incentive-based compensation during the three-year look-back period.” Accordingly, the proposed 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 for that incentive-based compensation. 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.

Incentive-Based Compensation Subject to Recovery Policy

The SEC proposes to define “incentive-based compensation” in a principles-based manner. As proposed, “incentive-based compensation” would be defined as “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.”

The proposed definition would further provide that “financial reporting measures” are measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measures derived wholly or in part from such financial information, and stock price and total shareholder return. Such measures would be encompassed by the definition of financial reporting measures whether or not included in a filing with the Commission, and may be presented outside the financial statements, such as in Management’s Discussion and Analysis of Financial Conditions and Results of Operations or the performance graph.

In addition to measures that are derived from the financial statements, the proposed definition of financial reporting measures would include performance measures based on stock price or total shareholder return. Although the phrase “financial information required to be reported under the securities laws” might be interpreted as applying only to accounting-based metrics, the SEC believes that it also includes performance measures such as stock price and total shareholder return that are affected by accounting-related information and that are subject to our disclosure requirements.

Time Period Covered by Recovery Policy

Under proposed Rule 10D-1, the three-year look-back period for the recovery policy required by the listing standards would be the three completed fiscal years immediately preceding the date the issuer is required to prepare an accounting restatement. The SEC believes that basing the look-back period on fiscal years, rather than a preceding 36-month period, is consistent with issuers’ general practice of making compensation decisions and awards on a fiscal year basis. Using the proposed recovery period trigger, if a calendar year issuer concludes in November 2018 that a restatement of previously issued financial statements is required and files the restated financial statements in January 2019, the recovery policy would apply to compensation received in 2015, 2016 and 2017.

When Incentive-Based Compensation Is “Received”

Section 10D does not specify when an executive officer is deemed to have received incentive-based compensation to which the recovery policy must apply. As proposed, incentive-based compensation would be deemed received for purposes of triggering the recovery policy under Section 10D 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. Under this standard, the date of receipt would depend upon the terms of the award. If the grant of an award is based, either wholly or in part, on satisfaction of a financial reporting measure, the award would be deemed received in the fiscal period when that measure was satisfied. If an equity award vests upon satisfaction of a financial reporting measure, the award would be deemed received in the fiscal period when it vests.


A particular award may be subject to multiple conditions. The SEC is not proposing that an executive officer must have satisfied all conditions to an award for the incentive-based compensation to be deemed received for purposes of triggering the recovery policy. For example, an issuer could grant an executive officer an RSU award in which the number of RSUs earned is determined at the end of the three-year incentive-based performance period (2015- 2017), but the award is subject to service-based vesting for two more years (2018-2019). Although the executive officer does not have a non-forfeitable interest in the RSUs before expiration of the subsequent two-year service-based vesting period, the number of shares in which the RSUs ultimately will be paid will be established at the end of the three-year performance period. In this circumstance the executive officer “receives” the compensation for purposes of triggering the recovery policy when the relevant financial reporting measure performance goal is attained, even if the executive officer has established only a contingent right to payment at that time.

Determination of Excess Compensation

Section 10D(2)(b) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with recovery policies that apply to the amount of incentive based compensation received “in excess of what would have been paid to the executive officer under the accounting restatement.” The SEC proposes to define the recoverable amount as “the amount of incentive-based compensation received by the executive officer or former executive officer that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the accounting restatement.” Applying this definition, after an accounting restatement, the issuer would first recalculate the applicable financial reporting measure and the amount of incentive-based compensation based thereon. The issuer would then determine whether, based on that financial reporting measure as calculated relying on the original financial statements and taking into account any discretion that the compensation committee had applied to reduce the amount originally received, the executive officer received a greater amount of incentive-based compensation than would have been received applying the recalculated financial reporting measure.

For incentive-based compensation that is based on stock price or total shareholder return, where the amount of erroneously awarded compensation is not subject to mathematical recalculation directly from the information in an accounting restatement, the recoverable amount may be determined based on a reasonable estimate of the effect of the accounting restatement on the applicable measure. 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. For these measures, the issuer would be required to maintain documentation of the determination of that reasonable estimate and provide such documentation to the relevant exchange or association.

The recoverable amount would be calculated on a pre-tax basis to ensure that the company recovers the full amount of incentive-based compensation that was erroneously awarded, consistent with the policy underlying Section 10D.

Board Discretion Regarding Whether to Seek Recovery

The Dodd-Frank Act provides that “the issuer will recover” incentive-based compensation, and does not address whether there are circumstances in which an issuer’s board of directors may exercise discretion not to recover. Proposed Rule 10D-1 provides that an issuer must recover erroneously awarded compensation in compliance with its recovery policy except to the extent that pursuit of recovery would be impracticable because it would impose undue costs on the issuer or its shareholders or would violate home country law and certain conditions are met.

The SEC believes the unqualified “no-fault” recovery mandate of Section 10D intends that the issuer should pursue recovery in most instances.

In the SEC’ s view, inconsistencies between the proposed rules and existing compensation contracts is not a basis for finding recovery to be impracticable, because the SEC believes issuers can amend those contracts to accommodate recovery. Further, the SEC indicated the only criteria that should be considered are whether the direct costs of enforcing recovery would exceed the recoverable amounts or whether recovery would violate home country law. Before concluding that it would be impracticable to recover any amount of excess incentive-based compensation based on enforcement costs, the issuer would first need to make a reasonable attempt to recover that incentive-based compensation. The issuer would be required to document its attempts to recover, and provide that documentation to the exchange. As discussed below, the issuer also would be required to disclose why it determined not to pursue recovery.

