Clawback Rules May Come Out in 2014, Go into Effect in Mid-2015, Attorney Says

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By Mary Hughes  

June 11 — If the Securities and Exchange Commission proposes clawback regulations this year, the substantive provisions could take effect next year, even after the peak proxy season, an attorney said during a June 10 webcast.

Although one aspect of the clawback requirement relates to disclosure, “the substantive action—putting in place, implementing, a clawback provision—is something that is not really tied to the proxy season,” said Ronald O. Mueller, a partner with Gibson, Dunn & Crutcher LLP in Washington.

That part could come into effect by the middle of 2015, in a midyear action similar to what the SEC did when it adopted the compensation committee rules under Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act in June 2012, he said during the Bloomberg BNA-sponsored webcast.

The SEC won't give a precise time frame, but it is possible that the commission may act by the end of this year or possibly by the end of October, he said.

The clawback requirement, which falls under Section 954 of the Dodd-Frank Act, involves pay to executive officers of companies that make accounting restatements. It requires the SEC to direct the national securities exchanges to require listed companies to recover from any current or former executive officer of the issuer who received incentive-based compensation during the three-year period preceding the date of a restatement any extra pay received as a result of the error.

Practical Challenges

Moreover, in drafting a clawback provision, company-specific issues will arise, including whether other triggering events should be included, such as violations of restrictive covenants or employee conduct that causes the company significant harm to its reputation, said Steven A. Seelig, senior executive compensation counsel at Towers Watson's Center for Research and Innovation in Washington.

There are a great variety of compensation arrangements, and trying to adapt a clawback to them in a way that makes sense and clears hurdles from tax and accounting requirements is going to be a challenge for a number of years, Mueller said. Some companies are saying, “Let's adopt something that approaches what Dodd-Frank will require,” understanding that they will have to amend the policy, he said. “We typically see companies including some discretion in their arrangements,” he added.

Tax, Accounting Issues

On the tax side, Doreen E. Lilienfeld, a partner with Shearman & Sterling LLP in New York, said an employee may take a loss deduction under tax code Section 165(a) in the tax year a clawback repayment is made. The deduction would be allowed only as a miscellaneous itemized deduction. Those deductions are claimed “below the line” and subject to the 2 percent of adjusted gross income floor and the alternative minimum tax, she said. “In other words, the taxpayer is not made whole at the end of the day,” she said.

Section 1341 “claim of right” is a more favorable rule, but it's not clear whether it applies to clawbacks, she said. Although not a clawback case, the U.S. Court of Federal Claims' March 2014 decision in Nacchio v. United States, 115 Fed. Cl. 195 (Fed. Cl. 2014), is instructive, Lilienfeld said.

The court in Nacchio confirmed that the $18 million in repayments that the plaintiff made were deductible. The court rejected the government's public policy argument and also took issue with the argument that permitting the deduction would reduce the sting of the punishment imposed on the plaintiff for insider trading.

On the accounting side, Seelig said two of the Big Four accounting firms have suggested that certain clawback policies may subject a company's equity grants to variable accounting. This could happen if an award is written in such a way that there may not be a mutual understanding of its terms, conditions and number of shares granted between the employee and employer, he said. Accounting firms are struggling with exactly how much discretion in a clawback provision might trigger variable accounting, he added.

Questions Remain

Many open questions remain, including what compensation will be covered, to whom the clawback will apply, when the three-year look-back period will be triggered and whether companies will be allowed any discretion in determining whether certain employees or certain conduct or small amounts may be excluded from clawback requirements, Mueller said.

As to how common restatements are, Seelig said that according to statistics compiled by Audit Analytics, an average of almost 4 percent of companies in the Russell 1000 Index had restatements during the period 2006 to 2011.

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To contact the editor responsible for this story: Phil Kushin at

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