# Listing Standards for Recovery of Erroneously Awarded Compensation

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2015-16613

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** July 14, 2015
- **Citation:** 80 FR 41144

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 229, 240, 249, and 274
[RELEASE NOS. 33-9861; 34-75342; IC-31702; File No. S7-12-15]
RIN 3235-AK99
Listing Standards for Recovery of Erroneously Awarded Compensation

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

We are proposing a new rule and rule and form amendments to implement the provisions of Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 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 rule and rule amendments would direct the national securities exchanges and national securities associations to establish listing standards that would require each issuer to develop and implement a policy providing for the recovery, under certain circumstances, of incentive-based compensation based on financial information required to be reported under the securities laws that is received by current or former executive officers, and require the disclosure of the policy. A listed issuer would be required to file the policy as an exhibit to its annual report.

DATES:

Comments should be received on or before September 14, 2015.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (
http://www.sec.gov/rules/proposed.shtml
);

• Send an email to
rule-comments@sec.gov;
or

• Use the Federal Rulemaking ePortal (
http://www.regulations.gov
). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments to Brent J. Fields, Secretary, U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-12-15. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (
http://www.sec.gov/rules/proposed.shtml
). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the SEC's Web site. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at
www.sec.gov
to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Anne Krauskopf, Senior Special Counsel, or Carolyn Sherman, Special Counsel at (202) 551-3500, in the Office of Chief Counsel, Division of Corporation Finance, or Joel K. Levine, Associate Chief Accountant at (202) 551-3400, in the Office of Chief Accountant, Division of Corporation Finance, U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

We are proposing to add new Rule 10D-1
1

under the Securities Exchange Act of 1934.
2

We also are proposing amendments to Items 402,
3

404
4

and 601
5

of Regulation S-K,
6

Item 22 of Schedule 14A,
7

Exchange Act Forms 20-F
8

and 40-F,
9

and Form N-CSR
10

under the Exchange Act and the Investment Company Act of 1940.
11

1
17 CFR 240.10D-1.

2
15 U.S.C. 78a
et seq.

3
17 CFR 229.402.

4
17 CFR 229.404.

5
17 CFR 229.601.

6
17 CFR 229.10
et seq.

7
17 CFR 240.14a-101.

8
17 CFR 249.220f.

9
17 CFR 249.240f.

10
17 CFR 249.331 and 274.128.

11
15 U.S.C. 80a-1
et seq.

Table of Contents

I. Background and Summary
7

II. Discussion of the Proposals
10

A. Issuers and Securities Subject to Proposed Exchange Act Rule 10D-1
11

1. General
11

2. Securities Futures Products and Standardized Options
17

3. Registered Investment Companies
20

B. Restatements
23

1. Restatements Triggering Application of Recovery Policy
23

2. Date the Issuer Is Required to Prepare an Accounting Restatement
28

C. Application of Recovery Policy
33

1. Executive Officers Subject to Recovery Policy
33

2. Incentive-Based Compensation
39

a. Incentive-Based Compensation Subject to Recovery Policy
39

b. Time Period Covered by Recovery Policy
51

c. When Incentive-Based Compensation Is “Received”
54

3. Recovery Process
58

a. Determination of Excess Compensation
58

b. Board Discretion Regarding Whether to Seek Recovery
67

c. Board Discretion Regarding Manner of Recovery
73

i. Amount to Be Recovered
74

ii. Means of Recovery
75

4. Compliance with Recovery Policy
79

D. Disclosure of Issuer Policy on Incentive-Based Compensation
80

1. Listed U.S. Issuers
83

2. Listed Foreign Issuers
88

E. Indemnification and Insurance
95

F. Transition and Timing
99

III. Economic Analysis
103

A. Baseline
105

B. Analysis of Potential Economic Effects
114

1. Potential Effects on Financial Reporting
115

2. Potential Effects on Executive Compensation
122

3. Additional Potential Effects on Listed Issuers
133

4. Potential Effects on U.S. Exchanges
140

5. Indemnification and Insurance
142

C. Alternatives
144

1. Exemptions for Certain Categories of Issuers
144

2. Excluding Incentive-Based Compensation Tied to Stock Price
145

3. Other Alternatives Considered
147

D. Request for Comment
149

IV. Paperwork Reduction Act
151

A. Background
151

B. Summary of Proposed Rule and Rule Amendments
153

C. Paperwork Reduction Act Burden Estimates
156

D. Solicitation of Comments
161

V. Small Business Regulatory Enforcement Fairness Act
162

VI. Initial Regulatory Flexibility Act Analysis
163

A. Reasons for, and Objectives of, the Proposed Action
163

B. Legal Basis
164

C. Small Entities Subject to the Proposed Action
164

D. Reporting, Recordkeeping, and other Compliance Requirements
166

E. Duplicative, Overlapping or Conflicting Federal Rules
169

F. Significant Alternatives
169

G. Solicitation of Comments
171

VII. Statutory Authority and Text of the Proposed Amendments
172

I. Background and Summary

We are proposing a new rule, and rule and form amendments to implement the provisions of Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”),
12

which added Section 10D to the Securities Exchange Act of 1934 (the “Exchange Act”). Specifically, Section 10D(a) of the Exchange Act requires the Commission to adopt rules directing the national securities exchanges
13

(the “exchanges”) and the national securities associations
14

(the “associations”) to prohibit the listing of any security of an issuer that is not in compliance with the requirements of Section 10D(b). Section 10D(b) requires the Commission to adopt rules directing the exchanges to establish listing standards to require each issuer to develop and implement a policy providing:

12
Public Law 111-203, 124 Stat. 1900 (2010).

13
A “national securities exchange” is an exchange registered as such under Section 6 of the Exchange Act [15 U.S.C. 78f]. There are currently eighteen exchanges registered under Section 6(a) of the Exchange Act: BATS Exchange, BATS Y-Exchange, BOX Options Exchange, C2 Options Exchange, Chicago Board Options Exchange, Chicago Stock Exchange, EDGA Exchange, EDGX Exchange, International Securities Exchange (“ISE”), ISE Gemini, Miami International Securities Exchange, NASDAQ OMX BX, NASDAQ OMX PHLX, The NASDAQ Stock Market, National Stock Exchange, New York Stock Exchange (“NYSE”), NYSE Arca and NYSE MKT. Certain exchanges are registered with the Commission through a notice filing under Section 6(g) of the Exchange Act for the purpose of trading security futures. As discussed in Section II.A.2, below, we propose to exempt security futures products and standardized options from the scope of the proposed rule. To the extent that our final rule exempts the listing of security futures products and standardized options from its scope, any registered national securities exchange that lists and trades only security futures products or standardized options would not be required to file a rule change in order to comply.

14
A “national securities association” is an association of brokers and dealers registered as such under Section 15A of the Exchange Act [15 U.S.C. 78o-3]. The Financial Industry Regulatory Authority (“FINRA”) is the only association registered with the Commission under section 15A(a) of the Exchange Act. Because FINRA does not list securities, generally we refer only to the exchanges in this release. However, if any associations were to list securities, the rule proposals would apply to them also.

In addition, Section 15A(k) of the Exchange Act (15 U.S.C. 78o-3(k) provides that a futures association registered under Section 17 of the Commodity Exchange Act (7 U.S.C. 21) shall be registered as an association for the limited purpose of regulating the activities of members who are registered as broker-dealers in security futures products pursuant to Section 15(b)(11) of the Exchange Act (15 U.S.C. 78o(b)(11)).

(1) For the disclosure of the issuer's policy on incentive-based compensation that is based on financial information required to be reported under the securities laws; and

(2) that, in the event that the issuer is required to prepare an accounting restatement due to the issuer's material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover from any of the issuer's current or former executive officers who received incentive-based compensation (including stock options awarded as compensation) during the three-year period preceding the date the issuer is required to prepare the accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

Other statutes and rules currently administered by the Commission also address the recovery of executive compensation:

• Section 304 of the Sarbanes-Oxley Act of 2002 (“SOX”)
15

provides that if an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct,
16

with any financial reporting requirements under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for any bonus or other incentive-based or equity-based compensation received by

that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and any profits realized from the sale of securities of the issuer during that 12-month period; and

15
15 U.S.C. 7243.

16
The CEO or CFO need not personally engage in misconduct for recovery to be required under Section 304. See
SEC
v.
Jenkins,
718 F.Supp. 2d 1070, 1074-75 (D. Ariz. 2010) (“[T]he misconduct of the issuer is the misconduct that triggers the reimbursement obligation of the CEO and the CFO.”);
SEC
v.
Baker,
2012 U.S. Dist. LEXIS 161784 (W.D. Tex 2012).

• Item 402(b) of Regulation S-K includes, as an example of the kind of information that should be addressed, if material, in the company's Compensation Discussion and Analysis (“CD&A”), company policies and decisions regarding the adjustment or recovery of awards or payments to named executive officers
17

if the relevant company performance measures upon which they are based are restated or otherwise adjusted in a manner that would reduce the size of an award or payment.
18

17
As defined in Item 402(a)(3) of Regulation S-K, “named executive officers” are all individuals serving as the company's principal executive officer during the last completed fiscal year, all individuals serving as the company's principal financial officer during that fiscal year, the company's three other most highly compensated executive officers who were serving as executive officers at the end of that year, and up to two additional individuals who would have been among the three most highly compensated but for not serving as executive officers at the end of that year.

18
Item 402(b)(2)(viii). Item 402(b) contains the requirements for CD&A, which is intended to be a narrative overview that puts into context the executive compensation disclosure provided in response to the other requirements of Item 402. The CD&A disclosure requirement is principles-based, in that it identifies the disclosure concept and provides several non-exclusive examples. Under Item 402(b)(1), companies must explain all material elements of their named executive officers' compensation by addressing mandatory principles-based topics in CD&A. Item 402(b)(2) sets forth nonexclusive examples of the kind of information that should be addressed in CD&A, if material.

The proposed rule and rule amendments would supplement these existing provisions by directing 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, we are 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.

Under the proposed rule and rule amendments, an issuer would be subject to delisting if it does not:

• Adopt a compensation recovery policy that complies with the applicable listing standard;

• disclose the policy in accordance with Commission rules, including providing the information in tagged data format; or

• comply with the policy's recovery provisions.

Listed issuers could, of course, adopt policies more extensive than those called for by the listing standards, so long as those policies at a minimum satisfied the listing standards, and exchanges and associations could adopt listing standards with requirements that are more extensive than those of proposed Rule 10D-1.

