Companies should start now to work on putting in place, or revising, their clawback policies in light of complex rules issued last month by the US Securities and Exchange Commission, experts say.
The 230-page regulation, first proposed in 2015 under the 2010 Dodd-Frank Act, requires that when stock issuers are required to prepare an accounting restatement, they restore improperly allocated incentive compensation paid to current or former executive officers for the preceding three-year period . Incentive-based remuneration is based on financial measures such as share price.
The rules, which do not require that the officials concerned were responsible for the recalculation, apply to a company̵7;s CEO, CFO, principal, accountant, vice president responsible for business units and anyone with policy-making functions.
Companies are prohibited from indemnifying any current or former employee subject to clawback. The rules allow officers to purchase third-party insurance to cover clawbacks, but companies cannot pay or reimburse the executive officer for any premiums paid.
There is nothing in the rules that is “terribly new or surprising,” said Dan A. Bailey, a member of Bailey Cavalieri LLC in Columbus, Ohio.
Howard E. Berkenblit, a partner with Sullivan & Worcester LLP in Boston, said that while it will require some work to revise existing policies or to implement new ones, “this is not particularly burdensome for companies.” The hard part will come if there has to be a recalculation, “but I think that will be unusual for most companies,” he said.
“I can’t imagine there will be that many situations ‘where recalculations will be required,'” although a recession could lead to an increase, said Kenneth E. Yeadon, a partner with Hinshaw Culbertson LLP in Chicago, who is a former SEC enforcement attorney.
Others are less happy.
“My overall concern with the clawback regulation is that it is so broad and comprehensive that it will require a much more frequent, periodic” look at the companies’ clawback regimes, said Jake Downing, a partner with King & Spalding LLP in Chicago.
“The concern I have about the rule is that it could create a lot of friction for very little benefit to companies,” said Priya Cherian Huskins, a San Francisco-based partner and senior vice president at brokerage Woodruff Sawyer & Co.
“The new rule would invariably pick up situations” where the rewrite may have been “a consequence of a different interpretation of a rule unrelated in any way to intentional misconduct,” she said.
“I think there will be companies that will take a harder look at their incentive arrangements” and decide whether to be affected by performance metrics like the stock price in light of the rules, said Daniel M. McClain, a partner with Reed Smith LLP in New York .
Observers say an unusual part of the rules is their broad applicability. Machua Millett, Boston-based chief innovation officer and head of alternative investments at Lockton Cos. LLC’s financial services group, said: “It reflects an acknowledgment by the SEC that companies have begun to expand ‘incentive-based compensation’ further down the corporate ladder.”
Kevin LaCroix, executive vice president in Beachwood, Ohio, for RT ProExec, a division of RT Specialty LLC, said the rules could lead to the creation of an insurance product for executives seeking coverage for clawbacks, “although I haven’t felt a huge rush of the industry to try to develop a product.”
Most directors’ and officers’ policies treat clawback provisions as disgorgement, which is not insurable, said Joseph P. Monteleone, a partner with Weber Gallagher Simpson Stapleton Fires & Newby LLP in Bedminster, New Jersey.
But Matthew McLellan, Washington-based CEO and D&O product manager for Marsh LLC, said, “We’ve seen insurance markets evolve for all kinds of risks. It may take some creativity” to underwrite and price
The“but new markets are emerging all the time. It’s definitely an opportunity.”
Companies should examine their compensation structures to see if they are subject to clawbacks, LaCroix said. They “will probably want to do a reality test of their financial reporting to ensure that there are internal controls and safeguards in place to guard against developments that could lead to restatements” that would trigger a refund.
They should start working on their clawback policies now “so they don’t get caught flat-footed,” with boards having little time to “really think through the issues,” said Brian V. Soares, a partner with Morgan Lewis & Bockius LLP in Washington .