REGULATORY PRESSURE on compensation just refuses to go away. While the US Securities and Exchange Commission’s compensation clawback rules have been in the works for some time, the putative upgrade to Dodd-Frank released on July 1 was yet another reminder – if one were needed – that companies and company executives are far from being off the hook and will be pursued vigorously by the attack dogs of central command if excessive rules being put in place are breached.
The comp clawback proposal was the final leg of the SEC’s series on executive compensation required under Dodd-Frank. And boy have they gone out with a bang. If you’ve been reading my columns and commentaries for any length of time, you’ll know my views on the policy obsession with compensation and the excessive lengths to which regulators have gone to deal with an issue that I feel has been serially over-played since the global financial crisis.
I’ve never subscribed to the notion of reward for failure, but setting comp as a central plank of the re-regulatory process in banking was always misguided, in my view. The latest SEC proposal takes it to new heights (or I should say depths) and massively broadens the issue beyond traders and bankers making excessive gains based on inappropriate incentives.
The clawback covers bonuses based on financial statements, stock price triggers and total shareholder return. Under the new rules, all public companies – and by the way that means companies that have their equity as well as bonds listed on the 18 recognised US exchanges and ECNs – will have to claw back comp if they are required to restate those accounts owing to material errors, in an amount proportionate to the quantum of the accounting restatement.
Never shy of pushing the button of extra-territoriality, foreign companies are also captured. And in a desire to leave no stone unturned, any association registered under the Exchange Act is also ensnared, just in case they were to list securities. As of today, that only covers FINRA, but it nonetheless seems a bizarre inclusion.
Failure to comply with obligatory clawback puts you on a track to delisting. Don’t get me wrong, if material errors in financial statements result from wrongdoing that breaches criminal or civil codes or appropriate exchange rules, that should be the route by which companies and company executives are pursued. And if that wrongdoing is so egregious that delisting is ordained, so be it.
But forcing exchanges to adopt delisting as a penalty for failure by their universe of companies to engage in comp clawback? That’s over the top if you ask me, because there’s not necessarily a direct link between executive compensation policy and company listing.
It’s another inappropriate and unwanted political spanner in the works of the functioning of the capital markets
FROM WHAT I can see, it’s another inappropriate and unwanted political spanner in the works of the functioning of the capital markets and the smooth transfer of capital in what’s supposed to be the most capitalist economy in the world. And because the rules grant zero flexibility to company boards, it undermines their internal governance processes and their ability to run their companies, in another example of a Big Brother approach to regulation.
The clawback relates to current and former executives in situ during the look-back period covered by the restatement. And a broad swathe of execs is covered: the C-Suite, anyone running a business unit PLUS execs at parent companies or subsidiaries. The definition of what constitutes ‘material’ is open to interpretation, so is left undefined.
Recovery can be in the form of equity options or underlying shares if the former have been exercised and are still held. If the underlying stock has been sold, regulators can come after you and demand cash. Companies are banned from making counter-balancing cash payments to execs to account for the clawback. As for transparency, companies will be required to add a recovery policy section in their 10-K and annual proxy statements, including the names of individuals to whom recovery applies. I say this is all going too far.
The look-back period covers the three fiscal years prior to any restatement. Three years? Why on earth three years? If I got stuffed with a cash clawback three years before any restatement, my first call would be to my legal counsel. That’s ridiculous.
The SEC says its proposed rules “are designed to improve the quality of financial reporting and benefit investors by providing enhanced accountability”. There’s obviously nothing wrong with improving financial reporting, but at what cost? Delisting is a grave penalty and should be forced only in extreme circumstances.
In the same way that I fail to see why EU compensation caps have any place in the Capital Requirements Directive because the two have nothing to do with each other, I say the same thing about the SEC’s draconian proposal.
The public comment period commenced on July 1. If you don’t like this control manoeuvre or feel it lacks appropriateness, say so. You have 60 days. Once that deadline has been reached, you know it’ll be too late. At that point, the SEC will move to its final rule, the exchanges will have to update their listing requirements and the rule becomes effective within a year. Don’t delay.