II. Discussion of the Proposals

We are proposing new Exchange Act Rule 10D-1 to set forth the listing requirements that exchanges would be directed to establish pursuant to Section 10D of the Exchange Act. We also are proposing rule amendments to Regulation S-K, to the forms by which foreign private issuers file their Exchange Act annual reports, and for certain investment companies, to Form N-CSR and Schedule 14A. These amendments would require disclosure of the listed issuer's policy on recovery of incentive-based compensation and information about actions taken pursuant to such recovery policy. In developing these proposals, we considered the comment letters we received on Section 10D pursuant to our initiative to receive advance public comment in implementing the Act.
19

19
In connection with all of the Dodd-Frank Act rulemakings, we sought comment from the public prior to the issuance of a proposing release. Comments related to the executive compensation provisions of the Dodd-Frank Act are available at
http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml.
Regarding Section 10D, we received pre-proposal letters from AFL-CIO, Americans for Financial Reform, As You Sow, Center for Effective Government, Demos, Institute for Policy Studies/Global Economy Project, International Brotherhood of Teamsters, Other98.org, Public Citizen and Service Employees International Union (“AFL-CIO Joint Letter”); American Benefits Council; Baker, Donelson, Bearman, Caldwell & Berkowitz, PC; Brian Foley & Company, Inc.; Center on Executive Compensation; Clark Consulting, LLC; Committee on Federal Regulation of Securities of the Section of Business Law of the American Bar Association (“ABA Business Law Section”); Compensia, Inc.; Davis Polk & Wardwell LLP; Frederic W. Cook & Co., Inc.; Mai Datta, Ph.D., Professor of Finance, Wayne State University; Stuart R. Lombardi; Meridian Compensation Partners, LLC; PGGM Investments; Pay Governance LLC; Protective Life Corporation; Robert E. Scully Jr., Member, Stites Harbison, PLLC; Society of Corporate Secretaries and Governance Professionals; Towers Watson; and Sheila Waddell.

A. Issuers and Securities Subject to Proposed Exchange Act Rule 10D-1

1. General

Section 10D of the Exchange Act provides that the Commission shall, by rule, direct the exchanges “to prohibit the listing of any security of an issuer that does not comply with the requirements of [Section 10D].” Commenters raised questions as to whether the rule should apply to all issuers with listed securities, such as foreign private issuers
20

and issuers of listed debt whose stock is not also listed.
21

20

See
letters from ABA Business Law Section (noting that foreign private issuers are not required to comply with the proxy rules or Item 402 executive compensation disclosure, and that home countries may have a greater interest in determining whether companies should have recourse against their executives) and Brian Foley & Company, Inc. (seeking clarification whether Section 954 applies to foreign private issuers).

21

See
letter from Brian Foley & Company, Inc.

For the reasons discussed below, the rule and rule amendments we propose would require exchanges to apply the disclosure and recovery policy requirements to all listed issuers, with only limited exceptions. As a preliminary matter, we read the language of Section 10D as generally calling for a broad application of the mandated listing standards. Section 10D does not distinguish among issuers or types of securities, and does not specifically instruct the Commission to exempt any particular types of issuers or securities or direct the Commission to permit the exchanges to provide such exemptions in listing them.
22

We recognize, however, that we could use our general exemptive authority under the Exchange Act
23

to exempt specific categories of issuers or securities to the extent that doing so would be necessary or appropriate in the public interest and consistent with the protection of investors. In evaluating whether to exempt specific categories of issuers and securities, though, we have considered whether providing exemptions from the requirements of Section 10D would be

consistent with what we understand to be the purpose of this statutory provision. In this regard, we note that a report by the Senate Committee on Banking, Housing and Urban Affairs stated that “[t]his proposal will clarify that all issuers must have a policy in place to recover compensation based on inaccurate accounting so that shareholders do not have to embark on costly legal expenses to recoup their losses or so that executives must return monies that should belong to the shareholders.”
24

As discussed below, we propose to exempt security futures products, standardized options, and the securities of certain registered investment companies from the proposed listing standards because we believe the compensation structures of issuers of these securities render application of the rule and rule amendments unnecessary.
25

We are not proposing otherwise to exempt categories of listed issuers, such as emerging growth companies,
26

smaller reporting companies,
27

foreign private issuers,
28

and controlled companies,
29

because we believe the objective of recovering excess incentive-based compensation is as relevant for these categories of listed issuers as for any other listed issuer. In reaching this conclusion, we also considered the relative burdens of compliance on these categories of issuers. As discussed more fully in the Economic Analysis, while we recognize that the proposed listing standards could, in certain respects, impose a disproportionate burden on these categories of issuers, there is also reason to believe that these issuers, as well as investors and the markets in general, may derive benefits from being subject to the proposed listing standards.
30

22
In this regard, Section 10D differs from the Act's other governance-related provisions, such as Section 951 Shareholder Vote on Executive Compensation Disclosure (amending the Exchange Act to add Section 14A) and Section 952 Compensation Committee Independence (amending the Exchange Act to add Section 10C), which include specific direction for either the Commission or the exchanges to consider exemptions for classes of issuers, or to provide exemptions. Additionally, Section 951 instructs the Commission to take into account whether Section 951's requirements disproportionately burden small issuers.

23
Section 36(a) of the Exchange Act (15 U.S.C. 78mm(a)).

24

See
Report of the Senate Committee on Banking, Housing, and Urban Affairs, S.3217, Report No. 111-176 at 135-36 (April 30, 2010) (“Senate Report”).

25

See
Sections II.A.2 and 3, below.

26
Section 2(a)(19) of the Securities Act of 1933 (the “Securities Act”) and Exchange Act Section 3(a)(80) define “emerging growth company” as “an issuer that had total annual gross revenues of less than $1,000,000,000 . . . during its most recently completed fiscal year.” An issuer shall continue to be deemed an emerging growth company until the earliest of (1) the last day of the fiscal year during which it had total annual gross revenues of $1 billion; (2) the last day of the fiscal year following the fifth anniversary of the first sale of its common equity securities; (3) the date on which it has issued more than $1 billion in non-convertible date during the previous three years; or (4) the date on which it is deemed a large accelerated filer.

27
Exchange Act Rule 12b-2 defines “smaller reporting company” as “an issuer that is not an investment company, an asset-backed issuer . . ., or a majority-owned subsidiary of a parent that is not a smaller reporting company and that: (1) Had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter, computed by multiplying the aggregate worldwide number of shares of its voting and non-voting common equity held by non-affiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity; or (2) in the case of an initial registration statement under the Securities Act or Exchange Act for shares of its common equity, had a public float of less than $75 million as of a date within 30 days of the date of the filing of the registration statement, computed by multiplying the aggregate worldwide number of such shares held by non-affiliates before the registration plus, in the case of a Securities Act registration statement, the number of such shares included in the registration statement by the estimated public offering price of the shares; or (3) in the case of an issuer whose public float as calculated under paragraph (1) or (2) of this definition was zero, had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.” Whether or not an issuer is a smaller reporting company is determined on an annual basis.

28
Exchange Act Rule 3b-4(c) defines “foreign private issuer” as “any foreign issuer other than a foreign government except for an issuer meeting the following conditions as of the last business day of its most recently completed second fiscal quarter: (1) More than 50 percent of the issuer's outstanding voting securities are directly or indirectly held of record by residents of the United States; and (2) (i) the majority of the executive officers or directors are United States citizens or residents, (ii) more than 50 percent of the assets of the issuer are located in the United States, or (iii) the business of the issuer is administered principally in the United States.” Exchange Act Rule 3b-4(b) defines “foreign issuer” as “any issuer which is a foreign government, a national of any foreign country or a corporation or other organization incorporated or organized under the laws of any foreign country.”

29
Under New York Stock Exchange Rule 303A.00 and NASDAQ Stock Market LLC Rule 5615(c) a “controlled compan[y]” is defined as a company of which more than 50% of the voting power for the election of directors is held by an individual, group or another company.

30

See
Section III, below.

In our determination of whether to propose exemptions for foreign private issuers we considered the views of commenters that submitted comments before this proposal
31

as well as the incidence of restatements among this category of listed issuers. We are aware of studies that indicate that these issuers, from time to time, restate their financial statements to correct accounting errors.
32

For example, during 2012 and 2013 foreign private issuers, which are approximately 10 percent of all registrants, accounted for over 10 percent of all restatements.
33

31

See
letters from Brian Foley & Company, Inc. (seeking clarification of whether Section 954 would apply to foreign private issuers and listed debt where the issuer's equity is not listed); ABA Business Law Section(recommending the Commission exercise its authority to exempt foreign private issuers from Section 954 rulemaking).

32

See
2013 Financial Restatements: A Thirteen Year Comparison, Audit Analytics (2014) (“A Thirteen Year Comparison”) (addressing accelerated foreign filers, non-accelerated foreign filers, accelerated U.S. filers, and non-accelerated U.S. filers), and Financial Restatement Trends in the United States: 2003-2012, Professor Susan Scholz, University of Kansas, Study Commissioned by the Center for Audit Quality (comparing U.S. and foreign issuers).

33

See
A Thirteen Year Comparison.

Although some exchange listing standards permit foreign private issuers to follow home country practice in lieu of certain corporate governance requirements,
34

our proposed rule and rule amendments would not permit the exchanges to exempt foreign private issuers from compliance with Section 10D's disclosure and recovery requirements. Consistent with a comment we received,
35

our proposal would, however, allow exchanges to permit foreign private issuers to forgo recovery as impracticable if the recovery of erroneously awarded compensation pursuant to Section 10D would violate the home country's laws so long as certain other conditions are met.
36

34

See, e.g.,
New York Stock Exchange Rule 303A.00 and NASDAQ Stock Market LLC Rule 5615(a)(3).

35

See
letter from ABA Business Law Section.

36

See
Section II.C.3.b, below, for a discussion of proposed board discretion in these circumstances.

We also considered the incidence of restatements for smaller reporting companies, emerging growth companies and controlled companies in determining not to exclude such companies from these requirements. For example, during 2012 and 2013, U.S. issuers who are not accelerated filers
37

accounted for approximately 55 percent of total U.S. issuer restatements.
38

37
As defined in Exchange Act Rule 12b-2 [17 CFR 240.12b-2].

38

See
A Thirteen Year Comparison.

