Issuer scope
The final rule directs national securities exchanges and associations to adopt listing standards and prohibit listing securities of any issuer not in compliance with the final rule.
Crowe observation: All listed issuers, which include smaller reporting companies (SRCs), emerging growth companies (EGCs), foreign private issuers (FPIs), and business development companies (BDCs), are subject to the final rule. The SEC observed that shareholders, regardless of issuer size, should benefit from recovery of compensation that was not appropriately earned.
Listing standards
Final Nasdaq and NYSE listing standards are available for issuers to draft their recovery policies.
Recovery
Issuer recovery policies
The final rule requires issuers, under applicable listing standards, to adopt and comply with written policies on erroneously awarded compensation. The policies must require the issuer, in the event of an accounting restatement, to recover from current or former executive officers the amount of incentive compensation that exceeds the amount that would have been received had the restated financial statements been used to calculate incentive compensation.
Compensation recovery causes
Accounting restatements, which for purposes of the final rule are defined as “due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws,” require an issuer to recover erroneously awarded compensation. The SEC concluded accounting restatements that trigger recovery include both “Big R” and “little r” restatements. “Big R” restatements correct errors material to previously issued financial statements, and “little r” restatements correct errors that are not material to previously issued financial statements but are material to the current period if they are left uncorrected or are corrected in the current period. The date an issuer is required to prepare an accounting restatement (the restatement conclusion date) is the earlier of the date the issuer’s board of directors concludes that the issuer is required to prepare an accounting restatement or the date a court, regulator, or similar body directs the issuer to prepare an accounting restatement.
Crowe observation: An out-of-period adjustment is the correction of an error in current-period financial statements when the error is immaterial to previously issued financial statements and the error correction is also immaterial to the current period. An out-of-period adjustment is not an accounting restatement and does not require an issuer to recover compensation.
Executive officers
The final rule defines executive officers as persons subject to recovery policies. Not limited to named executive officers (NEOs), executive officers are not defined by specific titles but include persons with an important role in financial reporting and policy-makers. Examples in the final rule include the president, principal financial officer, principal accounting officer or controller, vice presidents of significant business units, and others with a significant policy-making function. Current and former executive officers are subject to recovery policies if they served anytime during the incentive compensation performance period.
Crowe observation: Issuers must recover erroneously awarded compensation regardless of executive officer scienter. Additionally, issuers are prohibited from insuring or indemnifying any current or former executive officer against the loss of erroneous compensation and from reimbursing the executive officer for policy premiums paid or incurred for a third-party insurance policy.
Incentive compensation subject to recovery
The final rule defines incentive-based compensation subject to recovery as “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure,” which includes both GAAP and non-GAAP metrics.
Crowe observation: The final rule provides numerous examples of financial reporting measures, including share price and total shareholder return (TSR).
Examples of incentive compensation:
- Nonequity incentive plan awards, bonuses, or other cash awards earned based on satisfying a financial reporting measure
- Stock, including units, options, and appreciation rights, that are granted or vested based on satisfying a financial reporting measure or any proceeds from the sale of shares acquired from those awards
Examples of nonincentive compensation:
- Salaries, unless an increase was tied to a financial performance goal
- Discretionary bonuses that are not tied to a financial reporting measure or are based on subjective standards
- Nonequity incentive awards earned based on strategic measures (consummating a merger or divestiture) or operational measures (opening a number of stores, completion of a project, increase in market share)
- Equity awards for which:
- The grant is not contingent on reaching a financial reporting measure
- Vesting is contingent only on completion of an employment period and/or reaching one or more nonfinancial reporting measures
If an accounting restatement occurs, issuers must recalculate the financial reporting measures used to determine executive officer incentive compensation and then recover the excess of incentive compensation originally received versus incentive compensation that should have been received, without regard to any executive officer tax liabilities paid or incurred. In this calculation, incentive compensation is received in the first fiscal period when the financial reporting measure is reached, even if payment or grant occurs after that period. The calculation of erroneously awarded compensation must cover the three completed fiscal years before the restatement conclusion date.
Crowe observation: Directors cannot exercise discretion in recovery of erroneously awarded compensation, so issuers must proceed with recovery unless certain limited exceptions apply.
Disclosure considerations
Form 10-K filers
Cover page. The Form 10-K cover page includes two new checkboxes that separately indicate whether:
- The included financial statements reflect correction of an error to previously issued financial statements
- The error correction is a restatement that required applying the issuer’s policy on erroneously awarded compensation
Crowe observation: The filer would check the first checkbox and not the second when an issuer voluntarily revises previously issued financial statements for immaterial errors.
Required exhibit and executive compensation disclosure. Issuers must file their recovery policy as an annual report exhibit. If an accounting restatement occurs, but the issuer concludes that recovery under its policy was not required, the issuer must disclose why. For accounting restatements that require recovery, the issuer must disclose:
- Date that the issuer was required to prepare the accounting restatement and the aggregate dollar amount of erroneously awarded compensation, including how the amount was calculated, or why the amount has not been determined
- Aggregate dollar amount of erroneously awarded compensation outstanding at the end of the fiscal year
- Estimates and methodology used to determine erroneously awarded compensation tied to share price or TSR
Crowe observation: The final rule acknowledges issuers can use reasonable estimates to determine how a restatement affected stock price and TSR.
- Amount, separately for each current or former NEO and as a group for all other current or former executive officers, and underlying reasons when an issuer determines recovery is impracticable
- Amount, separately for each current or former NEO, of erroneous compensation outstanding 180 days or longer after the issuer determines the amount owed
Issuers must reduce applicable prior period summary compensation table amounts to reflect any erroneous compensation recovered under the recovery policy and provide footnote disclosure of the amounts.
Issuers that do not file Form 10-K
While cover page and disclosure requirements for non-Form 10-K filers (those that file Form 20-F, Form 40-F, or Form N-CSR) are largely similar to requirements for Form 10-K filers, non-Form 10-K filers should refer to the text of those forms for specific requirements.
XBRL
All issuers must use inline extensible business reporting language (XBRL) to tag required disclosures.
Near-term considerations for those charged with governance
Those charged with governance might consider:
- Assigning responsibilities for developing a recovery policy
- Regularly communicating with management to discuss progress
- Overseeing the design of controls and procedures necessary to comply with the final rule
- Evaluating whether the board’s compensation philosophy or the issuer’s current incentive compensation plans include incentive compensation tied to the achievement of financial reporting measures that would require recovery of erroneously awarded compensation
- Assessing changes to compensation philosophy or plans the board wishes to make
