Memorandum
SEC Proposes Executive Compensation Clawback Rule
July 23, 2015

On July 1, 2015, the Securities and Exchange Commission (“SEC”) proposed a rule requiring that national
securities exchanges and national securities associations prohibit the listing of any security of an issuer thatis not in compliance with Dodd-Frank’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 havebeen received under an accounting restatement” (commonly referred to as a “clawback policy”). 1 The
proposed rule would direct the exchanges to establish listing standards requiring issuers to: Adopt and comply with policies that provide for clawback of incentive-based pay that is based on financial
information reported under the securities laws. The policies would need to apply to the listed issuers’
executive officers; and Disclose those recovery policies as an exhibit to their annual reports.
Issuers may be subject to delisting if they do not comply with these standards.
Proposed Rule 10D-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) would
codify “the listing requirements that exchanges would be directed to establish pursuant to Section 10D of the
Exchange Act,” which was added by Section 954 of the Dodd-Frank Act.

Issuers and Securities Subject to the Proposed Rule
Under the proposed rule, the requirements would broadly apply to “all listed issuers,” including smallerreporting companies, emerging growth companies, foreign private issuers, controlled companies and issuers

1

Listing Standards for Recovery of Erroneously Awarded Compensation, Release Nos. 33-9861; 34-75342; File No. S712-15 (July 1, 2015), at 1 (hereinafter “Release”). The proposal passed by a 3-2 vote, with Commissioners Michael S.
Piwowar and Daniel M. Gallagher voting against the proposal.
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Memorandum – July 23, 20152of debt and non-equity securities. 2 Thus, there are more categories of issuers who would be subject to thisrule than to other Dodd Frank-based disclosure obligations, such as say-on-pay or pay ratio disclosure. The
requirements would also apply to all securities issued, with limited exceptions for:
 security futures products;
 standardized options; and securities of certain registered investment companies. 3

Clawback Trigger
Under the proposed rule, if issuers are required to prepare an accounting restatement to correct “an errorthat is material to previously issued financial statements, the obligation to prepare the restatement would
trigger application of the recovery policy.”4 The SEC does not state what type of error would be considered“material” for purposes of proposed Rule 10D-1 but does provide that issuers “should consider whether aseries of immaterial error corrections, whether or not they resulted in filing amendments to previously filed
financial statements, could be considered a material error when viewed in the aggregate.” 5 Further, the SEC
lists some “types of changes to an issuer’s financial statements [that] do not represent error corrections” andtherefore would not trigger the issuer’s clawback policy, including: “Retrospective application of a change in accounting principle;
 Retrospective revision to reportable segment information due to a change in the structure of issuers’internal organization;

2

Release at 10.

3

The proposed rule would not apply to a registered management investment company if such company has not awarded
incentive-based compensation to any executive officer of the company in the last three fiscal years (or, for companies
that have been listed for less than three years, since the initial listing). However, management investment companies
who have paid incentive-based compensation in the three-year period would be subject to the proposed rule. In
addition to management investment companies that have not paid incentive-based compensation to their executives
within the last three fiscal years, the SEC proposes to exempt from the requirements of Rule 10D-1 the listing of any
security issued by a unit investment trust.

4

GAAP defines an error in previously issued financial statements as “[a]n error in recognition, measurement,
presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the applicationof generally accepted accounting principles (GAAP), or oversight or misuse of facts that existed at the time thefinancial statements were prepared. A change from an accounting principle that is not generally accepted to one thatis generally accepted is a correction of an error.” Under IFRS, prior period errors are “omissions from, andmisstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or
misuse of, reliable information that: (a) was available when financial statements for those periods were authorised for
issue; and (b) could reasonably be expected to have been obtained and taken into account in the preparation andpresentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes inapplying accounting policies, oversights or misinterpretations of facts, and fraud.” Release at 24 n.66, quoting FASBASC Topic 250, Accounting Changes and Error Corrections; IAS 8, Accounting Policies, Changes in Accounting
Estimates and Errors, paragraph 5.

5Release at 25.
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Memorandum – July 23, 20153

 Retrospective reclassification due to a discontinued operation;
 Retrospective application of a change in reporting entity, such as from a reorganization of entities undercommon control; Retrospective adjustment to provisional amounts in connection with a prior business combination; and Retrospective revision for stock splits.”