We believe that smaller reporting companies constitute a substantial majority of U.S. non-accelerated filers. We also believe that at least some of these categories of issuers use incentive-based compensation arrangements that are based on achievement of financial reporting measures that may be affected by accounting restatements. As a result, we believe that shareholders of these listed issuers would benefit from a policy to recover excess incentive-based compensation and that applying the proposed rule and rule amendments to these issuers will further the statutory goal of assuring that executive officers do not retain incentive-based compensation that they received erroneously. For similar reasons, we are not proposing to grant the exchanges discretion to decide whether additional categories of issuers should be exempted from the proposed listing standards.

Further, Section 10D refers to “any security” of an issuer, which would include not only common equity securities, but also debt and preferred

securities. Accordingly, apart from the proposed exemptions discussed below, we are proposing that the listing standards and other requirements of the proposed rule and rule amendments apply without regard to the type of securities issued, including to issuers of listed debt or preferred securities that do not have listed equity. As described in the Economic Analysis,
39

the potential benefits of a recovery policy would likely accrue to the holders of debt and preferred securities as well as to equity holders. For the same reasons, we do not propose to grant the exchanges discretion to decide whether certain categories of securities should be exempted from the proposed listing standards.

39

See
Section III, below.

Request for Comment

1. Should the listing standards and other requirements of the proposed rule and rule amendments apply generally to all listed issuers, as proposed? If not, what types of issuers should be exempted, and why? Please explain the rationale that justifies exempting any particular category of issuer.

2. Should we distinguish among listed issuers based on the types of securities listed? Please explain the rationale for any such exemption. For example, do issuers with listed non-convertible debt or preferred stock that do not have listed common equity raise the same concerns as issuers with listed common equity? For listed issuers that do not have listed common equity, do the different residual claims against the cash flows of the issuer warrant a different treatment?

3. Would the proposed listing standards conflict with any home country laws, stock exchange requirements, or corporate governance arrangements that apply to foreign private issuers? If so, please explain the nature of those conflicts. Should the proposed rule and rule amendments allow exchanges to permit foreign private issuers to forego recovery of erroneously awarded compensation if recovery would violate the home country's laws and certain conditions were met, as proposed? Is such an exception necessary or appropriate? If no, why not? If not, are there more appropriate or effective means to address such conflicts?

4. In the event that a foreign private issuer's home country has a law that like Section 10D requires the issuer to disclose its policies on incentive-based compensation and recover erroneously awarded incentive-based compensation from current or former executive officers,
40

should the foreign private issuer be permitted to comply with its home country law instead of complying with the listing standard of the U.S. exchange that lists the foreign private issuer's securities? Please explain why or why not.

40

See, e.g.,
the UK Corporate Governance Code, September 2014, available at
https://frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-2014.pdf
. Under Section D. of the Corporate Governance Code, a company's remuneration scheme for executive directors for performance-related remuneration should “include provisions that would enable the company to recover sums paid or withhold the payment of any sum, and specify the circumstances in which it would be appropriate to do so.”
See also, e.g.,
Directive 2013/36/EU of the European Parliament and of the Council of June 26, 2013, available at
http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32013L0036.
The EU Capital Requirements Directive IV includes specific requirements on compensation, including a bonus cap up to 100% of variable remuneration or, with shareholder approval, 200% of total fixed pay, which must be subject to “malus or clawback” arrangements.

5. Should there be a mechanism to determine whether additional categories of issuers and/or securities should be exempted from the proposed listing standards? If so, what mechanism would be appropriate? Should new financial products that may be developed in the future be subject to the proposed requirements? Why or why not? What principles or requirements, if any, should apply to any mechanism? In the absence of a discretionary mechanism for future exemptions, would the proposed rule potentially hinder competition? If so, how?

2. Securities Futures Products and Standardized Options

The Exchange Act's definition of “equity security” includes any security future on any stock or similar security.
41

Exchanges registered under Section 6 of the Exchange Act and associations registered under Section 15A(a) of the Exchange Act may trade futures on individual securities and on narrow-based security indexes (“securities futures products”)
42

without such securities being subject to the registration requirements of the Securities Act of 1933 (“Securities Act”) and the Exchange Act so long as they are cleared by a clearing agency that is registered under Section 17A of the Exchange Act or that is exempt from registration under Section 17A(b)(7) of the Exchange Act.
43

In December 2002, we adopted rules to provide comparable regulatory treatment for standardized options.
44

41
Exchange Act Section 3(a)(11).

42
Exchange Act Section 3(a)(56) [15 U.S.C. 78c(a)(56)], and Commodities Exchange Act Section 1a(32) [7 U.S.C. 1a(32)] define “security futures product” as any security future or any put, call, straddle, option or privilege on any security future.

43

See
Securities Act Section 3(a)(14) [15 U.S.C. 77c(a)(14)], Exchange Act Section 12(a) [15 U.S.C. 78l(a)], and Exchange Act Rule 12h-1(e) [17 CFR 240.12h-1(e)].

44

See
Release No. 33-8171 (Dec. 23, 2002) [68 FR 188]. In that release, we exempted standardized options issued by registered clearing agencies and traded on a registered exchange or on a registered association from all provisions of the Securities Act, other than the antifraud provision of Section 17, as well as the Exchange Act registration provisions. Standardized options are defined in Exchange Act Rule 9b-1(a)(4) [17 CFR 240.9b-1(a)(4)] as option contracts trading on an exchange, an automated quotation system of a registered association, or a foreign securities exchange which relate to option classes the terms of which are limited to specific expiration dates and exercise prices, or such other securities as the Commission may, by order, designate.

The role of a clearing agency as the issuer for security futures products and standardized options is fundamentally different from that of other listed issuers.
45

The purchaser of security futures products and standardized options does not, except in the most formal sense, make an investment decision regarding the clearing agency. As a result, information about the clearing agency's business, its officers and directors and their compensation, and its financial statements is less relevant to investors in these securities than information about the issuer of the underlying security.
46

Moreover, the investment risk in security futures products and standardized options is largely determined by the market performance of the underlying security rather than the performance of the clearing agency, which is a self-regulatory organization subject to regulatory oversight.

45

See
Fair Administration and Governance of Self-Regulatory Organizations; Disclosure and Regulatory Reporting by Self-Regulatory Organizations; Recordkeeping Requirements for Self-Regulatory Organizations; Ownership and Voting Limitations for Members of Self-Regulatory Organizations; Ownership Reporting Requirements for Members of Self-Regulatory Organizations; Listing and Trading of Affiliated Securities by a Self-Regulatory Organization, Release No. 34-50699 (Nov. 18, 2004) [69 FR 71126], at n. 260 (“Standardized options and security futures products are issued and guaranteed by a clearing agency.”)

46

See Listing Standards for Compensation Committees,
Release No. 33-9199 (Mar. 30, 2011) at Section II.B.2.b.

In recognition of such fundamental differences, the Commission provided exemptions for security futures products and standardized options when it adopted the audit committee listing requirements in Exchange Act Rule10A-3
47

and the compensation committee listing requirements in Exchange Act Rule 10C-1.
48

Specifically, these rules exempt the listing of a security futures

product cleared by a clearing agency that is registered pursuant to Section 17A of the Exchange Act or that is exempt from registration pursuant to Section 17A(b)(7)(A) and the listing of a standardized option issued by a clearing agency that is registered pursuant to Section 17A of the Exchange Act. For the reasons that we exempted these securities from Rules 10A-3 and 10C-1, and because any relationship between any incentive-based compensation that the clearing agency pays its executive officers and its financial statements would not be significant to investors in these futures and options, we propose to exempt these securities from the requirements of proposed Rule 10D-1.
49

47

See
Exchange Act Rules 10A-3(c)(4) and (5).

48

See
Exchange Act Rules 10C-1(b)(5)(iii) and (iv).

49
For these same reasons, we believe exempting such securities from Rule 10D-1 would be in the public interest and consistent with the protection of investors. See Exchange Act Section 36(a).

Request for Comment

6. Are our proposed exemptions for listing securities futures products and standardized options appropriate? Why or why not?

7. Are there other types of securities that we should consider exempting from Rule 10D-1? If so, please explain which securities we should exempt and why.

3. Registered Investment Companies

In some cases, registered investment companies list their securities on an exchange. These registered investment companies generally include closed-end management investment companies and certain open-end management investment companies and unit investment trusts (“UITs”) that operate as exchange-traded funds (“ETFs”).
50

Listed registered management investment companies, unlike most other issuers, are generally externally managed and often have few, if any, employees that are compensated by the registered management investment companies, (
i.e.,
the issuers). Instead, registered management investment companies typically rely on employees of the investment adviser to manage fund assets and carry out other related business activities. Such employees are typically compensated by the investment adviser of the registered management investment company as opposed to the fund. There are a small number of listed registered management investment companies that are internally managed. Such internally managed registered management investment companies might pay executive officers incentive-based compensation, as defined in proposed Rule 10D-1.

50
See Investment Company Act Sections 5(a)(1) (definition of open-end management investment company) and 5(a)(2) (definition of closed-end management investment company) [15 U.S.C. 80a-5(a)]. See also Investment Company Act Section 4(2) (definition of UIT). ETFs are open-end management investment companies or UITs that offer redeemable securities that are listed and trade on an exchange. Since the investment portfolio of a UIT is generally fixed, UITs are not management investment companies. See text following note 48 below.

We believe that a listed registered management investment company
51

should be subject to the requirements of proposed Rule 10D-1 only to the extent that it pays executive officers incentive-based compensation. Accordingly, we propose to exempt the listing of any security issued by a registered management investment company if such management company has not awarded incentive-based compensation to any executive officer of the registered management investment company in any of the last three fiscal years or, in the case of a company that has been listed for less than three fiscal years, since the initial listing.
52

Management investment companies that have paid incentive-based compensation in that time period, however, would be subject to the rule and rule amendments and be required to have implemented a compensation recovery policy like other listed issuers. The conditional exemption would avoid causing management investment companies that do not pay incentive-based compensation to develop recovery policies they may never use.

51
We note that, as proposed, business development companies, which are a category of closed-end management investment company that are not registered under the Investment Company Act, would be subject to proposed Rule 10D-1. [15 U.S.C. 80a-2(a)(48) and 80a-53-64]. The purpose of business development companies is to fund small and developing businesses. In discussing the amendments to the Investment Company Act that established business development companies, the House Report noted such companies' special purpose and specifically recognized the need for such companies to be able to offer incentive-based compensation to their officers.
See
H.R. Rep. No. 1341, 96th Cong., 2d Sess. 21 (1980). We therefore see no reason to exempt business development companies that list their securities for trading on an exchange from the general requirements of the proposed rule.

