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Statement at an Open Meeting on Dodd-Frank Act “Clawback” Provision

Commissioner Luis A. Aguilar

July 1, 2015

When it comes to compensation, Americans believe you should earn your money.  They also believe, just as strongly, that you should not keep what you did not earn.  It’s fundamental to our values.  However, when companies have to restate their financial statements because they violated applicable reporting requirements, their executives may not be required to reimburse any incentive-based compensation that was erroneously paid.[1]  In other words, they get to keep what they never should have received in the first place.

And, quite often, we are talking about very large amounts.  In today’s corporate world, many executives are earning eye-catching sums.[2]  Much of the increase in executive compensation is commonly attributed to the impact of incentive-based compensation, including equity and other performance-based compensation plans.[3]

Incentive-based compensation plans are intended to align the interests of company managers and shareholders.[4]  However, when a company is required to issue a restatement, and when its executives have been paid compensation based on inflated financial results, this alignment disappears.  In such cases, it is only fair that these erroneously awarded payments be recovered.[5]     

To address this improper enrichment, Section 954 of the Dodd-Frank Act mandates that the Commission adopt rules to require that registered stock exchanges impose requirements that obligate listed companies to develop and implement policies that, in the event they are required to issue restatements, result in the recovery–or “clawback”–of erroneously paid incentive-based compensation.[6]

To fulfill that mandate, the Commission is proposing Rule 10D-1 to the Securities Exchange Act of 1934.[7]  Consistent with the breadth of the statutory mandate, today’s proposed rules define “incentive-based compensation” as compensation based in whole or in part upon achieving any “financial reporting measure.”[8]  This would include compensation based on stock price and/or total shareholder return (“TSR”), which are now widely used.  In fact, according to a study released on June 4, 2015, approximately 51% of the top 200 public companies making performance-based grants for executive compensation based it on a TSR measure.[9]  Today’s rules recognize this reality by defining incentive compensation to include performance-based compensation paid to executives based on a company’s stock price and/or TSR.[10]

To be clear, as the release points out, the definition of “incentive-based compensation” does not include all forms of executive compensation.[11]  For example, it does not include bonuses paid solely at the discretion of a company’s board of directors, or equity awards that vest solely upon completion of a specified employment period.[12]  The release asks questions as to whether these or other forms of executive compensation should be included in the definition of incentive-based compensation. 

Today’s proposed rules also contain the following components, among others:

  • First, today’s proposed rules apply to incentive-based compensation paid to any executive officers of the issuer.[13]  This helps ensure that all of those in a position of responsibility for executive-level decisions would be held accountable for the integrity of the company’s financial statements.
  • Second, while the proposed rules would require companies to pursue recovery of all incentive-based compensation, there are two exceptions for situations where a majority of the board’s independent directors determines that (i) pursuing such recovery would be impracticable because the direct expense of seeking recovery would exceed the recoverable amounts; or (ii) pursuing such recovery would violate foreign law.[14]  Under both of these exceptions, the issuer would be required to meet certain additional conditions designed to prevent these exceptions from undermining the effectiveness of the proposed rules.[15]  The release seeks public comment on whether the proposed rules include adequate protections to prevent these two exceptions from creating unintentionally large loop-holes.
  • Third, listed companies will be required to disclose both the substance of their recovery policies and how they implement their policies in practice.[16]  The proposed rules would also require each company to disclose when a decision has been made to forego recovery of incentive-based compensation that would otherwise be subject to the clawback policy.[17]
  • Fourth, listed issuers would be prohibited from engaging in an end-run around the clawback policy by indemnifying any current or former executive officer against the loss of erroneously awarded compensation.  Moreover, issuers would be prohibited from paying the premiums on an insurance policy that would cover an executive’s potential clawback obligations.[18]


In summary, taken together, the elements of the Commission’s proposed Rule 10D-1 should go a long way toward prohibiting improper enrichment of executives for companies faced with a restatement.  Moreover, the existence of a clawback policy should, among other things, incentivize executives to create a culture of compliance that results in accurate reporting of financial performance.  The end result is that, hopefully, fewer financial statements will be required to be restated.

For all these reasons, I will support the staff’s recommendation.  At their core, today’s proposed rules send the following message:  if you did not earn your compensation, you should not keep it.

In conclusion, I want to thank all of the staff who worked on this project, including those from the Division of Corporation Finance, the Division of Economic Research and Analysis, the Office of the Chief Accountant, and the Office of the General Counsel.  I appreciate the important work you do to protect investors.