Clawback Period
Under the proposed rule, exchanges and associations must adopt listing standards requiring issuers to adopt
and comply with policies mandating the recovery of excess incentive-based compensation “during the 3-year
period preceding the date on which the issuer is required to prepare an accounting restatement.” Notingthat Section 10D does not indicate when an issuer is “required to prepare an accounting restatement,” theSEC proposes that this requirement should run from the earlier of: The date the issuer’s board of directors, a committee of the board or authorized officer(s) “concludes, orreasonably should have concluded, that the issuer’s previously issued financial statements contain amaterial error; or The date a court, regulator or other legally authorized body directs the issuer to restate its previously
issued financial statements to correct a material error.”
According to the SEC, the first proposed date should generally coincide with the occurrence of an event thatwould be described in Item 4.02(a) of Exchange Act Form 8-K, “although neither proposed date ispredicated on a Form 8-K having been filed.” The first date would simply be the date the issuer has
concluded that previously issued financial statements contain a material error, even if the exact amount of
the error has not yet been determined.

Executives Subject to Recovery Policy
Under Section 10D(b)(2) of the Exchange Act, excess incentive-based compensation granted to “any current
or former executive officer of the issuer” is subject to clawback. Proposed Rule 10D-1 would apply to all
executive officers of the issuer. The proposed rule’s definition of “executive officer” would be modelled after
the definition of “officer” in Rule 16a-1(f) and would include the an issuer’s: president; principal financial officer; principal accounting officer (or in the absence of such an officer, the controller); any vice president in charge of a principal business unit, division or function;
 any other officer who performs a policy-making function;
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Memorandum – July 23, 20154

 any other person who performs similar policy-making functions for the issuer; and any executive officer of the issuer’s parents or subsidiaries if such officer performs policy-making
functions for the issuer.
In addition, as with the “officer” determination under Section 16, “if pursuant to Item 401(b) of Regulation
S-K the issuer identifies a person as an ‘executive officer,’ it would be presumed that the board of directors
has made that judgment and the persons so identified are executive officers for purposes of proposed Rule
10D-1.”
Under the proposed rule, recovery of excess incentive-based compensation would be required from any
individual who served as an executive officer “at any time during the performance period for that incentivebased compensation.” Accordingly, “incentive-based compensation derived from an award authorized
before the individual [became] an executive officer and inducement awards granted in new hire situations”
would be subject to clawback so long as the individual served as an executive officer at the company at any
time during the award’s performance period.

Incentive-Based Compensation Subject to Clawback
The SEC proposes to define “incentive-based compensation” as “any compensation that is granted, earned
or vested based wholly or in part upon the attainment of any financial reporting measure.” 6
In turn, “financial reporting measures” would be defined as “measures that are determined and presented inaccordance with the accounting principles used in preparing the issuer’s financial statements, any measuresderived wholly or in part from such financial information, and stock price and total shareholder return.”
Accordingly, “incentive-based compensation” would include the following types of awards that are earned
based wholly or in part by satisfying a financial target: options;
 cash awards;
 bonuses paid from a bonus pool; restricted stock, restricted stock units, performance share units, stock options and stock appreciationrights; and proceeds received upon the sale of shares acquired through an incentive plan.
 Under the proposed rule, incentive-based compensation is deemed received in the fiscal period during
which the financial reporting measure specified in the award is met, even if the payment or grant occurs
after the end of that period.

6

Release at 41 (emphasis added).
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Memorandum – July 23, 2015

5

Compensation Specifically Excluded from Incentive-Based Compensation
Incentive-based compensation would not include awards “granted, earned or vested based solely upon theoccurrence of certain non-financial events, such as opening a specified number of stores, obtaining
regulatory approval of a product, consummating a merger or divestiture, [or] completing a restructuring
plan or financing transaction.” The SEC does not consider the following types of compensation to be“incentive-based compensation”:
 salaries;
 bonuses paid solely at the discretion of the compensation committee or board that are not paid from abonus pool, the size of which is based wholly or in part on satisfying a financial reporting measureperformance goal; bonuses paid solely upon satisfying one or more subjective standards and/or completion of a specified
employment period;
 non-equity incentive plan awards earned solely upon satisfying one or more strategic or operational
measures; and equity awards for which the grant and vesting are not contingent upon achieving a financial reporting
measure performance goal.

Time Period Covered by Recovery Policy
Under the proposed rule, the three-year look-back period would be calculated as “the three completed fiscal
years immediately preceding the date the issuer is required to prepare an accounting restatement,” rather
than a preceding three-year calendar year period. If an issuer changes its fiscal year end during the threeyear look-back period, the issuer would be required to “recover any excess incentive-based compensation
received during the transition period occurring during, or immediately following, that three-year period in
addition to any excess incentive-based compensation received during the three-year look-back period (i.e., a
total of four periods).”