52
Proposed Rule 10D-1(b)(2)(iv). We expect that each exchange and association would adopt the necessary listing standards to ensure that those registered management investment companies that qualify for the exemption have complied with the proposed rule's exemption requirements.

We are also proposing to exempt the listing of any security issued by a UIT from the requirements of proposed Rule 10D-1.
53

Unlike management investment companies, UITs are pooled investment entities without a board of directors, corporate officers, or an investment adviser to render investment advice during the life of the UIT. In addition, because the investment portfolio of a UIT is generally fixed, UITs are not actively managed. Also, unlike registered management investment companies, UITs do not file a certified shareholder report. Accordingly, we believe that due to their particular structure and characteristics, the requirements of proposed Rule 10D-1 would be inapplicable to UITs.
54

53
Proposed Rule 10D-1(b)(2)(iii).

54
For similar reasons, the Commission exempted UITs when it adopted the audit committee listing requirements in Exchange Act Rule 10A-3.
See
Exchange Act Rules 10A-3(c)(6).

We are also proposing to amend Form N-CSR to redesignate Item 12 as Item 13
55

and to add new paragraph (a)(3) to that Item. The new paragraph would require any registered management investment company that would be subject to the requirements of proposed Rule 10D-1 to include as an exhibit to its annual report on Form N-CSR its policy on recovery of incentive-based compensation.

55
We are also proposing a conforming amendment to General Instruction D to Form N-CSR to refer to redesignated Item 13(a)(1).

We are also proposing to add new Item 12 to Form N-CSR as well as to amend Item 22 of Schedule 14A of the Exchange Act. Both amendments would require registered management investment companies that would be subject to proposed Rule 10D-1 to provide information that would mirror the disclosure requirements of Item 402(w) of Regulation S-K.
56

56

See
Section II.D.1, below.

Request for Comment

8. Are the exemptions for registered management investment companies and UITs as described above appropriate? Why or why not?

9. Should we conditionally exempt business development companies from the proposed listing standards, to the same extent as we propose to do with registered management investment companies? If so, please explain why.

10. Should we unconditionally exempt registered management investment companies from the proposed listing standards, as we propose to do with UITs? Should we unconditionally exempt registered open-end management investment companies that list their securities on an exchange, and only apply the conditional exemption to closed-end management investment companies? Please explain why.

11. Should we require listed registered management investment companies to disclose in annual reports on Form N-CSR or elsewhere whether or not the registered management investment company has in fact

awarded incentive-based compensation to executive officers in the last three fiscal years, or in the case of a registered management investment company that has been listed for less than three fiscal years, since the listing of the registered management investment company? Should a similar disclosure requirement apply to UITs?

B. Restatements

1. Restatements Triggering Application of Recovery Policy

Sections 10D(a) and 10D(b)(2) require exchanges and associations to adopt listing standards that require issuers to adopt and comply with policies that require recovery “in the event that the issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws.” The Senate Report indicated that Section 10D was intended to result in “public companies [adopting policies] to recover money that they erroneously paid in incentive compensation to executives as a result of material noncompliance with accounting rules. This is money that the executive would not have received if the accounting was done properly.”
57

Commenters equested guidance regarding the definition of material noncompliance generally.
58

One commenter recommended that the Commission either identify the circumstances that would constitute material noncompliance with financial reporting requirements or, at a minimum, provide examples of such circumstances as a guide for making such a determination, since the determination of whether or not any noncompliance is material would be based on the facts and circumstances of each situation.
59

In addressing who must make the material noncompliance determination, one commenter noted that Section 10D was unclear as to who must make this determination
60

and others recommended that the determination be left to the issuer.
61

57
Senate Report at 135.

58

See
letters from Frederic W. Cook & Co., Inc., Towers Watson, Baker, Donelson, Bearman, Caldwell & Berkowitz, PC and Compensia, Inc.

59

See
letter from Compensia, Inc.

60

See
letter from Compensia, Inc.

61

See
letters from Baker, Donelson, Bearman, Caldwell & Berkowitz, PC and David Polk & Wardwell LLP.

Two commenters noted that because a restatement would have to be the result of material noncompliance with financial reporting requirements, Congress recognized that not all accounting restatements would require recovery.
62

Several commenters recommended that the Commission exclude restatements based on changes in generally accepted accounting principles from the types of restatements that trigger recovery.
63

Another commenter observed that a change in accounting standards would appear not to trigger recovery, but a change in how an auditor interprets accounting standards may trigger recovery, even absent issues regarding whether the issuer had adequate controls in place over its financial reporting system.
64

62

See
letters from Towers Watson and Baker, Donelson, Bearman, Caldwell & Berkowitz, PC.

63

See
letters from Center on Executive Compensation, Frederic W. Cook & Co., Inc. and Protective Life Corporation.

64

See
letter from Towers Watson.

We believe that an error that is material to previously issued financial statements constitutes “material noncompliance” by the issuer with a financial reporting requirement under the securities laws, as contemplated by Section 10D. Accordingly, proposed Rule 10D-1 would provide that issuers adopt and comply with a written policy providing that in the event the issuer is required to prepare a restatement
65

to correct an error
66

that is material to previously issued financial statements,
67

the obligation to prepare the restatement would trigger application of the recovery policy.
68

In connection with this, proposed Rule 10D-1 would define 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.
69

We do not propose to describe any type or characteristic of an error that would be considered material for purposes of the listing standards required by proposed Rule 10D-1 because materiality is a determination that must be analyzed in the context of particular facts and circumstances. Moreover, materiality has received extensive and comprehensive judicial and regulatory attention.
70

We note that issuers 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.

65
Under U.S. Generally Accepted Accounting Principles (“GAAP”), a restatement is “the process of revising previously issued financial statements to reflect the correction of an error in those financial statements.”
See
FASB ASC Topic 250,
Accounting Changes and Error Corrections
(formerly SFAS No. 154,
Accounting Changes and Error Corrections
) (“ASC Topic 250”). Under International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS”), a retrospective restatement is “correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred.”
See
IAS 8,
Accounting Policies, Changes in Accounting Estimates and Errors,
paragraph 5.

66
Under GAAP, an error in previously issued financial statements is “[a]n error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles (GAAP), or oversight or misuse of facts that existed at the time the financial statements were prepared. A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.”
See
ASC Topic 250. Under IFRS, prior period errors are “omissions from, and misstatements in, the entity's financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that: (a) Was available when financial statements for those periods were authorised for issue; and (b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.”
See
IAS 8,
Accounting Policies, Changes in Accounting Estimates and Errors,
paragraph 5.

67
When we refer to financial statements, we mean the statement of financial position (balance sheet), income statement, statement of comprehensive income, statement of cash flows, statement of owners' equity, and accompanying footnotes, as required by Commission regulations. When we refer to financial statements for registered investment companies and business development companies, we mean the statement of assets and liabilities (balance sheet) or statement of net assets, statement of operations, statement of changes in net assets, statement of cash flows, schedules required by Rule 6-10 of Regulation S-X, financial highlights, and accompanying footnotes, as required by Commission regulations.

68
Proposed Rule 10D-1(c)(5).

69
Proposed Rule 10D-1(c)(1)

70

See, e.g.,

TSC Industries, Inc.
v.
Northway,
426 U.S. 438 (1976);
Basic
v.
Levinson,
485 U.S. 224 (1988).

As indicated in the accounting standards, 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;
71

71
A change in accounting principle is “[a] change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles that apply or when the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle.”
See
ASC Topic 250. IAS 8 has similar guidance. A change from an accounting principle that is not generally accepted to one that is generally accepted, however, would be a correction of an error.

• Retrospective revision to reportable segment information due to a change in

the structure of an issuer's internal organization;
72

72
If an issuer changes the structure of its internal organization in a manner that causes the composition of its reportable segments to change, the corresponding information for earlier periods, including interim periods, should be revised unless it is impracticable to do so.
See
ASC Topic 280-10-50-34. IFRS 8 has similar guidance.

• Retrospective reclassification due to a discontinued operation;
73

73

See
ASC Topic 205-20. IFRS 5 has similar guidance.

• Retrospective application of a change in reporting entity, such as from a reorganization of entities under common control;
74

74

See
ASC Topic 250-10-45-21. IFRS does not have specific guidance addressing this reporting matter.

• Retrospective adjustment to provisional amounts in connection with a prior business combination;
75

and

75

See
ASC Topic 805-10-25-13. IFRS 3 has similar guidance.

• Retrospective revision for stock splits.

Request for Comment

12. For purposes of proposed Rule 10D-1, an accounting restatement would be defined as the result of the process of revising previously issued financial statements to correct errors that are material to those financial statements. Rather than including this definition in our proposed rule, should we refer to the definition of “restatement” in GAAP?
76

If we do not refer to the definition in GAAP, is it appropriate to include in the proposed definition the phrase “errors that are material” or might it be confusing or redundant? Is our proposed approach the appropriate means to implement Section 10D, including its “material noncompliance” provision?

76

See
n.65, above.

13. If an issuer evaluates whether certain errors are material, and concludes that such errors are immaterial or are not the result of material noncompliance, should the issuer disclose its evaluation? If so, what should be disclosed and where should such disclosure be required?

14. Should any revision to previously issued financial statements that results in a reduction in incentive-based compensation received by an executive officer always trigger application of an issuer's recovery policy under the proposed listing standards? Why or why not?

15. As noted above, certain changes to the financial statements would not trigger recovery because they do not represent error corrections under the accounting standards. Are there any other types of changes to an issuer's financial statements that should not be deemed to trigger application of the issuer's recovery policy?

16. Should the proposed listing standards contain any anti-evasion language regarding the circumstances in which recovery would be triggered? If so, what should the language provide?

2. Date the Issuer Is Required To Prepare an Accounting Restatement

Section 10D(b)(2) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with policies that require the recovery of excess incentive-based compensation “during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement.” Section 10D does not specify when a listed issuer is “required to prepare an accounting restatement” for purposes of this recovery provision.