Board Discretion Regarding Manner of Recovery

Section 10D does not address whether an issuer’s board of directors may exercise discretion in the manner in which it recovers excess compensation to comply with the listing standards. As proposed, Rule 10D-1 would not limit the amount of compensation the board could seek to recover on any legal basis. However, under the proposed rule, issuers’ boards of directors would not be permitted to pursue differential recovery among executive officers, including in “pool plans,” where the board may have exercised discretion as to individual grants in allocating the bonus pool.

The proposal does not permit issuers to settle for less than the full recovery amount unless it is impracticable from a cost standpoint. In that circumstance, the same conditions discussed above would apply as for a determination to forgo recovery.

Means of Recovery

The SEC recognizes that the appropriate means of recovery may vary by issuer and by type of compensation arrangement. Consequently, the SEC believes issuers should be able to exercise discretion in how to accomplish recovery. Nevertheless, in exercising this discretion, the SEC believes that issuers should act in a manner that effectuates the purpose of the statute – to prevent executive officers from retaining compensation that they received and to which they were not entitled under the issuer’s restated results. Regardless of the means of recovery utilized, the SEC believes that issuers should recover excess incentive-based compensation reasonably promptly, as undue delay would constitute non-compliance with an issuer’s policy.

Compliance with Required Policy

Under the proposed rules, an issuer would be subject to delisting if it does not adopt and comply with its compensation recovery policy. The proposed rules do not specify the time by which the issuer must complete the recovery of excess incentive-based compensation. Rather, under proposed Rule 10D-1, an exchange would determine whether the steps an issuer is taking constitute compliance with its recovery policy. In making this assessment, an exchange would need to determine, among other things, whether the issuer was making a good faith effort to promptly pursue recovery.

Disclosure of Issuer Policy on Incentive-Based Compensation

Required Disclosures

The proposal would amend Item 601(b) of Regulation S-K to require that a listed issuer file its recovery policy as an exhibit to its annual report on Form 10-K. To further implement the Dodd-Frank Act, the SEC is using its discretionary authority to propose to amend Item 402 of Regulation S-K to require listed issuers to disclose how they have applied their recovery policies. Proposed Item 402(w) of Regulation S-K would apply if at any time during its last completed fiscal year either a restatement that required recovery of excess incentive-based compensation pursuant to the listed issuer’s compensation recovery policy was completed or there was an outstanding balance of excess incentive-based compensation from the application of that policy to a prior restatement. In this circumstance, the listed issuer would be required to provide the following information in its Item 402 disclosure:

  • for each restatement, the date on which the listed issuer was required to prepare an accounting restatement, the aggregate dollar amount of excess incentive-based compensation attributable to such accounting restatement and the aggregate dollar amount of excess incentive-based compensation that remains outstanding at the end of its last completed fiscal year;
  • the estimates used to determine the excess incentive-based compensation attributable to such accounting restatement, if the financial reporting measure related to a stock price or total shareholder return metric;
  • the name of each person subject to recovery of excess incentive-based compensation attributable to an accounting restatement, if any, from whom the listed issuer decided during the last completed fiscal year not to pursue recovery, the amount forgone for each such person, and a brief description of the reason the listed issuer decided in each case not to pursue recovery; and
  • the name of, and amount due from, each person from whom, at the end of its last completed fiscal year, excess incentive-based compensation had been outstanding for 180 days or longer since the date the issuer determined the amount the person owed.

Changes to Summary Compensation Table

The SEC is also proposing amendments to the Summary Compensation Table disclosure requirements. A new instruction to the Summary Compensation Table requires that any amounts recovered pursuant to a listed issuer’s erroneously awarded compensation recovery policy reduce the amount reported in the applicable column for the fiscal year in which the amount recovered initially was reported, and be identified by footnote.

XBRL Tagging

The proposed rules require that the disclosure required by proposed Item 402(w) be provided in interactive data format using XBRL using block-text tagging. The interactive data would have to be provided as an exhibit to the definitive proxy or information statement filed with the Commission and as an exhibit to the annual report on Form 10-K.   Issuers would be required to prepare their interactive data using the list of tags the Commission specifies and submit them with any supporting files the EDGAR Filer Manual prescribes. This requirement generally would apply to all listed issuers.

Indemnification and Insurance

Rule 10D-1, as proposed, prohibits a listed issuer 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 for premiums for such an insurance policy. In addition, the SEC believes that the anti-waiver provision in Section 29(a) of the Exchange Act would render any indemnification agreement unenforceable to the extent that the agreement purported to relieve the issuer of its obligation under Section 10(D).

Transition and Timing

The proposal requires that:

  • each exchange file its proposed listing rules no later than 90 days following publication of the final adopted version of Rule 10D-1 in the Federal Register, and that its rules be effective no later than one year following that publication date;
  • each listed issuer must adopt the recovery policy required by the proposed rules no later than 60 days following the date on which the applicable exchange’s rules become effective;
  • each listed issuer must recover all erroneously awarded incentive-based compensation received by executive officers and former executive officers as a result of attainment of a financial reporting measure based on or derived from financial information for any fiscal period ending on or after the effective date of Rule 10D-1 and that is granted, earned or vested on or after the effective date of Rule 10D-1 pursuant to the issuer’s recovery policy; and
  • listed issuers must file the required disclosures in applicable SEC filings required on or after the date on which the exchanges’ rules become effective.

The rule proposal is silent about how issuers should deal with retroactive application of the recovery policy to existing compensation arrangements. However, the SEC is crystal clear in its mandate that issuer compliance is required whether the 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.

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.