Why The WSJ Is Wrong About SEC Rulemaking On Claw backs

As noted by Broc Romanek, The Wall Street Journal yesterday announced:

The Securities and Exchange Commission will soon propose long-awaited rules forcing companies to claw back, or revoke, some of their top officials’ incentive pay if they have to restate the financial results that led to it, according to people familiar with the agency’s internal deliberations.

I would categorize this statement as generally, but not entirely, accurate.  Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires the SEC to require the stock exchanges to prohibit the listing of securities of issuers that have not developed and implemented compensation claw-back policies.  Thus, I expect that the SEC, when it gets around to it, will be forcing the stock exchanges to change their listing standards.  The SEC won't be directly forcing companies to claw back incentive pay.

The distinction is not without consequences.  First, the SEC rules would not directly impact companies whose securities are not listed on a national securities exchange.  Second, the SEC's eventual adoption of rules won't be the end of the story.  The exchanges will then need to adopt their own rules implementing the SEC's rules.  Third, a company that fails to implement a claw back policy would be violating the exchange's, not the SEC's, rules.  Lastly, this indirect form of regulation raises a knotty question of whether state labor codes would (or could) be preempted.  California law, for example, may prohibit incentive compensation pursuant to Section 221 of the Labor Code (“It shall be unlawful for any employer to collect or receive from an employee any part of wages theretofore paid by said employer to said employee.”).

On the subject of preemption, the Ninth Circuit Court of Appeals has stated that Congress has vested FINRA and the NYSE with the power to promulgate rules that, once adopted by the SEC, have the force of law.  McDaniel v. Wells Fargo Invs., LLC, 717 F.3d 668, 673 (9th Cir. 2013).  However, I'm not so sure that the Ninth Circuit is correct either with respect to its reading of Section 19(b) of the Securities Exchange Act or as a matter of constitutional law.  See Ninth Circuit Holds Private Company Rules Preempt California Law.

The WSJ article also makes this rather confused assertion:

The rules, if finalized, could force an executive who received stock options after the company met a performance target, such as a revenue figure, to return some or all of that compensation if a misstatement shows revenue fell below the executive’s performance target.

First, as noted above, the rules wouldn't apply directly to the executives.  As also noted above, the executives may claim state law limits or prevents recoupment by the company.  Also, the article seems to confuse the grant of options with performance vesting.