Several commenters requested clarification on how to determine the date on which the issuer is “required to prepare an accounting restatement” and provided suggestions in this regard.
77

One commenter asked whether a restatement would be “required” for purposes of Section 10D as of the date the financial statements are stated incorrectly.
78

Another commenter expressed the view that the date of the erroneous statement should be the date on which a new statement must be prepared.
79

Other commenters recommended that the recovery trigger should be the date the issuer files an accounting restatement due to the issuer's material noncompliance with a financial reporting requirement under the securities laws.
80

A different commenter suggested using the date the decision to undertake the restatement is made, providing as examples the date an issuer's board of directors authorizes the preparation of an accounting restatement or the date a court or regulatory authority orders or requires an issuer to prepare an accounting restatement.
81

Another commenter recommended that the issuer be deemed “required to prepare an accounting restatement” when a Current Report on Form 8-K is filed disclosing non-reliance on the issuer's financial statements, or, if no Form 8-K is required, the date that either the board of directors or management determines that a restatement is required.
82

77

See
letters from Center on Executive Compensation, Compensia, Inc., Davis Polk & Wardwell LLP, Meridian Compensation Partners, LLC, and Towers Watson.

78

See
letter from Towers Watson.

79

See
AFL-CIO Joint Letter.

80

See
letters from Center on Executive Compensation and Protective Life Corporation.

81

See
letter from Compensia, Inc.

82

See
letter from Davis Polk & Wardwell LLP.

We considered the alternatives identified by commenters for when an issuer is “required to prepare an accounting restatement” for purposes of the proposed listing standards, and are concerned that some of these alternatives would not operate effectively with the three-year look-back period for recovery prescribed by Section 10D. While the issuer has an obligation to file materially complete and accurate financial statements, which could support using the date the erroneous financial statements were filed as the triggering date for Section 10D, we believe this approach would not fully effectuate Section 10D's purpose. If the date of filing of the erroneous financial statements were used as the starting point for the look-back period, recovery would not apply to any incentive-based compensation received after that date, even when the amount was affected by the erroneous financial statements. For example, if 2014 net income was materially misstated, and a 2014-2016 long-term incentive plan had a performance measure of three-year cumulative net income, a look-back period that covered only the three years before the erroneous filing would not capture the compensation earned under that plan. While the date of the erroneous filing is easily discernible, using this date may result in listed issuers recovering only incentive-based compensation that was received during the fiscal year preceding the filing date of the financial statements that included the subsequently restated financial reporting measure. We believe this result would be inconsistent with the three-year look-back period that the statute specifies.

We also considered using the date the issuer files the accounting restatement for triggering the three-year look-back period. However, we believe this approach also would not appropriately implement Section 10D because the issuer necessarily would have been required to prepare an accounting restatement at some point before it actually filed the restatement.
83

Moreover, an issuer might improperly delay filing a restatement after determining that restatement was necessary, and by doing so could affect

the amounts of compensation subject to recovery.

83
As noted in Section II.C.2.b, below, the three-year look-back period is not meant to limit or designate the reporting periods for which an accounting restatement is required, or to limit which restated financial statements may be filed with the Commission.

In considering how best to craft a trigger for recovery under the proposed listing standards, we have sought to define the date on which an accounting restatement is required in a way that provides reasonable certainty for issuers, shareholders and exchanges while not permitting issuers to avoid recovery when a material error has occurred. To that end, we are proposing a definition that would be triggered by the occurrence of certain issuer or third-party determinations about the need for a restatement. Specifically, under the proposed listing standards, the proposed rule would state 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.
84

84
Proposed Rule 10D-1(c)(2).

A note to the proposed rule would indicate 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.
85

For the first proposed date to occur, the issuer merely needs to have concluded that previously issued financial statements contain a material error, which we expect may occur before the precise amount of the error has been determined. While we recognize that listed issuers must apply judgment before concluding that previously issued financial statements contain a material error, we believe this judgment should be applied on an objective basis, which is when a reasonable issuer, based on the facts available, would have concluded that the previously issued financial statements contain a material error. In this regard, while not dispositive, we believe that an issuer would have to consider carefully any notice received from its independent auditor that previously issued financial statements contain a material error.

85
Note to proposed Rule 10D-1(c)(2). For example, if a listed issuer files an Item 4.02(b) Form 8-K because it is advised by, or receives notice from, its independent accountant that disclosure should be made or action should be taken to prevent future reliance on a previously issued audit report or completed interim review related to previously issued financial statements that contain a material error, the triggering event for the recovery policy occurs when the listed issuer decides to restate its financial statements even if it subsequently neglects to file an Item 4.02(a) Form 8-K to report that decision.

We recognize that the second proposed date on which an issuer would be required to prepare a restatement for purposes of Section 10D may occur earlier than the board's determination if a court or other legally authorized body, such as a regulator, directs the issuer to restate.

We believe a definition that incorporates the proposed triggering events rather than leaving the determination solely to the discretion of the issuer would better realize the objectives of Section 10D while providing clarity about when a recovery policy, and specifically the determination of the three-year look-back period, will be triggered for purposes of the proposed listing standards. In this regard, we note that the proposed rule also states that an issuer's obligation to recover excess incentive-based compensation is not dependent on if or when the restated financial statements are filed. Further, we note that issuers that knowingly, recklessly or negligently misreport materially false or misleading financial information would be subject to liability under existing antifraud provisions.
86

86

See
Securities Act Section 17(a) [15 U.S.C. 77q(a)], Exchange Act Section 10(b) [15 U.S.C. 78j(b)] and Exchange Act Rule 10b-5 [17 CFR 240.10b-5].

Request for Comment

17. Is it appropriate to treat the earlier of the two proposed dates as “the date on which an issuer is required to prepare an accounting restatement” for purposes of triggering the Section 10D recovery obligation? If not, why not? Would using these dates provide sufficient certainty and transparency for issuers, investors and exchanges to determine when recovery would be triggered for purposes of compliance with the proposed listing standards? Are there additional triggers we should consider including?

18. Should receipt of a notice from a company's independent auditor that previously issued financial statements contain a material error constitute a date when the issuer “reasonably should have concluded” that such statements contain a material error? Why or why not? What if the issuer disagrees with the auditor's conclusion?

19. Are there other means of defining the date on which an issuer is required to prepare an accounting restatement that would provide clear benchmarks that do not inject subjectivity into when recovery would be triggered? If so, how should the date on which the issuer is required to prepare a restatement be defined?

C. Application of Recovery Policy

1. Executive Officers Subject to Recovery Policy

Section 10D(b)(2) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with policies that provide for recovery of excess incentive-based compensation from “any current or former executive officer of the issuer who received incentive-based compensation.” Section 10D does not define “executive officer” for purposes of the recovery policy.
87

87
The Senate Committee on Banking, Housing, and Urban Affairs noted that “[t]his policy is required to apply to executive officers, a very limited number of employees, and is not required to apply to other employees.” Senate Report at 136.

Several commenters requested guidance on the definition of executive officer.
88

One commenter
89

indicated that the Section 10D's reference to executive officer appears to use the executive officer definition in Exchange Act Rule 3b-7.
90

Another commenter
91

questioned whether the recovery policy would cover officers subject to Exchange Act Section 16
92

or only the

named executive officers.
93

Another specifically recommended using the Section 16 definition of “officer,” and stated that executive officers of subsidiaries should be included in the definition.
94

A different commenter requested guidance regarding how the recovery policy should apply to persons who are executive officers during only a portion of the recovery period.
95

88

See
letters from Baker, Donelson, Bearman, Caldwell & Berkowitz, PC, Towers Watson and Robert E. Scully Jr.

89

See
letter from Towers Watson.

90
Exchange Act Rule 3b-7 provides that “[t]he term executive officer, when used with reference to a registrant, means its president, any vice president of the registrant 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 registrant.” Executive officers of subsidiaries may be deemed executive officers of the registrant if they perform such policy making functions for the registrant.” 17 CFR 240.3b-7.

91

See
letter from Baker, Donelson, Bearman, Caldwell & Berkowitz, PC.

92
15 U.S.C. 78p. As defined in Exchange Act Rule 16a-1(f) [17 CFR 240.16a-1(f)], the term “officer” means “an 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. Officers of the issuer's parent(s) or subsidiaries shall be deemed officers of the issuer if they perform such policy-making functions for the issuer.” The rule also contains specific provisions with respect to limited partnerships and trusts, and a note providing that “policy-making function” is not intended to include policy making functions that are not

significant and that persons identified as “executive officers” pursuant to Item 401(b) of Regulation S-K [17 CFR 229.401(b)] are presumed to be officers for purposes of Section 16, as are other persons enumerated in Rule 16a-1(f) but not in Item 401(b). 15 U.S.C. 78p.

93

See
Item 402(a)(3) of Regulation S-K. For smaller reporting companies and emerging growth companies, named executive officers include the following: all individuals serving as the issuer's principal executive officer or acting in similar capacities during the last completed fiscal year, regardless of compensation level; the issuer's two most highly compensated executive officers other than the principal executive officer who were serving as executive officers at the end of the last completed fiscal year; and up to two additional individuals for whom disclosure would have been provided based on highest compensation but for the fact that the individual was not serving as an executive officer of the issuer at the end of the last completed fiscal year.
See
Item 402(m)(2) of Regulation S-K and Section 102(c) of the Jumpstart Our Business Startups Act (“JOBS Act”).

94

See
AFL-CIO Joint Letter.

95

See
letter from Baker, Donelson, Bearman, Caldwell & Berkowitz, PC.

We believe that Section 10D's mandatory recovery policy was intended to apply, at a minimum, to all executive officers of the issuer, rather than a more limited category such as the named executive officers for whom executive compensation disclosure is required under Item 402 of Regulation S-K. The Senate Report accompanying the statute indicates that “[t]his policy is required to apply to executive officers[.]”
96

Moreover, we believe applying the recovery policy to all executive officers would more effectively realize the statutory goal of Section 10D because officers with policy making functions and important roles in the preparation of financial statements set the tone for and manage the issuer. In this regard, we do not believe that a listed issuer should be unable to recover unearned compensation from an executive officer simply because he or she was not one of the individuals identified for purposes of Item 402's disclosure requirements.

96

See
Senate Report.

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). 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.
97

97
Proposed Rule 10D-1(c)(3), which also would specify who would be executive officers if the issuer is a limited partnership or trust.