Recovery Process
The proposed rule addresses certain considerations in the recovery process, including: Determination of Excess Compensation. Under the proposed rule, excess compensation would be
the portion of any incentive-based compensation in excess of what would have been earned, paid or
received had the compensation amount been determined based on the restated financial measure. If the
incentive-based compensation awarded is based on stock price or total shareholder return, such thatprecise mathematical calculation of the amount erroneously awarded is not possible, an issuer may use “areasonable estimate of the effect of the accounting restatement on the applicable measure.” Where a
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Memorandum – July 23, 2015

6“reasonable estimate” is reached, the issuer would be mandated to maintain and provide documentationof the “reasonable estimate” to the relevant exchange or association. Moreover, under the proposed rule,
the recoverable amount would be calculated on a pre-tax basis. Finally, in recognition that the proposed
rule overlaps somewhat with Section 304 under the Sarbanes-Oxley Act of 2002, the SEC noted that “[t]heproposed rule is not intended to alter or otherwise affect the interpretation of Section 304 or thedetermination by the Commission or the courts of when reimbursement is required under Section 304.”7
The SEC clarified that, under the proposed rule, if an executive reimburses an issuer under Section 304,
such amounts should be credited for Rule 10D-1 purposes. In addition, “recovery under Rule 10D-1 would
not preclude recovery under Section 304 to the extent any applicable amounts have not been reimbursed
to the issuer.” Extent of Board Discretion in Seeking Recovery. The proposed rule does not generally allow
boards of directors the discretion to determine whether or not to recover erroneously awarded incentive
compensation; rather, it requires issuers to recover such compensation except:– “to the extent that pursuit of recovery would be impracticable because it would impose undue costs on
the issuer or its shareholders” (i.e. that the direct costs of enforcing recovery would exceed recoverable
amounts); or– if recovery would violate home country law adopted prior to the date that proposed Rule 10D-1 ispublished in the Federal Register.
With regard to the first of these exceptions, the issuer would be required to first “make a reasonableattempt to recover” the incentive-based compensation at issue, document its recovery attempts andprovide such documentation to the exchange, and “disclose why it determined not to pursue recovery.”
Similarly, before relying on the second exception, “the issuer first would need to obtain an opinion ofhome country counsel, not unacceptable to the applicable national securities exchange or association, thatrecovery would result in such a violation.” With respect to either exception, the determination must be
made by “the issuer’s committee of independent directors that is responsible for executive compensation
decisions,” or, in the absence of such committee, “by a majority of the independent directors serving on
the board.”
 Differential Recovery. Under the proposed rule, boards may not seek differential recovery among
executive officers, including in “pool plans,” where discretion may have originally been exercised in7

Sarbanes-Oxley Section 304 provides that “[i]f an issuer is required to prepare an accounting restatement due to thematerial noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the
securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for—(1) any
bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial
document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of
the issuer during that 12-month period.”
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Memorandum – July 23, 20157allocating individual grants from the bonus pool. Rather, recovery should be pro rata based on the size ofthe original award.
 Means of Recovery. In recognition that “the appropriate means of recovery may vary by issuer and by
type of compensation arrangement,” the proposed rule would permit issuers to exercise discretion in themeans by which they accomplish recovery, provided that recovery is reasonably prompt. 8Compliance with Recovery Policy
Under proposed Rule 10D-1, the relevant exchange would determine whether an issuer’s actions constitutecompliance with its compensation recovery policy. An issuer found not to be in compliance with its recovery
policy is subject to delisting.

No Fault
Notably, proposed rule 10D-1 requires recovery “regardless of issuer or executive misconduct or the role ofthe executive in preparing the financial statements.”

Indemnification and Insurance
In the SEC’s view, indemnification and reimbursement arrangements would frustrate the purpose of Section
10D. Accordingly, under the proposed rule, issuers would be prohibited from: “indemnifying any executive officer or former executive officer against the loss of erroneously awarded
compensation”; and paying or reimbursing the executive for premiums for third-party insurance policies purchased by the
executive to fund potential recovery obligations.

Required Disclosure
Under Section 10D, exchanges and associations must adopt listing standards calling “for disclosure of thepolicy of the issuer on incentive-based compensation that is based on financial information required to bereported under the securities laws.”9 The SEC construes this requirement as referring to “disclosure of thelisted issuer’s policy related to recovery of erroneously awarded compensation.” Proposed Rule 10D-1 would
require listing standards to mandate that listed issuers disclose their recovery policies and file them inaccordance with the federal securities laws, as amended by the proposed rule.

8

Suggested methods of recovery by commenters include, among others: (i) deductions from future pay; (ii) deductions
from current compensation owing, then from after tax-funds or (iii) cancellation of unvested equity or offsetting
against amounts otherwise payable to the executive officer. Release at 75.

