On July 1, 2015, the Securities and Exchange Commission (the “SEC”) proposed rules to implement Section 954 of the Dodd-Frank Act, which added Section 10D to the Securities Exchange Act of 1934. Section 10D requires the Commission 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 (a “clawback”) that is received by an issuer’s executive officers in excess of what would have been received under an accounting restatement.

To assure that issuers listed on different exchanges are subject to the same disclosure requirements regarding compensation recovery policies, the SEC is proposing amendments to the disclosure rules that would require all issuers listed on any exchange to file their written recovery policy as an exhibit to their annual reports and, if they have taken actions pursuant to that policy, to disclose those actions.

Key Requirements of Proposed Rules

Under the proposed rules, all listed issuers would be required to adopt and comply with written policies for recovery of incentive-based compensation based on financial information required to be reported under the securities laws, applicable to the listed issuers’ executive officers, over a period of three years and to disclose those recovery policies in accordance with Commission rules.

An issuer would be required to perform a “clawback” of executive incentive-based compensation under the proposed rules in the event the issuer is required to restate a financial statement to correct material non-compliance with a financial reporting requirement.

Incentive-based compensation includes “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.” Under the proposed rules, “financial reporting measures” are measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measures derived wholly or in part from such financial information, and stock price and total shareholder return. The incentive-based compensation to be recovered by an issuer would be the difference between the amount received by an executive officer as a result of materially incorrect financial statements and the amount the executive officer would have received had the compensation been based on the restated financial statements.

Issuers, Securities and Executive Officers Subject to the Rule

The proposal would require exchanges to apply the disclosure and recovery policy requirements to all listed issuers, with only limited exceptions. The limited exceptions apply only to security futures products, standardized options, and the securities of certain registered investment companies. The SEC does not propose to exempt categories of listed issuers, such as emerging growth companies, smaller reporting companies, foreign private issuers, and controlled companies, because the SEC believes the objective of recovering excess incentive-based compensation is as relevant for these categories of listed issuers as for any other listed issuer.

A clawback policy must apply to current and former “executive officers,” which includes a company’s president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice president of the issuer in charge of a principal business unit, division or function (such as sales administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer. Executive officers of the issuer’s parents or subsidiaries would be deemed executive officers of the issuer if they perform such policy making functions for the issuer.

Timing

The SEC’s final rules will likely go into effect at the end of 2016 or early 2017. The rule proposal is silent about how issuers should deal with retroactive application of the recovery policy to existing compensation arrangements. However, the SEC is crystal clear in its mandate that issuer compliance is required whether the incentive-based compensation is received pursuant to a pre-existing contract or arrangement, or one that is entered into after the effective date of the exchange’s listing standard.