Crypto folks have been saying that they want the SEC to regulate these assets and related transactions with tailored rules. That was a theme in our recent webcast, “Cryptocurrency: Making Sense of the State of Play” – with Ava Labs’ Lee Schneider, Liquid Advisors’ Annemarie Tierney, Cooley’s Nancy Wojtas, and Coinbase’s Jolie Yang.
The transcript for that program is now available, which will be a helpful guide to anyone looking to responsibly navigate the securities law complexities of this work. Lee, Annemarie, Nancy & Jolie covered:
1. Overview of Regulatory Issues & Risks
2. Structuring Deals, Resales & Products in the Current Regulatory Environment
3. How to Handle Cryptocurrency Use in Transactions
4. Learnings from Recent High-Profile Token Collapses
5. Will the Ethereum Merge Affect the SEC’s Analysis?
6. Predictions & How to Prepare
One recurring takeaway was that practicing in this space is best suited for people who like a challenge.
Yesterday, the SEC adopted the clawback rules contemplated by Section 10D of the Exchange Act, which was added over a dozen years ago by the Dodd-Frank Act. Not surprisingly, the vote on the final rulemaking action was 3-2. As this Fact Sheet notes, the final rules ended up being broader than originally proposed, as foreshadowed by the reopening of the comment period in October 2021 and June 2022. When all is said and done with the implementation of the rules – which will require further action by the stock exchanges – most exchange-listed companies will have to adopt and comply with a clawback policy that conforms to these new rules, and will also have to provide disclosure in proxy and information statements and annual reports about the policies and how they are being implemented. A listed company will be subject to delisting if it does not adopt and comply with a clawback policy that meets the requirements of the to-be-adopted listing standards.
The clawback policy contemplated by the final rules is, in all likelihood, going to differ significantly from the clawback policies that most companies have adopted over the course of the past two decades. While clawback policies tend to focus on recovering incentive compensation that was based on misstated financial statements arising from fraud where the executive from whom the compensation is being recovered had some culpability in making the misstatements, the listing standards that the stock exchanges are directed to adopt will call for a clawback policy that requires no culpability on the part of current or former executives, the recovery of incentive compensation received during the three-year period preceding the date the company is required to prepare the accounting restatement, and recovery will be triggered by a broad range of accounting restatements, including the now quite popular “little ‘r’ restatement.”
The amount of recoverable compensation will be the amount of incentive-based compensation received by the executive officer or former executive officer that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the restated financial statements. The SEC’s rules contemplate that the listing standards can provide for very limited impracticability exceptions.
Of course new listing standards are not enough, so the SEC will require enhanced disclosure about the compensation recovery policy (to be tagged using inline XBRL), as a well as a requirement to file the policy as an exhibit to the annual report and two new check boxes on the cover of Form 10-K, with one indicating whether the financial statements included in the filing reflects the correction of an error to previously issued financial statements, and another indicating whether any of those error corrections are restatements that required a compensation recovery analysis.
For a more information about the new clawback rules, stay tuned to our continuing coverage over on CompensationStandards.com. If you do not have access to all of the great resources that are available on CompensationStandards.com, now might be a good time to think about becoming a member of that site. You know the drill by now – sign up today online, email sales@ccrcorp.com or call 1-800-737-1271.
The focus on clawback policies dates back to the post-Enron era and the enactment of Section 304 of Sarbanes-Oxley, which permits the SEC to order the disgorgement of bonuses and incentive-based compensation earned by the CEO and CFO in the year following the filing of any financial statement that the issuer is required to restate because of misconduct. Following the lead from Sarbanes-Oxley and the fundamental concern that executives should not be able to keep incentive compensation paid based on misstated financial statements that had to be restated, companies began adopting clawback policies as a good governance practice. The ensuing couple of decades of “private ordering” largely led to clawback policies which focused on the consequences of a full-blown accounting restatement (usually arising from some sort of fraud or other misconduct) which requires the company to amend its prior periodic reports to correct the errors in the financial statements included in those reports. Essentially, these are restatements that lead to the filing of an Item 4.02 Form 8-K. As originally proposed, the SEC’s Dodd-Frank Act era clawback appeared to follow suit.