In particular, the proposed definition would expressly include the principal financial officer and the principal accounting officer (or if there is no such accounting officer, the controller) among the officers specified. We believe that their responsibility for financial information justifies their inclusion in the definition of “executive officer” for this purpose, just as these officers were specifically included in the Rule 16a-1(f) definition of “officer.
98

Although the compensation recovery provisions of Section 10D apply without regard to an executive officer's responsibility for preparing the issuer's financial statements, we believe that it is clearly appropriate for officers with an important role in financial reporting to be subject to the recovery policy. The proposed definition, like Rule 16a-1(f), provides that executive officers of the issuer's parents or subsidiaries may be deemed executive officers of the issuer if they perform policy making functions for the issuer. As is the case for Section 16 officer determination, if pursuant to Item 401(b) of Regulation S-K the issuer identifies a person as an “executive officer,” it would be presumed that the board of directors has made that judgment and the persons so identified are executive officers for purposes of proposed Rule 10D-1.
99

98
17 CFR 240.16a-1(f). In proposing their inclusion in the Rule 16a-1(f) definition of “officer,” the Commission noted that principal financial officers and principal accounting officers are required to sign an issuer's Securities Act registration statements and Exchange Act annual reports on Form 10-K. Release No. 34-27148 (Aug. 18, 1989) [54 FR 35667] at n. 31. Subsequently, Section 302 of SOX required the principal financial officer, as well as the principal executive officer, to certify the information contained in each annual or quarterly report filed under Section 13(a) or 15(d) of the Exchange, and the effectiveness of the issuer's internal controls. Listed companies could, of course, adopt policies that applied to a larger group of employees so long as the policy at a minimum applied to executive officers.

99

See
proposed Note to Rule10D-1(c)(3), modeled on the
Note
to Rule 16a-1(f).

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].” We believe that the statute was designed to require recovery of excess incentive-based compensation provided for service as an executive officer. Accordingly, the rule and rule amendments we propose would 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.
100

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. As proposed, recovery would not apply to an individual who is an executive officer at the time recovery is required if that individual had not been an executive officer at any time during the performance period for the incentive-based compensation subject to recovery.

100
Proposed Rule 10D-1(b)(1)(i)(B).

Request for Comment

20. Consistent with the Rule 16a-1(f) definition of “officer”, should we define “executive officers” to expressly include the principal financial officer and the principal accounting officer (or if there is no such accounting officer, the controller), as proposed?

21. Are there any other officers, such as the chief legal officer, chief information officer, or such other officer, who by virtue of their position should be specifically named as executive officers subject to the issuer's recovery policy? If so, which additional officers should be subject to the issuer's recovery policy and why?

22. Are there any other officers who should be included in the group of executive officers subject to the issuer's recovery policy, but who may not fall within the proposed definition? Is the definition of executive officer appropriate? If not, how else should executive officer be defined?

23. Alternatively, is the proposed definition of “executive officer” too broad? Should we instead limit the recovery policy to “named executive officers,” as defined in Items 402(a)(3) and 402(m)(2) of Regulation S-K or otherwise define a more narrow set of officers subject to recovery?

24. Will the scope of the term “executive officer” for purposes of Section 10D affect issuers' practices in

identifying executive officers for other purposes? If so, how, and what if anything should we do to address that? Are there other means of simplifying the identification of “executive officers” for purposes of Rule 10D-1 that would promote consistency with identifying executive officers for other purposes, such as Item 401(b) of Regulation S-K? Is there another, more appropriate definition?

25. Is it consistent with the purposes of Section 10D to apply recovery to any incentive-based compensation earned during the three completed fiscal years immediately preceding the date that the issuer is required to prepare a restatement if that person served as an executive officer at any time during the performance period? Alternatively, should an individual be subject to recovery only for incentive-based compensation earned during the portion of the performance period during which the individual was serving as an executive officer? Should an individual who is an executive officer at the time recovery is required be subject to recovery even if that individual did not serve as an executive officer of the issuer at any time during the performance period for the affected incentive-based compensation? If a different standard should govern the circumstances when an executive officer or former executive officer is subject to recovery, what should that standard be, and why should it apply?

2. Incentive-Based Compensation

a. Incentive-Based Compensation Subject to Recovery Policy

Section 10D(b)(2) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with recovery policies that apply to “incentive-based compensation (including stock options awarded as compensation)” that is received, based on the erroneous data, in “excess of what would have been paid to the executive officer under the accounting restatement.” Implicit in these statutory requirements is that the amount of such compensation received in the three-year look-back period would have been less if the financial statements originally had been prepared as later restated.

Several commenters recommended that the Commission clarify the types of compensation to which the listing standards' recovery policy would apply.
101

To that end, some commenters suggested potential standards that focused on the compensation being based on or related to publicly reported financial statements.
102

For example, one commenter stated that any form of compensation that is contingent upon the achievement of one or more pre-determined and objective performance goals “that expressly relate to and are derived from one or more financial or stock price metric set forth in an issuer's financial statements filed with the Commission” should be incentive-based compensation for purposes of Section 10D.
103

In some cases, commenters suggested we look to the existing definitions of “incentive plan,” “equity incentive plan award” and “non-equity incentive plan award” in Item 402(a)(6)(iii) of Regulation S-K in defining incentive-based compensation subject to recovery.
104

101

See, e.g.,
letters from ABA Business Law Section, American Benefits Council, Center on Executive Compensation, Meridian Compensation Partners, LLC, Protective Life Corporation, Robert E. Scully Jr, and Society of Corporate Secretaries and Governance Professionals.

102

See, e.g.,
letters from ABA Business Law Section, American Benefits Council, Center on Executive Compensation, David Polk, and Meridian Compensation Partners, LLC.

103

See
letter from Meridian Compensation Partners, LLC.

104

See
letters from ABA Business Law Section and David Polk.

To identify compensation that is awarded or vests based on financial performance measures, some commenters
105

provided various examples of financial information required to be reported under the securities laws, such as revenue, net income and earnings per share, and examples of related non-GAAP measures, such as EBITDA.
106

Commenters also recommended that awards based solely on satisfaction of non-financial measures—for example, operational measures such as market share and customer satisfaction, subjective measures such as leadership, and strategic measures such as consummation of a merger—should not be subject to an issuer's recovery policy.
107

Generally, commenters who specifically addressed stock price and total shareholder return
108

measures recommended excluding them from recovery policies,
109

or expressed the view that any connection between the erroneous data relating to an accounting restatement and the fluctuating value of the issuer's stock would be tangential and speculative.
110

105

See, e.g.,
letters from Center on Executive Compensation, Meridian Compensation Partners, LLC and Protective Life Corporation.

106
Earnings before interest, taxes, depreciation and amortization.

107

See, e.g.,
letters from Center on Executive Compensation, Meridian Compensation Partners, LLC, Protective Life Corporation, and Society of Corporate Secretaries and Governance Professionals.

108
“Total shareholder return” or “TSR” is a measure based on the change in stock price plus dividends over a period of time.

109

See
letters from Center on Executive Compensation and Protective Life Corporation.

110

See
letter from American Benefits Council.

One commenter who addressed the statute's inclusion of “stock options awarded as compensation” questioned whether recovery should apply to the extent the enhancement in an award's value is solely attributable to increases in the fair market value of the underlying shares.
111

Other commenters recommended excluding from recovery equity awards that are not granted upon achievement of one or more pre-determined and objective financial metrics, and that vest solely upon the passage of time, continued service or satisfaction of non-financial metrics.
112

111

See
letter from American Benefits Council.

112

See
letters from Center on Executive Compensation, Compensia, Meridian Compensation Partners, LLC and Protective Life Corporation.

Commenters also raised questions whether other forms of compensation, such as discretionary bonuses, future benefits under supplemental retirement benefit plans calculated based on incentive compensation awards and investment returns on incentive-based compensation deferred pursuant to deferred compensation plans, would be incentive-based compensation subject to recovery.
113

In particular, some commenters requested guidance concerning bonuses paid pursuant to “pool plans,” where achievement of financial performance measures establishes the overall size of the bonus pool, but discretion is exercised in determining the amount of individual bonuses.
114

113

See, e.g.,
letter from Robert E. Scully, Jr.

114

See
letters from Center on Executive Compensation and Protective Life Corporation.

In considering how best to define incentive-based compensation for purposes of the proposed rule,
115

we have considered the statutory language of Section 10D, the views of commenters, and the administrability of any mandatory recovery policy that encompasses such compensation. Rather than identifying each type or form of compensation to which a recovery policy required under the listing standards would apply, for purposes of proposed Rule 10D-1 we propose to define “incentive-based compensation” in a principles-based manner, which we believe would enable the rule and rule amendments to operate effectively as new forms of compensation and new measures of

performance upon which compensation is based are developed. 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.”
116

115
The proposed definition would be applicable only to recovery of incentive-based compensation under proposed Rule 10D-1, and would not apply to the recovery of incentive-based compensation pursuant to SOX Section 304.

116

See
proposed Rule 10D-1(c)(4). “In part,” is included in the definition to clarify that incentive-based compensation need not be based solely upon attainment of a financial reporting measure. An example of compensation that is based in part upon the attainment of a financial reporting measure would include an award in which 60 percent of the target amount is earned if a certain revenue level is achieved, and 40 percent of the target amount is earned if a certain number of new stores are opened. Similarly, an award for which the amount earned is based on attainment of a financial reporting measure but is subject to subsequent discretion by the compensation committee to either increase or decrease the amount would be based in part upon attainment of the 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,
117

any measures derived wholly or in part from such financial information,
118

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,
119

and may be presented outside the financial statements, such as in Management's Discussion and Analysis of Financial Conditions and Results of Operations (“MD&A”)
120

or the performance graph.
121

Accordingly, examples of financial reporting measures would include, but would not be limited to, the following accounting-based measures (including measures derived therefrom):

117
For foreign private issuers whose financial statements are based upon a comprehensive body of accounting principles other than GAAP or IFRS, the restatement would relate to amounts reported using such other accounting principles but not the reconciliation to GAAP. We would not consider the reconciliation to GAAP to be within the meaning of financial reporting measures for purposes of this proposed rule.

118
The proposed definition is broader than a “non-GAAP financial measure” for purposes of Exchange Act Regulation G [17 CFR 244.100
et seq.
] and Item 10 of Regulation S-K [17 CFR 229.10].

119
For example, same store sales or regional sales volume may not be disclosed in a filing with the Commission, but nevertheless could be affected by an accounting restatement for revenue recognition.

120
17 CFR 229.303.
See also
Item 5, Form 20-F. Examples of this could be accounts receivable turnover, EBITDA, or sales per square foot.

121
17 CFR 229.201(e).