[1] It is possible, and even likely, that some listed companies already have some form of clawback policies in place.  The Commission’s Division of Economic and Risk Analysis (DERA) estimates that approximately 23% of all filers currently disclose that they have some form of an executive compensation clawback policy.  In the case of larger issuers, many of them are likely already to have implemented some form of a clawback policy.  The Commission’s DERA staff estimates that, as of June 14, 2015, approximately 64% of the issuers that comprise the S&P 500 and approximately 50% of the issuers that comprise the S&P 1500 reported having a recovery policy in some form.  See Listing Standards for Recovery of Erroneously Awarded Compensation, SEC Release Nos. 33-9861, 34-75342, IC-31702 (July 1, 2015), at Section III.A. (Economic Analysis/Baseline), available at (hereinafter “Clawback Proposing Release”).

In addition, as a matter of law, Section 304 of the Sarbanes-Oxley Act of 2002 (“SOX”) provides that if an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirements under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for any bonus or other incentive-based or equity-based compensation received by that person from the issuer, or profits from stock sales of that issuer.

[2] See Alyssa Davis and Lawrence Mishel, CEO Pay Continues to Rise as Typical Workers Are Paid Less, Economic Policy Institute (June 12, 2014), available at also Elliot Blair Smith and  Phil Kuntz, CEO Pay 1,795-to-1 Multiple of Wages Skirts U.S. Law, Bloomberg (Apr. 30, 2013), available at (noting that Bloomberg-compiled data showed that “across the Standard & Poor’s 500 Index of companies, the average multiple of CEO compensation to that of rank-and-file workers is 204, up 20 percent since 2009.”)  Elliot Blair Smith and Phil Kuntz, Top CEO Pay Ratios, Bloomberg (Apr. 30, 2013), available at also, Lawrence Mishel and Natalie Sabadish, CEO Pay in 2012 was Extraordinarily High Relative to Typical Workers and Other High Earners, Economic Policy Institute, Issue Brief  No. 367 (June 26, 2013), available at

[3] See Lucian Bebchuk and Yaniv Grinstein, The Growth of Executive Pay, Harvard John M. Olin Center for Law, Economics, and Business, Discussion Paper No. 518 (Apr. 2005), available at; Equilar, Measuring Short-Term and Long-Term Performance in 2012 (May 28, 2013), available at (noting that “the number of companies providing performance-based equity to their CEOs has increased from 50.1 percent in 2010 to 61.8 percent in 2012.”); see also Alyssa Davis and Lawrence Mishel, CEO Pay Continues to Rise as Typical Workers Are Paid Less, Economic Policy Institute (June 12, 2014), available at (noting that “[m]ost CEO pay packages allow pay to rise whenever the firm’s stock value rises and permit CEOs to cash out stock options regardless of whether or not the rise in the firm’s stock value was exceptional relative to other comparable firms.”); How incentive-based pay drove a 20% pay bump for health care association CEOs, The Daily Briefing (June 9, 2015), available at  A 2013 joint Wall Street Journal/Hay Group study of large public company CEO compensation found that performance awards made up more than half of a CEO’s long-term incentive awards at 51% of the value in 2013, up from 49% in 2012.  In addition, this study found that many companies continued to add such plans, “rising to a record 83 percent of all companies, up from 72 percent in 2012.”  See The Wall Street Journal/Hay Group CEO compensation survey 2013, available at

[4] See Institutional Shareholder Services Inc., 2013 Corporate Governance Policy Updates and Process: Executive Summary (Nov. 16, 2012), available at  (“Stock-based compensation or open market purchases of company stock are intended to align executives' or directors' interests with shareholders.”)  See also Deborah S. Archambeault, F. Todd Dezoort, and Dana R. Hermanson, Audit Committee Incentive Compensation and Accounting Restatements, Contemporary Accounting Research (Winter 2008), available at (noting that “the use of incentive compensation is designed to align directors’ and executives’ interests with those of shareholders.”)

[5] In addition to concerns raised by the payment of performance-based compensation that had not been properly earned, the nature of incentive-based compensation has raised other concerns.  For example, the Financial Crisis Inquiry Commission (“FCIC”), in its post-mortem of the 2008 financial crisis, found that incentive-based compensation promoted a focus more on short-term results rather than longer term benefits.  This “short-termism” led people to make higher-risk business decisions that could result in higher rewards without sufficient regard to the downside risks.  In particular, the FCIC found that one of the contributing factors to the financial crisis was that compensation systems too often rewarded “the quick deal, the short-term gain–without proper consideration of long-term consequences.”  See Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report:  Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (Feb. 25, 2011), at xix, available at  A Congressional Oversight Panel, in its own review of the financial crisis, found that a short-term focus encouraged by executive compensation practices led to accounting manipulations, risky trading, or other unsustainable business practices that yielded short-term favorable financial reports without sufficient regard for downside risk or long-term business health.  See Congressional Oversight Panel Special Report on Regulatory Reform: Modernizing the American Financial Regulatory System: Recommendations for Improving Oversight, Protecting Consumers, and Ensuring Stability (Feb. 2009), available at (notes 67-80 and accompanying text).  In fact, that same panel concluded that clawback provisions that would recover executive pay could help restore symmetry and a longer-term perspective to executive compensation systems.