But then, a funny thing happened on the way to adoption of the final clawback rules. In recent years, full-blown accounting restatements have not been happening quite as often as they once did, for a variety of reasons. While such restatements have by no means gone the way of the dinosaur, they are certainly not the fixture of public company reporting that they once were. At the same time, we have seen an increase in what is often referred to as a little “r” restatement, which requires no Item 4.02 Form 8-K and which allows a company to fix its prior periods in a periodic report with no amendment of previously filed reports. Little “r” restatements are required to correct errors that were not material to previously issued financial statements, but would result in a material misstatement if: (i) the errors were left uncorrected in the current report; or (ii) the error correction was recognized in the current period. The SEC staff has been focused on little “r” restatements over the past decade or so, raising comments on filings to test whether a purported little “r” restatement should have been a full-blown accounting restatement under GAAP, so there has certainly been some skepticism about this approach.
Incorporating little “r” restatements as a triggering event in the final clawback rules will certainly expand the reach of clawback policies adopted pursuant to the listing standards that the stock exchanges are obligated to promulgate. The concept moves clawback policies even farther away from the original concern that executives should return their incentive compensation earned based on misstated financial statement where the misstatements arose due to some sort of fraud or misconduct, toward the more mundane world of recovering compensation erroneously earned due to run-of-the-mill accounting errors. The change also required the Commission to consider ways to make the little “r” restatement more visible, thus necessitating the check box approach on the cover of the annual report. All in all, the change means that compensation recovery policies are going to be invoked much more often, and perhaps for much smaller recoveries.
Thankfully, you will not have to come up with a new clawback policy quickly in response to the new rules. The SEC’s Fact Sheet notes the following timetable for the new rules and exchange listing standards:
The rules and amendments will become effective 60 days following publication of the release in the Federal Register. Exchanges will be required to file proposed listing standards no later than 90 days following publication of the release in the Federal Register, and the listing standards must be effective no later than one year following such publication. Issuers subject to such listing standards will be required to adopt a recovery policy no later than 60 days following the date on which the applicable listing standards become effective and must begin to comply with these disclosure requirements in proxy and information statements and the issuer’s annual report filed on or after the issuer adopts its recovery policy.
The adopting release states, “We would not expect compliance with the disclosure requirement until issuers are required to have a policy under the applicable exchange listing standard.”
I have been out speaking about all of the new SEC rules that have been adopted, are being adopted and that remain to be considered, and one thing is clear – we will all have a lot of extra work to do in the coming months and years. One persistent concern that I hear from others is that companies are struggling to prepare for the largely unknown costs associated with all of these new rules in their budgets for 2023 and beyond. Further, the increased compliance burdens are coming at a time when many companies are seeking to tighten their belts in light of rising costs and the prospect of recession.
With these concerns in mind, I compiled the following list of things to consider as you enter the budgeting process:
1. Educating Your Company. Now is a critical time to educate the Board of Directors, management and others within the company about the increased compliance burden from new SEC rules. Developing buy-in from the top and from others in the organization will be crucial to ensuring an allocation of appropriate resources to the compliance function. I believe that this should include education about proposed rules, even though we do not ultimately know how the final rules will come out. In addition, keep everyone updated as new requirements become effective so they can be aware of when it may be necessary to reallocate or add resources to the compliance function.
2. Leveraging Internal Resources. Assess the resources that you already have access to internally in order to determine whether you could use these resources when new rules come into effect. For example, many companies have found that their internal audit and/or finance function can be helpful when formulating or improving controls regarding climate change reporting in anticipation of SEC rules requiring mandatory reporting of climate change matters. It is helpful to develop an inventory of available internal resources and how those resources can be useful to the compliance function, and then develop relationships with the individuals in those functions so they will be ready to assist when the time comes.
3. Evaluating Outside Advisors. Some new SEC requirements will require the use of outside advisors, while, in other cases, outside advisors may be useful to the compliance process. For example, many companies are finding out now that they will need to engage valuation firms to value equity awards for the purposes of complying with the SEC’s new Pay versus Performance rules. You may have an existing relationship with a valuation firm, or you may need to establish a relationship with a valuation firm for this purpose – in either case, it is critical to have a dialogue with them now, given the increased demand for their services as a result of the rule. In another example, the SEC’s proposed climate change disclosure rules contemplate the use of a third party for attestation of GHG emissions metrics, so it is important to understand now what such services will cost and to begin mapping out the process for engaging such advisors. Further, some companies may find it more efficient to utilize outside advisors for developing their compliance approach, particularly for something as big as the SEC’s climate change rules, so the potential cost of such outside resources should be factored into the planning process now.
