That was a key conclusion of a PricewaterhouseCoopers (PwC) report by authors Ken Stoler, Kevin Hassan, and Julie Sheeran into how companies might have to deal with the recordkeeping implications of the financial reform clawback mandates.
“We understand there is some uncertainty around how the provisions of the Act will be applied and interpreted. However, we believe the clawback provision called for under the Act would likely be objectively determinable (i.e., whether or not an accounting restatement has occurred), and the consequence would not be subjective or open to discretion (i.e., any excess value must be returned to the company),” the authors wrote. “As a result, we believe there generally should not be any potential accounting implications beyond the typical accounting for clawbacks prescribed under the stock compensation literature.”
The PwC report pointed out that clawbacks are generally accounted for if and when the contingent event sparking the clawback occurs. PwC said at the time a clawback is invoked, the company would recognize the value returned by the individual. If the individual returns shares, the shares would be treated as treasury stock while income would be recognized to the extent of compensation expense previously recognized for that particular award and any excess value would be recorded as an increase to additional paid-in capital.
The PwC authors contended that the accounting for clawbacks presumes the key terms and conditions of the clawback feature are mutually understood by the company and employee when the award is issued. The problem occurs when there is subjectivity or discretion about what sparks the clawback, which could produce a conclusion that there is no accounting grant date. That, in turn means variable accounting for the fair value of the award until a grant date can be agreed upon between both parties, PwC said.
“To ensure that these performance-type clawback features will result in the establishment of a grant date at inception, the metrics should be clear and determinable on an objective basis,” the authors contended. “Conditions based on the operations of the employer will need to be based on metrics that are established upfront at the grant date. “
According to the PwC report, the Dodd-Frank Act requires national securities exchanges and associations to adjust their listing standards to prohibit listing for any company that does not implement and publicly disclose a clawback policy to recover incentive-based compensation paid to current or former executive officers based on erroneous financial data (see Financial Reform Measure Includes Compliance Provisions).
The triggering event for the recovery, under the act, is an accounting restatement of the company’s financial statements because of any material noncompliance with any financial reporting requirement under the securities laws. The recovery look-back period is three years from the date of the accounting restatement. The amount to be recovered is the excess incentive-based compensation (including stock options) over what would have been paid based on the restated amounts.
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