SOX for the first time provided a provsion that allowed for clawbacks of executive compensation in certain limited circumstances. The provision sought to fill a serious gap in the corporate governance process. Fiduciary duties were sufficiently anemic that they failed to compel boards to seek to recover compensation paid on the basis of financial statements that later proved to be materially inaccurate. As a result, Congress was forced to imposed such an obligation, federalizing another aspect of corporate governance.
Section 304 of SOX allows for clawbacks of performance based compensation following an accounting restatement "due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws." 15 U.S.C. 7243. The provision only allows for clawbacks of compensation paid to the CEO and CFO. Neither officer, however, need to have actually engaged in the relevant misconduct.
SOX, however, was a tepid effort. The provision essentially provided no enforcement mechanism for the failure of boards to clawback compensation following a triggering restatement. With no private right of action, the only source of enforcement was the SEC. The SEC has brought only a small number of claims seeking clawbacks, including one this week. See In re Yazdani, Exchange Act Release No. 73201 (admin. proc. Sept. 24, 2014) ("Respondent . . . shall, within 30 days of the entry of this Order, reimburse Saba for a total of $2,570,596 in . . . bonuses, other incentive-based or equity-based . . . compensation, and . . . stock sale profits pursuant to Section 304(a) of SOX.").
Dodd-Frank, however, provided a second generation clawback provision. Specifically, Section 954 required listed companies to put in place a policy mandating that:
- 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 issuer will recover from any current or former executive officer of the issuer who received incentivebased compensation (including stock options awarded as compensation) during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.
The policy, therefore, expanded the circumstances that would trigger a clawback and expanded the persons subject to the requirement. Most importantly, however, the provision imposed a burden on issuers to clawback the funds. Thus, clawbacks would cease to be a matter left to the limited resources of the SEC.
The clawback provision, however, remains an idea on paper, not one that has been put into practice. The provision requires SEC rulemaking. No rule proposal has yet to emerge, although the provision is on the SEC's rulemaking agenda. As the Unified Agenda states:
- The Division is considering recommending that the Commission propose rules to implement section 954 of the Dodd Frank Act, which requires the Commission to adopt rules to direct national securities exchanges to prohibit the listing of securities of issuers that have not developed and implemented a policy providing for disclosure of the issuer's policy on incentive-based compensation and mandating the clawback of such compensation in certain circumstances.
Yet a proposal has not yet surfaced. Until it does, the limited resources of the SEC effectively means that clawbacks are likely to remain an important but under-utilized tool in ensuring proper corporate governance.
For a discussion of the clawback provisions under SOX and Dodd-Frank, see Financial Institutions, the Market, and the Continuing Problem of Executive Compensation.