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The Securities and Exchange Commission (SEC) published its final clawback rule in the Federal Register on November 28, 2022, which establishes the following deadlines:
The stock exchanges are required to update their listing standards to incorporate the SEC’s final clawback rule no later than 90 days after the publication date, or February 27, 2023.
The stock exchanges’ updated listing standards must become effective no later than one year after publication or November 28, 2023.
Companies have 60 days from the effective date of the listing standards to adopt a compliant clawback policy; assuming the exchanges set the effective date as of November 28, 2023, companies will need to adopt a compliant clawback policy no later than January 27, 2024.
Incentive-based compensation (as defined under the rules) earned by current or former executive officers based on the attainment financial measures (including stock price or TSR measures) for fiscal years ending after November 28, 2023 or compensation granted, earned, or vested on or after November 28, 2023 is covered by the clawback rules.
On October 26, 2022, the Securities and Exchange Commission (SEC) adopted the final rule requiring that all listed companies adopt and disclose a clawback policy as required under Dodd-Frank. These final rules follow the SEC’s issuance of proposed rules in July 2015, which laid dormant until the re-opening of two separate comment periods in October 2021 and June 2022.
The new clawback rule requires that a listed company adopt and disclose a policy for the recoupment of incentive compensation from its current and former executive officers in the event the company is required to prepare “an accounting restatement due to material noncompliance” under the securities law (colloquially referred to as a “clawback” policy).
The final rule also requires national exchanges to prohibit the listing of any security of an issuer that does not develop and implement a clawback policy that complies with the new rule.
The key provisions of the final clawback rules include the following:
- Excludes “out of period” adjustments (corrections of immaterial errors recorded in the current period)
- Excludes revisions due to internal reorganizations impacting reportable segment disclosures or changes in capital structure (e.g., stock splits, stock dividends, etc.)
- This calculation must be filed with the applicable exchange
- To avail itself of this exception, a company must make a good faith attempt to recover the erroneous compensation and document the cost of recovery
- In the case of a violation of home country law, the company must obtain a legal opinion from counsel that a recovery is impermissible under local law
- We suggest companies review the representative list of operational and strategic measures provided by the SEC in the final rule to evaluate which of its existing financial measures might be subject to clawback (e.g., an increase in same store sales is considered a financial metric, whereas an increase in store openings is considered an operational metric)
- Date required to prepare the accounting restatement;
- Aggregate dollar amount of clawback and analysis of how the amount was calculated;
- Aggregate amount that remains unrecovered at the end of the current fiscal year;
- If the clawback is attributable to incentive compensation based on stock price or TSR, the estimates used to calculate the clawback amount and methodology used; and
- Amounts owed by each executive officer that is outstanding more that 180 days or longer
- One checkbox indicates whether prior year period financial statements included in the filing have been restated
- The other checkbox indicates if a restatement triggered a clawback during the current fiscal year
Companies will need to adopt new or review and amend existing clawback policies, to comply with the new rules. Some of the changes might require:
This may also be a good opportunity to evaluate other aspects of existing clawback policies including whether (i) the clawback triggers should include misconduct, material violation of the company’s code of conduct, or action/inactions that led to significant reputational damage to the company or (ii) an expansion of incentive plan participants that would be subject to some or all the clawback triggers. For example, non-executives could be subject to the clawback trigger for a material violation of the company’s code of conduct, but not a restatement.
In addition, a recent Department of Justice (DOJ) memorandum on corporate criminal enforcement indicates one of the factors it will consider in evaluating remediation and the effectiveness of compliance programs will include whether compensation systems that are designed to deter and penalize misconduct and reward compliance, (i.e., clawbacks) are implemented. Thus, the inclusion of a general misconduct trigger in a clawback policy might help mitigate DOJ penalties and other actions.
A copy of the final SEC rule can be found here.
During the last week of August, the Securities and Exchange Commission (SEC) released its final set of rules regarding the mandated “Pay Versus Performance” (PVP) disclosure. The new rules are the culmination of various proposals by the SEC dating back to 2015 when the agency first responded to the Dodd-Frank legislative requirement. Pay Governance LLC prepared two recent Viewpoints summarizing our interpretation and analysis of the new disclosure requirements (see Pay Governance Viewpoint on Executive Compensation, SEC Releases Final Rules Regarding Pay-Versus-Performance (PVP) Disclosures dated August 31, 2022 and PVP Q&A: Our Interpretations of the New Pay for Performance Rules dated September 15, 2022).