4. Keeping up to Speed. Now more than ever, it is important to keep up to speed on what the SEC is doing and planning for the future. Our resources – including this website and all of the other CCRcorp websites and publications – are a great option for you to consider as you try to find the most cost-effective way to stay abreast of the developments and obtain actionable advice from the experts. I encourage you to reach out to sales@ccrcorp.com or call 1-800-737-1271 to discuss your options.
Over on PracticalESG.com, Lawrence Heim recently blogged about the latest notice from the International Sustainability Standards Board (ISSB) on its progress toward refining its first two proposed sustainability-related disclosure standards. Lawrence notes:
This new notice from the ISSB has some interesting developments. The organization:
– Voted unanimously to require company disclosures on Scope 1, Scope 2 and Scope 3 greenhouse gas (GHG) emissions
– Will develop relief provisions to help companies apply the Scope 3 requirements. This relief will be decided at a future meeting and could include giving companies more time to provide Scope 3 disclosures and working with jurisdictions on so-called “safe harbor” provisions.
– Confirmed it will use the same definition of “material” as is used in IFRS Accounting Standards and will discuss at a future meeting the need for further guidance on how to determine what is material information.
– Confirmed use of the Task Force on Climate-related Financial Disclosures (TCFD) architecture as the basis for its Standards
Our view: The second and third points above are pretty important and could signal a change. This may be the beginning of a slow death for “double materiality” that is somewhat popular in the EU. The current definition of “material” under IFRS accounting standards is established in the October 2018 amendments to IAS 1 and IAS 8, which went into effect January 2020. This definition – which focuses on financial statement information – is:
“Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.”
This seems to take us back to square one in terms of trying to decode “materiality” in accounting and disclosure regimes. As with so many other things, time will tell. With the ISSB standards expected to be finalized at the first of the year, we shouldn’t have too much longer to wait.
If you are looking for a resource to stay up to speed on all of the latest ESG developments and to get the critical insights that you need in this space, PracticalESG is the place to go. Sign up today!
The PCAOB has been on a hiring spree of late. Last week, the PCAOB announced that Barbara Vanich was appointed Chief Auditor of the PCAOB. Vanich has led Office of the Chief Auditor in an acting capacity since November 2020. The Office of the Chief Auditor manages the development of PCAOB standards and ensures that PCAOB standards are appropriately communicated to auditors and other stakeholders. Earlier this week, the PCAOB announced that James McNamara was appointed as the organization’s first-ever Chief Operating Officer. In this role, McNamara will focus on improving the PCAOB’s organizational effectiveness. He will also serve as the chief administrative officer of the PCAOB and oversee its Office of Administration.
As Liz noted last week, tomorrow the SEC will consider adoption of the final rule amendments to implement the provisions of Section 954 of the Dodd-Frank Act, which added Section 10D to the Exchange Act. Section 10D requires the SEC to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with Section 10D’s requirements for disclosure of the issuer’s policy on incentive-based compensation and recovery of incentive-based compensation that is received in excess of what would have been received under an accounting restatement.
Why, over a dozen years after the enactment of the Dodd-Frank Act and more than seven years since the rules were initially proposed, is the Commission considering these rules on Wednesday? I guess one answer is that it had to happen sooner or later – Congress gave the SEC a specific directive to adopt the rules, and in the ensuing twelve years various SEC Chairs and Commissioners opted to kick the can down the road, but now Chair Gensler is committed to closing out the open Dodd-Frank Act rulemakings directives (with the SEC adopting the pay versus performance disclosure requirement over the summer). Why did those before Gensler and the current Commission choose to kick the can down the road on the clawback rules and pay versus performance? Partly because they had other more pressing things on their agenda, and perhaps partly because they recognized that both the clawback and pay versus performance directives were already largely obsolete given that the world had “moved on” since the post-financial crisis Dodd-Frank Act measures were first contemplated.