• Revenues;

• Net income;

• Operating income;

• Profitability of one or more reportable segments;
122

122
As disclosed in a financial statement footnote.
See
ASC Topic 280.

• Financial ratios (
e.g.,
accounts receivable turnover and inventory turnover rates);

• Net assets or net asset value per share (for registered investment companies and business development companies that are subject to the rule);

• EBITDA;
123

123
Earnings before interest, taxes, depreciation and amortization.

• Funds from operations (“FFO”)
124

and adjusted funds from operations (“AFFO”);

124
FFO is a non-GAAP financial measure commonly used in the real estate industry.

• Liquidity measures (
e.g.,
working capital, operating cash flow);

• Return measures (
e.g.,
return on invested capital, return on assets);

• Earnings measures (
e.g.,
earnings per share);

• Sales per square foot or same store sales, where sales is subject to an accounting restatement;

• Revenue per user, or average revenue per user, where revenue is subject to an accounting restatement;

• Cost per employee, where cost is subject to an accounting restatement;

• Any of such financial reporting measures relative to a peer group, where the issuer's financial reporting measure is subject to an accounting restatement; and

• Tax basis income.

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. Section 10D(b) requires disclosure of an issuer's policy with respect to “incentive-based compensation that is based on financial information required to be reported under the securities laws” and recovery of compensation awarded “based on the erroneous data.” Although the phrase “financial information required to be reported under the securities laws” might be interpreted as applying only to accounting-based metrics, we believe 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.
125

Further, Congress' direction to include compensation that is
based on
financial information and to recover compensation
based on
the erroneous accounting data suggests that we should include incentive compensation tied to measures such as stock price and total shareholder return to the extent that improper accounting affects such measures, and in turn results in excess compensation. We also recognize that total shareholder return is a frequently used performance metric for executive compensation,
126

and that excluding it might not promote the goals we believe Congress intended. Moreover, we are concerned that not including TSR could incentivize issuers to alter their executive compensation arrangements in ways that would avoid application of the mandatory recovery policy and result in less efficient incentive alignment.
127

125
In this regard, we note that Item 201 of Regulation S-K requires issuers with common equity the principal market for which is an exchange, to disclose the high and low sales prices “for each full quarterly period within the two most recent fiscal years and any subsequent interim period for which financial statements are included . . . .” In addition, Item 201(e) of Regulation S-K requires issuers that are not smaller reporting companies to disclose stock price information and a performance graph comparing the company's cumulative total shareholder return with a performance indicator of the overall stock market and either a published industry index or company-determined peer comparison.

126

See
Section III, below.

127

See
Section III, below.

In proposing that the statutory language should be interpreted to encompass incentive-based compensation tied to stock price and total shareholder return, as well as accounting-based metrics, we have considered potential administrative burdens that could be imposed on issuers in determining the amount of compensation to be recovered. In some cases, issuers may need to engage in complex analyses that require significant technical expertise and specialized knowledge, and may involve substantial exercise of judgment in order to determine the stock price impact of a material restatement. Due to the presence of confounding factors, it sometimes may be difficult to establish the relationship between an accounting error and the stock price. We recognize these potential challenges and, as discussed more fully below,
128

are proposing that issuers be permitted to use reasonable estimates when determining the impact of a restatement on stock price and total shareholder return and to require them to disclose the estimates.
129

We believe that being able to use reasonable estimates to assess the effect of the accounting restatement on these performance measures in determining the amount of erroneously awarded compensation should help to mitigate these potential difficulties.

128

See
Section II.C.3.a, below.

129

See
Section II.D.1, below.

While the definition we are proposing is intended to be applied broadly and flexibly, it does not encompass all forms

of incentive compensation.
130

An incentive plan award that is granted, earned or vested based solely upon the occurrence of certain non-financial events, such as opening a specified number of stores, obtaining regulatory approval of a product, consummating a merger or divestiture, completing a restructuring plan or financing transaction, would not be “incentive-based compensation” because these measures of performance are not financial reporting measures. Although these non-financial metrics are not included in the proposed definition, we are soliciting comment below on whether the definition of “incentive-based compensation” should include additional performance measures.

130
In this regard we note that the proposed definition of “incentive-based compensation” is narrower in scope than the definition of “incentive plan,” in Item 402(a)(6)(iii) of Regulation S-K, which is “any plan providing compensation intended to serve as an incentive for performance to occur over a specified period, whether such performance is measured by reference to financial performance of the registrant or an affiliate, the registrant's stock price, or any other performance measure.” Item 402(a)(6)(iii) of Regulation S-K [17 CFR 229.402(a)(6)(iii)]. The proposed Rule 10D-1 definition would not include “other performance measures” in light of Section 10D's reference to incentive-based compensation based on financial information required to be reported under the federal securities laws.

The statute further specifies that incentive-based compensation to which recovery should apply under the recovery policy required by the listing standard “includ[es] stock options awarded as compensation.” Accordingly, as proposed, “incentive-based compensation” would include options and other equity awards whose grant or vesting is based wholly or in part upon the attainment of any measure based upon or derived from financial reporting measures.
131

Applying the proposed Rule 10D-1 definition, compensation that would be subject to the recovery policy required by the proposed listing standards would include, but not be limited to:

131
This would be the standard for purposes of proposed Rule 10D-1 even though time-vested stock options are generally considered “performance-based” for purposes of exclusion from the Internal Revenue Code Section 162(m) $1 million cap on tax-deductible executive compensation if the amount of compensation attributable to the options is based solely on an increase in company stock price, assuming the exercise price is no less than fair market value of the underlying stock on the date of grant.
See
26 CFR 1.162-27(e)(2)(vi).

• Non-equity incentive plan awards that are earned based wholly or in part on satisfying a financial reporting measure performance goal;

• Bonuses paid from a “bonus pool,” the size of which is determined based wholly or in part on satisfying a financial reporting measure performance goal;

• Restricted stock, restricted stock units (“RSUs”), performance share units (“PSUs”), stock options, and stock appreciation rights (“SARs”) that are granted or become vested based wholly or in part on satisfying a financial reporting measure performance goal; and

• Proceeds received upon the sale of shares acquired through an incentive plan that were granted or vested based wholly or in part on satisfying a financial reporting measure performance goal.

Examples of compensation that would
not
be “incentive-based compensation” for this purpose would include, but not be limited to:

• Salaries;
132

132
However, to the extent that an executive officer receives a salary increase earned wholly or in part based on the attainment of a financial reporting measure, such a salary increase would be subject to recovery as a non-equity incentive plan award for purposes of proposed Rule 10D-1.

• Bonuses paid solely at the discretion of the compensation committee or board that are not paid from a “bonus pool,” the size of which is determined based wholly or in part on satisfying a financial reporting measure performance goal;

• Bonuses paid solely upon satisfying one or more subjective standards (
e.g.,
demonstrated leadership) and/or completion of a specified employment period;

• Non-equity incentive plan awards earned solely upon satisfying one or more strategic measures (
e.g.,
consummating a merger or divestiture), or operational measures (
e.g.,
opening a specified number of stores, completion of a project, increase in market share); and

• Equity awards for which the grant is not contingent upon achieving any financial reporting measure performance goal and vesting is contingent solely upon completion of a specified employment period and/or attaining one or more non-financial reporting measures.

Request for Comment

26. Is the scope of incentive-based compensation subject to recovery under Section 10D(b) properly defined by reference to compensation that is granted, earned or vested based wholly or in part upon attainment of any measure that is determined or presented in accordance with applicable accounting principles? If not, please explain what other forms of compensation should be covered and why.

27. Is the proposed definition of “incentive-based compensation” the best means to capture all forms of compensation that could be subject to reduction if recalculated based on an accounting restatement? If not, please explain what other forms of compensation, which would not be covered by the proposed definition, should be covered.

28. Are there circumstances in which compensation that is received upon completion of a specified employment period or upon the attainment of any other goal that is not covered by our proposed definition should be considered incentive-based compensation subject to recovery? Why or why not? If so, how would an issuer calculate the recoverable amounts in the event of an accounting restatement? Are there any other measures of compensation that should be included in the definition of incentive-based compensation? If so, which ones and why?

29. Should compensation that is based upon stock price performance or total shareholder return be considered incentive-based compensation subject to recovery? If not, please explain why not. If compensation that is based on stock price performance or total shareholder return is included as incentive-based compensation subject to recovery, what calculations would need to be made to determine the recoverable amount? What are the costs and technical expertise required to prepare these calculations? Who would make these calculations for issuers? Would the costs be greater than for calculations tied to other financial reporting measures, which would be subject to mathematical recalculation directly from the information in an accounting restatement? Would the exchanges be able to efficiently assess these calculations for purposes of enforcing compliance with their listing standards? Why or why not? Should we require an independent third party to assess management's calculations?

30. Should incentive-based compensation be defined to include compensation that is based on satisfying one or more subjective standards (such as demonstrated leadership) to the extent that such subjective standards are satisfied in whole or in part by meeting a financial reporting measure performance goal (such as stock price performance or revenue metrics)? If so, how could this approach be implemented? Is it sufficient that the current proposal encompasses “any compensation that is granted, earned or vested based wholly or in part upon the

attainment of a financial reporting measure”? If not, why not?

31. Should the proposed rule or listing standards contain any anti-evasion language that would treat as incentive-based compensation amounts received purportedly based on one or more subjective standards but that are in fact based on financial information metrics, total shareholder return or stock price performance? If so, what should the language provide?

32. Should the definition of “incentive-based compensation” included in Rule 10D-1 be principles-based, as proposed? Alternatively, should the definition specify performance measures that may be affected by an accounting restatement? If so, please explain which examples should be included and why.

33. Regarding the statutory provision that incentive-based compensation subject to recovery “includ[es] stock options awarded as compensation,” does the proposed definition provide a basis by which issuers can identify equity awards that would be covered? If not, please explain why not. If all options should be subject to recovery, how should the amount subject to recovery following an accounting restatement be computed for time-vested options that are not granted based on satisfaction of a financial reporting measure performance goal?

34. Regarding bonuses granted from a “bonus pool,” the size of which is based wholly or in part upon satisfying a financial reporting measure performance goal, does the proposed definition properly subject this form of compensation to recovery? If not, how should we treat such compensation for purposes of Rule 10D-1?

35. Is further guidance needed as to how the proposed definition would apply to forms of compensation that may be paid out on a deferred basis, such as employee or employer contributions of incentive-based compensation to nonqualified deferred compensation plans and earnings thereon, and future retirement benefits payable under pension plans, such as supplemental retirement benefit plans, that are calculated based on incentive-based compensation?
133

If so, what further guidance should we provide?