We stated in the previous Viewpoints that we would supplement our commentary with follow-on analyses and insights regarding the disclosure rules, and this Viewpoint provides an example of both the required and allowed disclosure under the final rule. Regarding supplemental disclosures, the SEC has granted companies significant latitude to include “additional measures of compensation or financial performance and other supplemental disclosures provided such disclosures are clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosure”.
Each company will need to decide the form and content of its own PVP disclosure and whether to include supplemental information based on company-specific circumstances, disclosure philosophy, newness of the rules, and other factors. For example, many companies may opt for a more conservative approach in their initial PVP disclosure given the newness of the rules, unresolved interpretative issues, and general reluctance to set a precedent for future disclosures that may not properly reflect the companies’ PVP relationship.
The required tabular disclosure, footnotes, and narrative included in this example have been supplemented with optional graphics to assist in visualizing the SEC’s 234-page final rule.
1. To calculate CAP, the following amounts were deducted from and added to Summary Compensation Table (SCT) total compensation
(i) Reflects “all other compensation” reported in the SCT for each year shown.
(ii) Represents the grant date fair value of equity-based awards granted each year. We did not report a change in pension value for any of the years reflected in this table; therefore, a deduction from SCT total related to pension value is not needed.
(iii) Reflects the value of equity calculated in accordance with the SEC methodology for determining CAP for each year shown. The equity component of CAP for fiscal year 2022 is further detailed in the supplemental table below.
2. The non-principal executive officer (PEO) named executive officers (NEOs) reflected in columns (d) and (e) represent the following individuals for each of the years shown: C. MacArthur, F. Walters, P. Karlowicz, and T. Johnson.
The five items listed below represent the most important metrics we used to determine CAP for FY2022 as further described in our Compensation Discussion and Analysis (CD&A) within the sections titled “Annual Incentive Compensation” and “Long-Term Incentive Compensation.”
1. TSR: Company versus Peer Group
As shown in the chart below, the Company’s 3-year cumulative TSR is less than the companies included in our industry index. There are several reasons for this:
2. CAP versus TSR
As shown in the chart below, the PEO and other NEOs’ CAP amounts are aligned with the Company’s TSR. This is due primarily to the Company’s use of equity incentives, which are tied directly to stock price in addition to the company’s financial performance.
3. CAP versus Net Income
As shown in the chart below, the Company’s net income has steadily increased while the PEO and other NEOs’ CAP has varied significantly each year. This is due in large part to the significant emphasis the Company places on equity incentives, which are sensitive to changes in stock price. In addition, the Company does not use net income to determine compensation levels or incentive plan payouts.
4. CAP versus Company-Selected Measure (CSM)
The chart below compares the PEO and other NEOs’ CAP to our CSM, 3-year relative TSR (rTSR), which indicates there is a very strong relationship between rTSR and CAP. The peer companies used to calculate rTSR are included in the CD&A and include some, but not all, of the companies in the XYZ index. The selection criteria for the rTSR peer group are also included in the CD&A.
The Company’s rTSR determines the number of performance shares that vest for each 3-year cycle, ranging from 0% to 200%. In 2020, the PSUs earned equaled 38% of target; in 2021, the PSUs earned equaled 200% of target; and in 2022, the PSUs earned equaled 25% of target, which is a key driver of the amount of, and change in, CAP.
Because approximately 75% of the CEO’s equity incentives are earned based on rTSR and only 50% of the other NEOs are based on rTSR, the impact of rTSR on CAP — both positive and negative — is more pronounced for the CEO compared to the other NEOs. That is why, for example, 2021 CAP increased more for the CEO than the other NEOs and decreased by more in 2022.
5. SCT Total versus CAP
Although there is no requirement to compare SCT and CAP, the chart below shows SCT compensation has increased modestly while CAP has varied significantly between years. This is due to several factors:
As noted in our previous Viewpoints, there are several activities companies should undertake now to get a head start on this extensive and complex disclosure requirement. The guidance included in this, and future Viewpoints will remain focused on providing our clients with the insights and information needed to comply with the new rules and to assist in framing their PVP story.
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