What You Need to Know About the SEC's Final Clawback Rules

17 minute read | November.02.2022

On October 26, 2022, the Securities and Exchange Commission (“SEC”) adopted final rules, first proposed by the SEC in 2015, requiring the recoupment of erroneously awarded incentive compensation received by current and former executive officers, pursuant to Section 10D of the Securities Exchange Act of 1934, as amended (“Exchange Act”), a provision added by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rules direct national securities exchanges (such as Nasdaq and NYSE) to adopt listing standards requiring listed companies to develop and implement a compensation clawback policy and to provide disclosure regarding the policy and any actions taken to recover compensation under such a policy.

The new listing standards will have an effective date no later than one year after publication of the release in the Federal Register, and companies will have to adopt a clawback policy and begin complying with the disclosure obligations within 60 days thereafter.

What are the new rules?

Pursuant to new Exchange Act Rule 10D-1, national securities exchanges are directed to adopt listing standards that require a listed company to:

  • develop and comply with a written clawback policy for the recoupment of erroneously awarded incentive compensation received by current and former executive officers in the event of an accounting restatement (either “Big R” or “little r”), regardless of whether the executive officer engaged in any misconduct and regardless of fault, with the policy applying to compensation received during the three-year period preceding the determination that an accounting restatement is required; and
  • disclose any actions the company has taken pursuant to such a policy.

Additionally, companies will be required to file a copy of the compensation clawback policy as an exhibit to annual reports on Form 10-K and to indicate compliance with the policy through new check boxes on the cover page of Form 10-K.

What type of compensation is covered?

Only performance-based cash and equity compensation that is granted, earned or vested based in whole or in part on the attainment of any financial reporting measure is covered (“Covered Compensation”). Salaries, discretionary cash bonuses not based on the attainment of financial reporting measures and purely time-based equity awards are not covered.

What is a financial reporting measure?

A “financial reporting measure” is any measure determined and presented in accordance with the accounting principles used in preparing a company’s financial statements, including “non-GAAP” financial measures (such as those appearing in earnings releases or MD&A), and any measures based in whole or in part from such measures.[1] Examples include measures based on: revenues, net income, operating income, financial ratios, EBITDA, liquidity measures, return measures (such as return on assets), profitability of one or more segments, sales per square foot, same store sales, revenue per user, and cost per employee. Additionally, the rules identify stock price and total shareholder return (“TSR”) as financial reporting measures. The SEC acknowledged concerns that inclusion of TSR “could discourage the use of TSR as a performance measure” by companies subject to these rules.

Which executives and what periods are covered?

The rules apply to all current and former executive officers (as such term is used for establishing insiders’ reporting obligations under Section 16 of the Exchange Act[2]) who receive payments of Covered Compensation during the three completed fiscal years (the “Covered Period”) preceding the date the company is required to prepare the accounting restatement. For example, if a calendar year company determines, or reasonably should have determined, in November of a calendar year that a restatement is required, the Covered Period would include the three previously completed calendar years. Under the rules, Covered Compensation received prior to a person becoming an executive officer will not be required to be recouped while the same is not true for a former executive officer who receives Covered Compensation during the Covered Period.

What must be recovered?

The recoverable amount is the amount of Covered Compensation received by the current or former executive officer in excess of the amount that otherwise would have been received had it been determined based on the restated financial measure, computed without regard to taxes paid. For Covered Compensation based on stock price or TSR, if the amount of erroneously awarded compensation is not subject to direct mathematical recalculation, the amount must be based on a “reasonable estimate” of the effect of the restatement on stock price or TSR.[3]

Covered Compensation is deemed received in a fiscal period during which the financial reporting measure specified in the award is attained, even if the payment or grant of the Covered Compensation occurred after the end of that period. For example:

  • if the grant of an award is based, either wholly or in part, on satisfaction of a financial reporting measure performance goal, the award would be deemed received in the fiscal period when that measure was satisfied;
  • if an equity award vests only upon satisfaction of a financial reporting measure performance condition, the award would be deemed received in the fiscal period when it vests;
  • a non-equity incentive plan award would be deemed received in the fiscal year that the executive officer earns the award based on satisfaction of the relevant financial reporting measure performance goal, rather than a subsequent date on which the award was paid;[4] and
  • a discretionary cash award earned upon satisfaction of a financial reporting measure performance goal would be deemed received in the fiscal period when that measure is satisfied.

