Public Companies - Clawback Policy for Accounting Restatements Expected in 2012

In the first half of 2012, the Securities and Exchange Commission is expected to issue new rules requiring public companies to implement a clawback policy mandating the recoupment of certain incentive-based compensation that was awarded to executive officers if there is an accounting restatement due to material noncompliance with financial reporting requirements under the securities laws.[1]  These new rules, required by Section 954 of the Dodd-Frank Act, are not expected to impact the 2012 proxy season for public companies with annual meetings scheduled for the first half of 2012.  Yet, these companies may be required to implement this new policy during the 2012 calendar year in order to comply with stock exchange listing standards.

From time immemorial, compensation reduction to executives engaging in bad acts has been a common provision in employment agreements.  The philosophy is simple; if an executive commits a malfeasance such as theft from the company or otherwise acts in direct conflict with the best interests of the company, then they don’t deserve to get paid.  But not all companies include such provisions in their employment agreements.  Not all such provisions provide the level of detail that eliminates ambiguity in their enforcement.  And many companies are not willing to enforce the provisions that they have, for fear of costly and time-consuming litigation or a desire to move on from the employee’s unfortunate departure and to devote their energies to improving the company’s future prospects.

Statutorily-required compensation recoupment from executives as a result of accounting restatements first came into prevalence in 2002 with the enactment of the Sarbanes-Oxley Act.  Section 304 of Sarbanes-Oxley provides that in the event of an accounting restatement due to material noncompliance of the issuer, as a result of misconduct, with financial reporting requirements under the federal securities laws, the company’s CEO and CFO shall reimburse the company for (i) incentive-based and equity-based compensation that was paid out to them, and (ii) any profits from the sale of company securities, each during the twelve (12) month period following the filing which contained the financial statements requiring the restatement.

Compensation “clawbacks” of senior executives further expanded in 2009 for companies participating in the federal Troubled Assets Relief Program (TARP).  These companies were required to agree to clawback any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate, regardless of whether they had engaged in misconduct.

Section 954 of Dodd-Frank extends this compensation “clawback” concept to include a greater number of senior management over a longer time period than is present under Section 304 of Sarbanes-Oxley.  Questions remain regarding who exactly will constitute “executive officers,” and what will constitute “material noncompliance,” among other things.  Interesting legal questions may also arise regarding the enforceability of Section 954 vis-à-vis previously-awarded compensation arrangements that will have been in existence before the new rules are implemented.  All the same, companies can expect to be required to adopt a recoupment policy relating to accounting restatements and applying to certain of its senior management in 2012, and may also be advised to include recoupment provisions in employment agreements with senior management on a going-forward basis after these new SEC rules take effect in 2012.

As we await SEC rulemaking on this matter, public companies are advised to review their existing employment agreements and incentive-based compensation arrangements to ascertain how these arrangements will likely be impacted by the new SEC rules.  In particular, Compensation Committees will want to be mindful that these new rules may impact their decision-making process regarding how to structure compensation for senior management.  Public companies may also want to consider proactively implementing a recoupment policy that will further encourage a culture of sound financial reporting, and that can later be tuned to fit the new rules after they take effect.  Please contact Thompson & Thompson LLP if you would like for us to provide you with a form Compensation Recoupment Policy for preliminary review and discussion.  We will be updating our form Compensation Recoupment Policy after the proposed rules for this policy have been published by the SEC.


[1] More specifically, Section 954 of the Dodd-Frank Act requires that stock exchange listing standards be amended to require that issuers adopt a policy providing that, if an issuer is required to prepare an accounting restatement due to material noncompliance with any financial reporting requirement under the securities laws, it will recover from any current or former executive officer who received incentive-based compensation (including stock options awarded as compensation) during the three-year period preceding the date on which the issuer is required to prepare an accounting restatement, amounts based on the erroneous data, in excess of what would have been paid under the restatement. Additional disclosure will also be required of an issuer’s policy on incentive-based compensation that is based on financial information required to be reported under the securities laws.

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