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Firms should prepare for SEC clawback rules: Experts


Companies should start now to work on introducing, or revising, their clawback policies in light of complex rules issued last month by the U.S. Securities and Exchange Commission, experts say.

The 230-page regulation, which was first proposed in 2015 in compliance with the 2010 Dodd-Frank Act, requires that when stock issuers must prepare an accounting restatement, they recover erroneously awarded incentive compensation paid to current or former executive officers for the preceding three-year period. Incentive-based compensation is based on financial measures such as stock price.

The rules, which do not require that the impacted officials were at fault for the restatement, apply to a company’s president, principal financial officer, principal accounting officer, vice presidents who are in charge of business units and anyone who has policymaking functions.

Companies are prohibited from indemnifying any current or former officer subject to the clawback. The rules do permit officers to purchase a third-party insurance policy to cover clawbacks, but companies cannot pay or reimburse the executive officer for any premiums paid.

There is nothing in the rules that is “terribly new or surprising,” said Dan A. Bailey, a member of Bailey Cavalieri LLC in Columbus, Ohio.

Howard E. Berkenblit, a partner with Sullivan & Worcester LLP in Boston, said that while it will require some work to revise existing policies or to implement new ones “this is not terribly burdensome on companies.” The hard part comes if there has to be a restatement, “but I think that will be infrequent for most companies,” he said.

“I can’t imagine there are going to be that many situations” where restatements will be called for,” although a recession may lead to an increase, said Kenneth E. Yeadon, a partner with Hinshaw Culbertson LLP in Chicago, who is a former SEC enforcement attorney.

Others are less sanguine.

“My overarching concern with the clawback regulation is that it is so broad and encompassing that it is going to require a much more frequent, periodic” look at companies’ clawback regime, said Jake Downing, a partner with King & Spalding LLP in Chicago.

“The concern I have about the rule is that it may lead to a lot of friction for very little benefit for companies,” said Priya Cherian Huskins, San Francisco-based partner and senior vice president at broker Woodruff Sawyer & Co.

“The new rule would invariably pick up situations” where the restatement may have been “a consequence of a different interpretation of a rule that is not in any way related to intentional misconduct,” she said.

“I do think that there will be companies that will take a harder look at their incentive arrangements” and decide whether it should be impacted by performance matrixes such as the stock price in light of the rules, said Daniel M. McClain, a partner with Reed Smith LLP in New York.

Observers say one unusual element of the rules is their wide applicability. Machua Millett, Boston-based chief innovation officer and alternative investment practice leader in Lockton Cos. LLC’s financial services group, said, “It reflects an acknowledgment by the SEC that companies have started extending” incentive-based compensation “further down the corporate ladder.”

Kevin LaCroix, executive vice president in Beachwood, Ohio, for RT ProExec, a division of R-T Specialty LLC, said the rules could lead to creating an insurance product for executives seeking coverage for clawbacks, “although I haven’t sensed a great rush by the industry to try and develop a product.”

Most directors and officers insurance policies treat clawback provisions as disgorgement, which is not insurable, said Joseph P. Monteleone, a partner with Weber Gallagher Simpson Stapleton Fires & Newby LLP in Bedminster, New Jersey.

However, Matthew McLellan, Washington-based managing director and D&O product leader for Marsh LLC, said, “We’ve seen insurance marketplaces develop for all sorts of risk. It can take some creativity” to underwrite and price it, “but new markets are emerging all the time. It’s certainly a possibility.”

Companies should examine their compensation structures to see if they are subject to clawbacks, Mr. LaCroix said. They “will probably want to do a reality test on their financial reporting to make sure that there are internal controls and safeguards in place to guard against developments that could lead to restatements” that would trigger a clawback.

They should start working on their clawback policies now “so they’re not caught flatfooted,” with boards having little time to “really think through the issues,” said Brian V. Soares, a partner with Morgan Lewis & Bockius LLP in Washington.