On 1 July 2015, the Securities and Exchange Commission (SEC) released a proposal for new rules that require companies to disclose their policies on recovery of incentive-based excess compensation (relative to that which should have been received under an accounting restatement) from current or former executive officers. The proposed rules would significantly expand the clawback provisions of Sarbanes-Oxley Act, Section 304, and mandate that national securities exchanges prohibit listing any security whose issuer does not comply with the requirements.

The proposal does not require proof of either executive misconduct or a role in preparing the financial statements to obtain recovery, and it is not limited to executive officers. Recent academic studies have found that voluntary adoption of compensation clawback provisions lead to fewer financial restatements and increases internal control. Other studies have found these clawback provisions result in higher CEO compensation, greater CEO-pay-for-performance sensitivity and lower firm risk.

Higher costs and ambiguous guidance on recovery

The SEC recognises that the ruling will likely create new direct and indirect costs to the issuers and thereby reduce shareholder benefits. Specifically, the SEC mentions direct costs such as: (i) legal and consulting fees to develop new policies and to modify compensation packages; (ii) increased disclosure requirements; and (iii) the cost to calculate the recovery amount, prepare and disclose such information, and potential litigation costs, if the party subject to clawback disputes the findings.

Oct-Dec 2015 Issue