The Advisors' Blog

Yesterday, by a 3-2 vote, the SEC adopted rules that will (eventually) require exchange-listed companies to maintain “clawback policies” for “the recovery of erroneously awarded incentive-based compensation received by current or former executive officers.” The SEC’s original proposal on these rules dates back to 2015. The Commission reopened the comment period in October 2021 and again in June 2022.

Here’s the 230-page adopting release – and the press release and 2-page Fact Sheet. Stay tuned for expert guidance via a CompensationStandards.com webcast on this topic – as well as in-depth analysis & practical takeaways from Dave Lynn in The Corporate Executive. We’ll also be posting the inevitable deluge of memos in our “Clawbacks” Practice Area. In the meantime, here’s a “baker’s dozen” things to know:

1. Rule Requires Policy & Disclosure: Nearly all exchange-listed companies will have to adopt and comply with a clawback policy that conforms to these new rules, and will also have to provide disclosure in proxy & information statements and annual reports about the policies and how they are being implemented.

2. Delisting at Stake: A company will be subject to delisting if it does not adopt and comply with a compensation recovery policy that meets the requirements of the listing standards.

3. Applies To “little r” Restatements: That policy must provide that, in the event the issuer is required to prepare an accounting restatement, including to correct an error that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period (“little r” restatements), the issuer will recover incentive-based compensation paid to its current or former executive officers based on any misstated financial reporting measure.

4. Three-Year Lookback: The policy must apply to compensation received during the three-year period preceding the date the issuer is required to prepare the accounting restatement.

5. Applies to Current & Former Executives: The policy has to direct the company to recover erroneously awarded compensation from both current and former executive officers.

6. Three Limited “Impracticability” Exceptions: The only allowable exceptions to enforcing the policy are:

– Direct expenses paid to third parties to assist in enforcing the policy would exceed the amount to be recovered and the issuer has made a reasonable attempt to recover;

– Recovery would violate home country law that existed at the time of adoption of the rule, and the issuer provides an opinion of counsel to that effect to the exchange (regarding state laws, which Emily blogged about last year as a potential issue, the SEC says on page 92 of the adopting release that it’s not aware of any state laws that would clearly prohibit recovery, although executives may assert that as a defense and companies may need to address such matters as part of the recovery process); or

– Recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code.

7. New Exhibit to Annual Report: The clawback policy must be filed as an exhibit to the annual report, under Item 601(b)(97) of Regulation S-K.

8. Disclose Application of Policy: Companies must disclose how they have applied their recovery policies, including:

– The date on which the company was required to prepare an accounting restatement & the aggregate dollar amount of erroneously awarded compensation attributable to such accounting restatement (including an analysis of how the recoverable amount was calculated) or, if the amount has not yet been determined, an explanation of the reasons and disclosure of the amount and related disclosures in the next filing that is subject to Item 402 of Regulation S-K;

– The aggregate dollar amount of erroneously awarded compensation that remains outstanding at the end of its last completed fiscal year;

– If the financial reporting measure related to a stock price or TSR metric, the estimates used to determine the amount of erroneously awarded compensation attributable to such accounting restatement and an explanation of the methodology used for such estimates;

– If recovery would be impracticable pursuant to 17 CFR 240.10D-1(b)(1)(iv) (“Rule 10D-1(b)(1)(iv)”), for each current and former named executive officer and for all other current and former executive officers as a group, disclose the amount of recovery forgone and a brief description of the reason the listed registrant decided in each case not to pursue recovery; and

– For each current and former named executive officer, disclose the amount of erroneously awarded compensation still owed that had been outstanding for 180 days or longer since the date the issuer determined the amount owed.

– If compensation is recovered, companies must also reduce figures in the Summary Compensation Table, under a new instruction to that item.

9. XBRL Tags Required: Companies will be required to use Inline XBRL to tag their compensation recovery disclosure.

10. New Form 10-K Check Boxes: The rules add two new check boxes on the cover page of Form 10-K. One to indicate whether the financial statements included in the filings reflect correction of an error to previously issued financial statements, and one to indicate whether any of those error corrections are restatements that required a recovery analysis.

Hopefully someone smarter than me will clarify, but it does not seem immediately clear from the release whether these check boxes (especially the first one) will be required for Form 10-Ks that are filed in 2023, after the SEC rule is effective but before companies have to make any other disclosure about policies.

11. Comply in Late 2023/Early 2024: Assuming the typical Federal Register time frame and that the exchanges fully leverage the permitted compliance & effective date windows, we’re looking at an effective date in approximately January 2023 (60 days following publication of the release in the Federal Register), exchanges proposing listing standards in approximately February 2023 (90 days following publication of the release in the Federal Register), those listing standards becoming effective in approximately November 2023 (1 year after the publication date), and companies having to adopt policies in early January 2024 (within 60 days of the effective date of the listing standard), with disclosure following in annual reports and proxy statements that are filed after that date.

The release states, “We would not expect compliance with the disclosure requirement until issuers are required to have a policy under the applicable exchange listing standard.”

12. Plenty of Work Required Between Now & 2024: I’m sure nobody reading this thinks they can wait until December of next year to throw together a clawback policy. You hopefully have already been socializing the notion with the board and executives, and probably have some form of existing policy and concepts in plan documents and agreements. Now, you’ll need to analyze how those align with the new rule, what changes are needed, whether and how to position policies & agreements to overcome defenses that may apply under state laws and anticipate tax and other consequences, what disclosure will look like, etc. The expectation from most folks I’ve talked to is that the exchange listing standards will track the SEC rule pretty closely – but of course we won’t know for sure until they actually submit the proposals.

13. Don’t Forget Other Clawback Rules & Enforcement Initiatives: As Dave blogged earlier this week on TheCorporateCounsel.net, companies must also be mindful of the interplay with SOX 304 clawbacks and current enforcement initiatives when preparing policies and related compliance efforts. This Freshfields blog from late last year explains how Dodd-Frank clawbacks generally differ from the existing Sarbanes-Oxley rule.

As expected, the rules are prescriptive – and companies will face a lot of challenges in adopting and enforcing the policies that they require. That is not the fault of the Staff, but is a function of a stale mandate on a very complicated topic, made even more complex by the intervening prevalence of “little r” restatements.

– Liz Dunshee