The reality is that compensation recovery has become a key feature of compensation programs at many companies, seen as an important tool in managing risks associated with compensation plans. While there is no uniform model for compensation clawback policies, companies have been able to adopt policies that are best suited for their particular circumstances. Few (if any) compensation recovery policies go as far as the SEC’s proposed rules would contemplate, with recovery required on a “no fault” basis, without regard to whether any misconduct occurred or to an executive officer’s responsibility for the erroneous financial statements. Further, clawbacks are never triggered by little “r” restatements, as the SEC’s reopening release suggests the Commission may be considering.
Now, when the dust settles on the SEC rulemaking and the stock exchange standard-setting that the SEC’s rules will direct, the many years of “private ordering” on clawback policies will be undone, and companies will be forced to adopt a one-size-fits-all approach that is not tailored to their own particular circumstances. While this action will allow the SEC to check this Dodd-Frank era rulemaking off its To Do list, I am not sure I would call it “progress” when it comes to investor protection.
As this Dechert memo notes, and as Liz discussed on The Advisor’s Blog over on CompensationStandards.com, the SEC’s Division of Enforcement and the DOJ have recently launched initiatives targeting executive compensation clawbacks. The Dechert memo notes:
– The SEC is aggressively pursuing SOX 304 compensation clawbacks from Chief Executive Officers and Chief Financial Officers of public companies that have been required to restate financial reports in connection with misconduct at the company—even when the CEO and CFO are not involved and their compensation is not tied to the misconduct.
– DOJ has announced that compensation clawbacks will be considered as a factor in whether to bring and settle criminal charges against corporations. DOJ will evaluate not only whether companies have adopted clawback provisions in executive compensation packages, but also whether companies have, in practice, actually pursued clawbacks.
The Dechert memo indicates that several of the SEC’s recent cases where Section 304 clawbacks were pursued are settled actions involving executives with zero alleged culpability. According to SEC Deputy Director of Enforcement Sanjay Wadhwa, the Enforcement Division views “the Commission’s use of SOX 304 orders against executives who were not charged under any additional provisions” as an “important element” of the recent SOX 304 enforcement actions, with the enforcement theory being that such actions “create[] accountability and establish[] incentives to prevent corporate wrongdoing.”
Further, SEC Enforcement Division Chief Counsel Sam Waldon highlighted three key aspects of how this Enforcement Division is applying SOX 304:
– It is pursuing these cases regardless of whether the CEO and CFO at issue were culpable for the underlying securities law violation.
– It views SOX 304 as not “limited by fraud delta,” meaning the SEC intends to seek “the full amount of the reimbursement that is required by the statute” not merely the amount by which the executive’s compensation was allegedly inflated due to the reporting problem.
– It will seek to prevent director and officer insurance policy proceeds from being used to indemnify covered executives for SOX 304 reimbursements.
As Liz noted in The Advisor’s blog, back in September the DOJ adopted its first-ever Department-wide policy to guide prosecutors on considering corporate compensation programs & clawback policies in criminal enforcement decisions, according to a 15-page memo from Deputy AG Lisa Monaco. The memo notes:
Corporations can best deter misconduct if they make clear that all individuals who engage in or contribute to criminal misconduct will be held personally accountable. In assessing a compliance program, prosecutors should consider whether the corporation’s compensation agreements, arrangements, and packages (the “compensation systems”) incorporate elements such as compensation clawback provisions-that enable penalties to be levied against current or former employees, executives, or directors whose direct or supervisory actions or omissions contributed to criminal conduct. Since misconduct is often discovered after it has occurred, prosecutors should examine whether compensation systems are crafted in a way that allows for retroactive discipline, including through the use of clawback measures, partial escrowing of compensation, or equivalent arrangements.
Suffice it to say, with the SEC’s consideration of clawback rule tomorrow and the recently announced SEC Enforcement and DOJ focus on clawbacks, this is a topic that is going to be grabbing a great deal of attention over the coming months.
I would say that just about anyone who has worked at the SEC has at some point encountered the momentary confusion in a conversation when someone you are speaking with thinks that you are associated with the Southeastern Conference, not the Securities and Exchange Commission. SEC Chair Gary Gensler picked up on this theme in a speech at the SIFMA Annual Meeting yesterday, setting up his remarks by noting how both the Commission and the Southeastern Conference were born in 1933, and both organizations are focused on competition. The speech focused on the role of competition in what the Securities and Exchange Commission does, and how the agency employs the tools that it has across the fixed income, equity, and private markets.
Broc blogged about this amusing comparison of the two SECs a decade ago.
