Clawbacks, Fiduciary Duties, and Block-Tagging (Part 1)

In another 3-2 vote, the Commission proposed rules that would implement the clawback requirements mandated by Dodd-Frank.  Pub. L. No. 111-203, 124 Stat. 1900 (2010).  Continuing the trend of supplanting state substantive law in the corporate governance area, Section 954 of Dodd-Frank commanded that the SEC adopt rules governing clawbacks of compensation following certain restatements.  

As has been the case with most substantive governance provisions (say on pay is a significant exception), Congress required the SEC to do so through the adoption of listing standards.  As a result, the clawback provisions will apply only to listed companies.  

In many respects, the need for this type of requirement reflects a failing of corporate governance under state law. Had corporate practice already provided for clawbacks, there would have been little need for Congress to step in and command that these policies be implemented.  Moreover, Congress already provided for clawbacks in more narrow circumstances in Sarbanes-Oxley.  See Section 304 of the Sarbanes-Oxley Act of 2002.  The provision certainly alerted boards that Congress was concerned over the payment of performance based compensation based upon erroneous financial statements.    

Yet between 2002 (SOX) and 2010 (Dodd-Frank), Section 304 of SOX apparently did not have a significant effect on compensation practices.  It therefore required an act of Congress to mandate clawbacks. In other words, a board's fiduciary obligations were not sufficiently robust to require that directors come up with their own standards for collecting compensation paid as a result of inaccurate financial statements. Presumably had clawbacks been implemented as part of a system of private ordering, the provisions would likely have been more limited than what Congress ultimately adopted.  

We will discuss two aspects of this proposal.  First, some commentators and at least one dissenting commissioner argued that the board should have received broad discretion in determining whether to seek clawbacks.  Second, for the second time, the Commission has proposed provisions that would require the use of XBRL in the proxy statement.  Moreover, for the first time, the Commission has proposed the use of "block-tagging" in the text of a document (footnotes are block tagged in the financial statements).  

J Robert Brown Jr.