# 80 FR 41144: Listing Standards for Recovery of Erroneously Awarded Compensation

> Federal · Regulations · In force

URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2015-16613

## Section

- **Citation:** 80 FR 41144
- **Heading:** Listing Standards for Recovery of Erroneously Awarded Compensation
- **Jurisdiction:** Federal
- **Kind:** Regulations
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** Federal Register / Vol. 80 / 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
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
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
equired 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
alysis 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
nge, 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
red 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
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)
d compensation received by
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
ve 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
licy, 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
iative 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
0D 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
ers 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 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
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
t 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
imated 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
I, 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
.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
ule 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 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
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
uer 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
sed 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]
es 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
ts 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 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
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)
ged 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]
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)
dition, 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
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
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
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
ters 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
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
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
rpretations 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
es 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 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
th 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
resent 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
iance 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
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
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
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)
r 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)
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
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
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 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
t 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
93 See Item 402(a)(3) of Regulation S-K
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
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
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
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
sons 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
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
25
. 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
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
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
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
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
table 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
tter 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 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
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]
uch 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
• 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
d “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
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
e 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 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
e 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)
d “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
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.,

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Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2015-16613. Check the current official text before relying on it. Not legal advice.