Indeed, similar reasoning was used recently to support recently released new clawback and compensation rules by the Financial Conduct Authority (“FCA”) and the Bank of England Prudential Regulation Authority (“PRA”).  In announcing the rules, Martin Wheatley, FCA CEO, stated that “[t]his is a crucial step to rebuild public trust in financial services, and allows firms and regulators to build long term decision making and effective risk management into people’s pay packets.”  See The Prudential Regulation Authority and The Financial Conduct Authority announce new rules on remuneration (June 23, 2015), available at  In particular, these new rules would, among other things, extend the deferral period (i.e., the period during which variable compensation is withheld following the end of the accrual period) to seven years for senior managers, five years for PRA designated risk managers with senior, managerial, or supervisory roles, and three to five years for all other staff whose actions could have a material impact on a firm (so-called “material risk takers”).  In addition, the FCA introduced clawback rules for a period of seven years from award of variable compensation for all material risk takers, which were already applied by the PRA. Where a firm or regulatory authorities have commenced inquiries into potential material failures, both the PRA and the FCA clawback rules add a possible three additional years for senior managers (ten years in total) at the end of the seven-year period.  See id.

[6] See Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, H.R. 4173 (July 2010) (the “Dodd-Frank Act”).  Section 954 also requires the Commission to adopt these rules for “national securities associations.”  A “national securities association” is an association of brokers and dealers registered as such under Section 15A of the Exchange Act [15 U.S.C. 78o-3].  Currently, the Financial Industry Regulatory Authority (“FINRA”) is the only association registered with the Commission under section 15A(a) of the Exchange Act, but FINRA does not list securities.  However, if any associations were to list securities, today’s rule proposals would apply to them as well.

[7] Consistent with Section 954 of the Dodd-Frank Act, the Commission’s proposed rules triggering recovery of erroneously awarded compensation apply to accounting restatements due to material non-compliance with any financial reporting requirement under the federal securities laws.  See Clawback Proposing Release at Section II.B.1. (Discussion of the Proposals/Restatements/Restatements Triggering Application of Recovery Policy).  In discussing the statutory mandate for these rules, a Congressional committee stated that it would be “unfair to shareholders for corporations to allow executives to retain compensation that they were awarded erroneously.”  See The Restoring American Financial Stability Act of 2010, Senate Report 111-176 (Apr. 2010), at 136, available at  Moreover, in adopting Section 954 of the Dodd-Frank Act, Congress recognized that the federal clawback mechanism on unearned executive pay “should be strengthened.”  See id. at 135-136.

[8] See Clawback Proposing Release at Section II.C.2.a. (Discussion of the Proposals/Application of Recovery Policy/Incentive-Based Compensation/Incentive-Based Compensation Subject to Recovery Policy).  Under these proposed rules, “[f]inancial reporting measures are measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measures that are derived wholly or in part from such measures, and stock price and total shareholder return.  A financial reporting measure need not be presented within the financial statements or included in a filing with the Commission.”  See Clawback Proposing Release at Section VII, referring to new Section 240.10D-1(c)(4) (Statutory Authority and Text of the Proposed Amendments/Listing Standards Relating to Recovery of Erroneously Awarded Compensation/Definitions/Incentive-Based Compensation).

[9] See James F. Reda and David M. Schmidt, The Holy Grail: What LTI Measures Drive Corporate Performance?, Financial Executives International, FEI Daily (June 4, 2015), available at (In this study, the TSR measure refers to either TSR or relative TSR, which is measured as company TSR as compared with a peer or industry group.).  Furthermore, today’s release also cites to a 2012 study that found that for CEOs of S&P 1500 firms, TSR was the most frequent performance metric used in long-term incentive plans, with 48% of such plans tied to it.  See Clawback Proposing Release at Section III.A.  (Economic Analysis/Baseline). 

