By Amy Leisinger, J.D.
The Investment Company Institute (ICI) and the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC) have submitted comments on the SEC’s proposal on listing standards for recovery of erroneously awarded compensation. While generally supportive of the Commission’s efforts, the ICI urged the SEC to exclude all registered investment companies from the proposed requirements, and the CCMC argued that the proposal is “needlessly complex and overly prescriptive” and requested clarification and changes to a number of provisions.
Rule proposal. The SEC’s proposal directs the national securities exchanges and associations to adopt listing standards to require listed companies to implement policies for clawing back incentive-based compensation later found to have been awarded in error. Proposed Rule 10D-1 would require recovery from both current and former executive officers who received incentive-based compensation during the three fiscal years preceding an accounting restatement to correct a material error. The amount to be clawed back would be based on the compensation that exceeds what an executive officer would have received as reflected in the accounting restatement.
An executive officer does not have to be responsible for any misconduct or for the erroneous financial statements for the clawback provision to apply, and the rule provides exceptions to the clawback requirement: (1) when the expense of enforcing the recovery would exceed the amount to be recovered; or (2) when the recovery would violate the home country law of a foreign private issuer. The proposal would also require disclosure of listed companies’ recovery policies and their actions under those policies.
ICI comments. In its comments, the ICI expressed concern that the proposed rule would subject certain registered investment companies to new disclosure requirements. Exchange Act Section 10D and the proposed rule generally do not apply to registered mutual funds because they do not issue listed securities, and, in drafting the proposal, the SEC exempted the securities of most investment companies because of their compensation structures. However, the proposal provides only a conditional exemption listed registered management investment companies (such as ETFs and closed-end funds) if the company has not awarded incentive-based compensation to any executive officer in the last three fiscal years.
The ICI suggests an unconditional exemption for all listed funds, noting that the concerns underlying the Dodd-Frank Act do not apply to these types of funds. Further, the ICI states, removing listed funds from application of the proposed rule would be consistent with Commission positions excluding all registered investment companies from prior compensation rulings and would more accurately reflect the structure and accounting practices of the funds. The organization also notes that listed funds’ financial statements and accounting practices are less complex than those of operating companies and involve far fewer estimates and judgments. Accounting restatements are relatively rare for listed funds, and, as such, the cost of listed funds’ compliance with the proposed changes would outweigh any potential benefits, the ICI concludes.
CCMC comments. In its comments, the CCMC noted that clawbacks will drive good governance practices but only if required and executed in “balanced” manner. The prescriptive nature of the proposal will hinder the ability of exchanges to develop standards appropriately suited for particularized business circumstances, according to the group. The proposal creates a burdensome recovery process by requiring recovery of compensation in except under limited circumstances that impose undue costs on the issuer or its shareholders, according to the group, and the SEC should consider providing boards of directors the discretion to assign collection responsibility to the Commission when voluntary disgorgement cannot be obtained. In addition, according to CCMC, the SEC’s proposal to prohibit a listed issuer from indemnifying any executive officer against loss should be modified to take the same approach as in other regulations: stating that indemnification is contrary to public policy but leaving the final determination to the courts.
The proposal also should be modified to take into account the application of foreign laws and the potential effects on foreign private issuers to avoid creating disincentives for U.S. listing and to minimize economic burdens on investors and smaller reporting companies, the group explains. Further, in connection with a final Rule 10D-1, the SEC should clarify the concept of “restatement” to coincide with existing positions and should refine the definition of “executive officer” to avoid covering officers with little or no actual control over the preparation of financial statements. The SEC should also take steps to avoid applying the proposed rule retroactively and should provide an economic analysis concerning whether the proposed changes will promote capital formation and competition, the CCMC concluded.