133

See
Section II.C.3.a, below, addressing the computation of excess incentive-based compensation for these forms of compensation.

b. Time Period Covered by Recovery Policy

Section 10D(b)(2) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with recovery policies that apply to excess incentive-based compensation received “during the three-year period preceding the date on which the issuer is required to prepare an accounting restatement” but does not otherwise specify how this three -year look-back period should be measured. Commenters recommended that the listing standards address this point.
134

One commenter suggested that it be the three fiscal years preceding the date that a Form 8-K is filed disclosing non-reliance on the issuer's financial statements, or, if no Form 8-K is required, preceding the date that either the board of directors or management makes a determination that a restatement is required.
135

134

See
letters from Frederic W. Cook & Co., Inc., ABA Business Law Section and Baker, Donelson, Bearman, Caldwell & Berkowitz, PC.

135

See
letter from Davis Polk & Wardwell LLP.

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.
136

We believe 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. The three-year look-back period is not meant to alter the reporting periods for which an accounting restatement is required or for which restated financial statements are to be filed with the Commission.
137

Moreover, an issuer would not be able to delay or relieve itself from the obligation to recover erroneously awarded incentive-based compensation by delaying or failing to file restated financial statements.

136
Proposed Rule 10D-1(b)(ii).

137
For example, assume the three-year look-back period is 2016, 2017 and 2018, and incentive compensation received (as “received” would be defined in proposed Rule 10D-1(c)(6), discussed in Section II.C.2.c, below) in 2016 was earned by achieving a certain level of cumulative operating income for the two-year period from 2015 to 2016. In determining the amount of excess compensation received in 2016, the issuer would be required to prepare restated financial statements for 2015 and 2016 even if the issuer does not file one or both of those restated financial statements.

In proposing Rule 10D-1, we considered other approaches, such as a recovery policy that requires issuers to recover incentive-based compensation received during any period of three consecutive years preceding the date on which the issuer is required to prepare an accounting restatement so long as the incentive-based compensation was affected by the error. However, we do not believe that this approach is the most appropriate means to implement Section 10D because it would require additional judgments about which three years' compensation should be subject to recovery, making it less objective and harder for exchanges and listed issuers to apply uniformly.

In situations where an issuer has changed its fiscal year end during the three-year look-back period, we are proposing that the issuer must recover any excess incentive-based compensation received during the transition period occurring during, or immediately following, that three-year period in addition to any excess incentive-based compensation received during the three-year look-back period (
i.e.,
a total of four periods).
138

A transition period refers to the period between the closing date of the issuer's previous fiscal year end and the opening date of its new fiscal year.
139

For example, consider a situation in which, in late 2015, an issuer changes its fiscal closing date from June 30 to December 31, and subsequently reports on the transition period from July 1, 2015 to December 31, 2015. If the issuer's board of directors concludes in May 2017 that it will restate previously issued financial statements due to a material error, the look-back period would consist of the year ended June 30, 2014, the year ended June 30, 2015, the period from July 1, 2015 to December 31, 2015, and the year ended December 31, 2016. However, consistent with Rule 3-06(a) of Regulation S-X, a transition period of nine to 12 months would be considered a full year in applying the three-year look-back period requirement.

138
Proposed Rule 10D-1(b)(1)(ii).

139
17 CFR 240.13a-10 and 17 CFR 240.15d-10

Request for Comment

36. Is the proposed approach to determine the three-year look-back period for recovery an appropriate means to implement Section 10D? Does it properly reflect the way in which issuers make their compensation decisions (on a fiscal year by fiscal year basis)? Why or why not?

37. Should a different approach be used to determine the three-year look-back period for recovery? If so, how should the look-back period be determined, and why? For example, should an issuer be permitted to apply

its recovery policy to any three-year period in which incentive-based compensation received by executive officers was affected by the accounting error?

38. Is the proposed approach regarding transition periods related to a change in fiscal year appropriate? If not, what alternative approach should we consider? Consistent with Rule 3-06(a) of Regulation S-X, should a transition period of nine to 12 months be considered a full year in satisfying the three-year look-back period requirement?

c. When Incentive-Based Compensation Is “Received”

Section 10D does not specify when an executive officer should be deemed to have received incentive-based compensation for the recovery policy required under the applicable listing standards. One commenter asked the Commission to clarify whether an option or SAR is received when it is granted or when it is exercised or whether restricted stock, RSUs, other stock-based compensation and long-term cash incentives are received when granted, earned, vested or paid out.
140

Another commenter suggested that compensation be deemed received on the earlier of the date the compensation is paid to or earned by the executive officer, construing “earned” to mean when an executive officer obtains a non-forfeitable interest in a compensatory award.
141

140

See
letter from Brian Foley & Company, Inc.

141

See
letter from Meridian Compensation Partners, LLC.

As proposed, incentive-based compensation would be deemed received for purposes of triggering the recovery policy under Section 10D in the fiscal period
142

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.
143

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. Similarly, a cash award earned upon satisfaction of a financial reporting measure would be deemed received in the fiscal period when that measure is satisfied.

142
Including a transition period for a change in fiscal year, if applicable.

143
Proposed Rule 10D-1(c)(6).

A particular award may be subject to multiple conditions. We are 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 light of Section 10D's purpose to require listed issuers to recover compensation that “the executive would not have received if the accounting was done properly,”
144

we believe that 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. If the issuer's board of directors concludes in 2018 that the issuer will restate previously issued financial statements for 2015 through 2017 (the three-year performance period),
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the recovery policy should apply to reduce the number of RSUs ultimately payable in stock, even though the executive has not yet satisfied the two-year service-based vesting condition to payment. In this example, if the executive officer were deemed not to receive the RSUs before obtaining a non-forfeitable interest in them, such a restatement of the financial statements that would reduce the number of RSUs ultimately payable in stock would not be subject to recovery because the incentive-based compensation would not have been received during the three-year look-back period. We do not believe such an outcome would appropriately implement the policy underlying Section 10D, because it would mean that the mere passage of time pursuant to a service-based vesting condition or a subsequent performance condition unrelated to a financial reporting measure
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would preclude the issuer from recovering incentive-based compensation.

144

See
Senate Report at 135.

145
In this example, the three-year performance period coincides with the three-year look-back period covered by the recovery policy.
See
Section II.C.2.b. above regarding the three-year look-back period.

146
For example, if the subsequent condition in the example above was not service-based vesting but instead called for the issuer to open 100 stores during 2018 and 2019, or required the executive to comply with a non-compete or non-solicitation covenant during those years.

Ministerial acts or other conditions necessary to effect issuance or payment, such as calculating the amount earned or obtaining the board of directors' approval of payment, would not affect the determination of the date received. For example, for an equity award deemed received upon grant, receipt would occur in the fiscal year that the relevant financial reporting measure performance goal was satisfied, rather than a subsequent date on which the award was issued.
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Similarly, a non-equity incentive plan award would be deemed received in the fiscal year that the executive earns the award based on satisfaction of the relevant financial reporting measure performance goal, rather than a subsequent date on which the award was paid.
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147
The fiscal year in which an incentive-based equity award is deemed received upon grant in some cases may be a fiscal year preceding the fiscal year in which the ASC Topic 718 grant date occurs and for which it is reported in the Summary Compensation Table and Grants of Plan-Based Awards Table because our requirements for reporting equity awards in the Summary Compensation Table do not utilize a “performance year” standard.
See Proxy Disclosure Enhancements,
Release No. 33-9089 (Dec. 16, 2009) [74 FR 68334] at Section II.A.2.c.

148
This would be the same fiscal year for which the non-equity incentive plan award earnings are reported in the Summary Compensation Table, based on Instruction 1 to Item 402(c)(2)(vii), which provides: “If the relevant performance measure is satisfied during the fiscal year (including for a single year in a plan with a multi-year performance measure), the earnings are reportable for that fiscal year, even if not payable until a later date, and are not reportable again in the fiscal year when amounts are paid to the named executive officer.”

Under proposed Rule 10D-1, incentive-based compensation would be subject to the issuer's recovery policy to the extent that it is received while the issuer has a class of securities listed on an exchange or an association.
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An award of incentive-based compensation granted to an executive officer before the issuer lists a class of securities would be subject to the recovery policy, so long as the incentive-based compensation was received by the executive officer while the issuer had a class of listed securities. Incentive-based compensation received by an executive officer before the issuer's securities become listed would not be subject to the recovery policy under our proposed

rule. As proposed, an exchange would not be permitted to list an issuer that it has delisted or that has been delisted from another exchange for failing to comply with its recovery policy until the issuer comes into compliance with that policy.
150

149
Proposed Rule 10D-1(b)(1)(i)(A).

150
Proposed Rule 10D-1(b)(1)(vi).

Request for Comment

39. Should incentive-based compensation be deemed “received” for purposes of triggering the recovery policy under Section 10D in the fiscal year during which attainment of the financial reporting measure specified in the incentive-based compensation award, by its terms, causes the incentive-based compensation to be granted, to be earned or to vest, as proposed? If not, when should incentive-based compensation be deemed “received” for purposes of triggering the recovery policy?

40. Should an executive officer be required to obtain a non-forfeitable entitlement to the incentive-based compensation to “receive” the compensation? Would such a requirement effectuate the purpose of Section 10D? Should the rule specifically address the treatment of awards subject to multiple vesting conditions, only some of which may be linked to financial reporting measures? If so, what would be the appropriate treatment of such rewards?

41. If following receipt, as proposed to be defined, an executive officer contributes incentive-based compensation to a nonqualified deferred compensation plan, how should deferral affect recovery?
151

151

See
Section II.C.3.a, below, addressing the computation of excess incentive-based compensation for this form of compensation.

42. Should incentive-based compensation be subject to the issuer's recovery policy only to the extent that it is received while the issuer has a class of securities listed, as proposed? If not, please explain in what circumstances a different standard should apply and why. For example, if a company lists in 2017, and restates the three prior fiscal years in 2018, should its policy require recovery of incentive-based compensation received in 2015 or 2016?

3. Recovery Process

a. 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.”

Commenters recommended that the Commission clarify how excess compensation subject to recovery should be determined.
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One commenter suggested that the Commission establish a clear set of guidelines as to how issuers should calculate the recoverable amount under a variety of common arrangements, or alternatively, a clear set of principles to be used to make such calculations.
153

In some cases, commenters recommended s

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2015-16613. Public record. Not legal advice.