9Release at 79, quoting Exchange Act §10D(b)(1).
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Memorandum – July 23, 20158

 Listed U.S. Issuers. Under proposed Rule 10D-1, each U.S.-listed issuer must disclose its recovery
policy as an exhibit to its annual report on Form 10-K. Moreover, the proposed rule would amend Item
402 of Regulation S-K “to require listed issuers to disclose how they have applied their recovery policies.”
Specifically, “if at any time during its last completed fiscal year either a restatement that required recovery
of excess incentive-based compensation pursuant to the issuer’s compensation recovery policy wascompleted or there was an outstanding balance of excess incentive-based compensation from theapplication of that policy to a prior restatement,” new Item 402(w) would require listed issuers todisclose:– for each restatement, the date on which the listed issuer was required to prepare the restatement, thetotal dollar amount of excess incentive-based compensation attributable to the restatement and thetotal amount of excess incentive-based compensation remaining outstanding at the end of the issuer’s
last completed fiscal year;– the estimates used to determine excess incentive-based compensation attributable to the accountrestatement, “if the financial reporting measure related to stock price or total shareholder return
metric”;– the name of each person subject to recovery, “if any, from whom the listed issuer decided during thelast completed fiscal year not to pursue recovery, the amount foregone for each such person, and a brief
description of the reason” the issuer decided not to pursue recovery; and– “[t]he name of, and amount due from, each person from whom, at the end of its last completed fiscal
year, excess incentive-based compensation had been outstanding for 180 days or longer since the datethe issuer determined the amount the person owed” to the issuer.
The SEC proposes to require this disclosure as a separate item under Item 402, rather than as anamendment to Compensation Discussion and Analysis (“CD&A”); however, an issuer that is required tohave a CD&A may decide to include its disclosure “in its CD&A discussion of its recovery policies anddecisions.”
The SEC further proposes to add a new instruction to the Summary Compensation Table that “would
require that any amounts recovered pursuant to a listed issuer’s erroneously awarded compensation
recovery policy reduce the amount reported in the applicable column for the fiscal year in which theamount recovered initially was reported, and be identified by footnote.” This new instruction would apply
to any filing requiring a Summary Compensation Table, including Securities Act registration statements.
Finally, the SEC proposes that the new Item 402(w) disclosure be provided “in interactive data format
using XBRL using block-text tagging.”
 Listed Foreign Issuers. Under the proposed rule, foreign private issuers “would be required to provide
the same information called for in Item 402(w), and to file their erroneously awarded compensation

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Memorandum – July 23, 20159policies as an exhibit to, the annual reports they file with the Commission” on Form 20-F, Form 10-K, or
Form 40-F. Listed foreign issuers would also be required to tag the required disclosure using interactive
XBRL format.

TimingThe SEC set a 60-day period for public comment on its proposed rule. Within 90 days after the publicationof the final SEC rule in the Federal Register, the national securities exchanges are required to publish
implementing rules that will take effect no later than one year after the publication of the final SEC rule.
Listed issuers will then have 60 days following the effective date of the relevant exchange’s rules to adopt
clawback policies. The SEC also proposes that listed issuers be required to recover excess incentive-based
compensation received “as a result of attainment of a financial reporting measure based on or derived fromfinancial information for any fiscal period ending on or before the effective date of Rule 10D-1 and that is
granted, earned or vested on or after the effective date of Rule 10D-1 pursuant to the issuer’s recovery policy.”
Finally, the SEC proposes that the mandated disclosures would be required to be included in SEC filings
made on or after the date on which the exchange rules become effective.

Takeaways from the Proposed Rule
 Update the Board of Directors/Compensation Committee. Consider updating the board and/or
compensation committee on the proposed rule, including its potential implications, and begin
contemplating how to address the new proposed requirements.
 Review Executive Compensation Structure. Issuers should review the elements of their executive
compensation plans to determine which elements are subject to the proposed rule’s definition of“incentive-based compensation.” Start Considering the Structure or Substance of a New Policy. Although the SEC’s final rule may
differ from the proposed rule and the listing standards adopted by the exchanges may be more expansive
than those required by the final rule, corporate boards and management may choose to begin thinking
about how best to approach, from a structural and substantive perspective, the new policy that they may
be required to adopt pursuant to the proposed rule.

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Memorandum – July 23, 201510

If you have any questions or would like additional information, please do not hesitate to contact Yafit Cohn
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Practice, or any of the following members of the Firm’s Executive Compensation and Employee Benefits
Practice:
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Brian D. Robbins+1-212-455-3090
brobbins@stblaw.com

Andrew Blau
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Laurence M. Moss
+1-212-455-2280
larry.moss@stblaw.com

David B. Teigman+1-212-455-3428
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Jamin R. Koslowe+1-212-455-3514
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aadler@stblaw.com

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