[10] Notably, today’s release points out that were incentive-based compensation tied to TSR to be excluded from the definition of “incentive-based compensation,” issuers would be incentivized “to shift compensation away from forms subject to recovery to forms tied to market-based metrics such as stock price and TSR that would not be subject to recovery.”  See Clawback Proposing Release at Section III.C.2.  (Economic Analysis/Alternatives/ Excluding Incentive-Based Compensation Tied to Stock Price).  In other words, if the Commission had determined not to include performance-based compensation based on stock price or TSR, this could result in the perverse incentive for issuers to move executive compensation arrangements into arrangements that are based on stock price or TSR measures in order to avoid the clawback regime.  See Clawback Proposing Release at Section II.C.2.a.  (Discussion of the Proposals/Application of Recovery Policy/Incentive-Based Compensation/Incentive-Based Compensation Subject to Recovery Policy) (stating that excluding such market-based metrics “could incentivize issuers to alter their executive compensation arrangements in ways that would avoid application of the mandatory recovery policy and result in less efficient incentive alignment.”).  This could have the unfortunate consequence of encouraging issuers and their executives to have an even more short-term focus than they may already have in the absence of these proposed rules.

[11] For a description of examples of performance-based compensation measures and other compensation measures that would not be considered “incentive-based compensation” for the purpose of today’s proposed rules, such as salaries and non-equity incentive plan awards earned solely upon satisfying one or more operational measures (e.g., opening a specified number of stores, completion of a project, increase in market share), see Clawback Proposing Release at Section II.C.2.a. (Discussion of the Proposals/Application of Recovery Policy/Incentive-Based Compensation/Incentive-Based Compensation Subject to Recovery Policy).

[12] See Clawback Proposing Release at Section II.C.2.a. (Discussion of the Proposals/Application of Recovery Policy/Incentive-Based Compensation/Incentive-Based Compensation Subject to Recovery Policy).

[13] See Clawback Proposing Release at Section II.C.1 (Discussion of the Proposals/Application of Recovery Policy/Executive Officers Subject to Recovery Policy).  The proposing release makes it clear that the clawback rules mandated by Congress were “intended to apply, at a minimum, to all executive officers of the issuer, rather than a mere limited category such as named executive officers for whom executive compensation disclosure is required under Item 402 of Regulation S-K.  See id.  Specifically, the proposed rules, which are modeled after the definition of “officer” in Exchange Act Rule 16a-1(f), provide that the definition of “executive officer” include, among others, the issuer’s president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division, or function (such as sales administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer.  Executive officers of the issuer’s parents or subsidiaries would be deemed executive officers of the issuer if they perform such policy making functions for the issuer.  In addition, if pursuant to Item 401(b) of Regulation S-K the issuer identifies a person as an “executive officer,” that person would also be an executive officer for the purposes of today’s proposed rules.  See id.   

[14] See Clawback Proposing Release at Section II.C.3.b. (Discussion of the Proposals/Application of Recovery Policy/Recovery Process/Board Discretion Regarding Whether to Seek Recovery). 

[15] The proposed rules add certain additional conditions to ensure that these two exceptions do not become loop-holes that swallow the rule.  For example, before concluding that it would be impracticable to recover any amount of excess incentive-based compensation based on enforcement costs, the issuer would first need to make a reasonable attempt to recover that incentive-based compensation.  In addition, the issuer would be required to document its attempts to clawback the required incentive-based compensation, and provide that documentation to the applicable exchange or association.  Separately, before concluding that it would be impracticable to recover executive compensation because doing so would violate foreign law, the issuer first would need to obtain an opinion of foreign local counsel, not unacceptable to the applicable national securities exchange or association, that recovery would result in such a violation.  In addition, to minimize any incentive countries may have to change their laws in response to this provision, the relevant foreign law must have been adopted in such home country prior to the effective date of these proposed rules.  See Clawback Proposing Release at Section II.C.3.b. (Discussion of the Proposals/Application of Recovery Policy/Recovery Process/Board Discretion Regarding Whether to Seek Recovery).

[16] For example, among other disclosures required under the proposed rules, these rules would require that a listed issuer provide the estimates used to determine the excess incentive-based compensation attributable to a relevant accounting restatement, if the financial reporting measure at issue related to a stock price or total shareholder return metric.  See Clawback Proposing Release at Section II.D. (Discussion of the Proposals/Disclosure of Issuer Policy on Incentive-Based Compensation.  In addition, the required disclosures under these proposed rules would have to be provided in interactive data format using XBRL data tagging, making it easier for the SEC staff and investors to review.  See Clawback Proposing Release at Section II.D. (Discussion of the Proposals/Disclosure of Issuer Policy on Incentive-Based Compensation).

[17] See Clawback Proposing Release at Section II.D. (Discussion of the Proposals/Disclosure of Issuer Policy on Incentive-Based Compensation).

[18] See Clawback Proposing Release at Section II.E. (Discussion of the Proposals/Indemnification and Insurance).

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