In calculating recoverable amounts, companies are to apply a principles-based approach, with the determination depending on the particular facts and circumstances applicable to compensation arrangements. Companies and boards of directors are advised to “consider the statute’s goal to return erroneously awarded compensation to the [company] and its shareholders, and their fiduciary duties to those shareholders,” in making such calculations. See below for some limited examples of how recoverable amounts may be calculated:

  • for cash awards, the recoverable amount would be the difference between the amount of the cash award (whether payable as a lump sum or over time) that was received and the amount that should have been received applying the restated financial reporting measure; and
  • for equity awards, if the shares, options, or SARs are still held at the time of recovery, the recoverable amount would be the number of such securities received in excess of the number that should have been received applying the restated financial reporting measure (or the value of that excess number). If the options or SARs have been exercised, but the underlying shares have not been sold, the recoverable amount would be the number of shares underlying the excess options or SARs (or the value thereof).

How is it recovered?

The final rules provide boards of directors with discretion, subject to certain restrictions, regarding the means of recovery, which should be done reasonably promptly. Rule 10D-1 does not limit the amount of compensation the board is required to recover, but the rule does not permit boards of directors to settle for less than the full recovery amount unless they satisfy the conditions that demonstrate recovery is impracticable. Recovery is not required if: (i) the direct costs of seeking recovery would exceed the recoverable amount, (ii) recovery would violate the company’s home country laws, or (iii) recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code. To facilitate the enforcement of such measures, we recommend that companies consult with legal counsel to determine how to best build into compensation arrangements the covered executive’s acknowledgement and consent to such actions.

What types of restatements are covered?

Under the final rules, a company’s clawback policy will be triggered in the event that the company is required to prepare an accounting restatement due to the material noncompliance by the company with any financial reporting requirement under the securities laws, regardless of whether company or officer misconduct was the cause for such accounting restatement.  Specifically, recovery is required with respect to both (i) restatements that correct errors that are material to previously issued financial statements (commonly referred to as “Big R” restatements), and (ii) restatements that correct errors that are not material to previously issued financial statements, but would result in a material misstatement if (a) the errors were left uncorrected in the current report or (b) the error correction was recognized in the current period (commonly referred to as “little r” restatements).

What must be disclosed?

Pursuant to the final rules, each listed company is required to: (i) file its written clawback policy as an exhibit to its annual report; (ii) indicate by check boxes on its annual report whether the financial statements included in the filings reflect correction of an error to previously issued financial statements (including both “Big R” and “little r” restatements) and whether any of those error corrections are restatements that required a recovery analysis; and (iii) provide disclosure of any actions the company has taken pursuant to such policy, with such disclosure included as part of a company’s Regulation S-K, Item 402, Executive Compensation disclosures in Annual Reports on Form 10-K and/or proxy and information statements calling for the same.[5]

If a company is required to prepare an accounting restatement that required recovery pursuant to its clawback policy, it must disclose, as relevant: (i) the date it was required to prepare an accounting restatement and the aggregate dollar amount of erroneously awarded compensation attributable to such accounting restatement, including an analysis of how the amount was calculated (and, if the financial reporting measure related to a stock price or TSR metric, the estimates that were used in determining the erroneously awarded compensation attributable to such accounting restatement and an explanation of the methodology used for such estimates); (ii) the aggregate dollar amount that remains outstanding at the end of the last completed fiscal year and any outstanding amounts due from any covered executive for 180 days or longer; and (iii) if recovery would be impracticable, the amount of recovery forgone and a description of the reason the company decided not to pursue recovery. Companies must use Inline XBRL to tag their compensation clawback disclosure.

Note that Items 402(c) and 402(n) of Regulation S-K (relating to summary compensation table calculations) have also been amended to clarify that summary compensation table amounts must be adjusted to reflect any clawbacks, and that such adjustments must also be explained by footnote to the summary compensation table.

When to comply?

The final rules will become effective 60 days following publication of the release in the Federal Register. The exchanges must file proposed listing standards to implement the new clawback rules within 90 days following publication of the release in the Federal Register. The listing standards must have an effective date no later than one year following such publication. Listed companies are required to adopt a clawback policy within 60 days following the date on which the applicable listing standards become effective, and they must begin complying with the disclosure requirements in proxy and information statements and their annual reports filed on or after adoption of the clawback policy. Providing limited transitional relief, a company will only be required to apply the recovery policy to incentive-based compensation received after the effective date of the applicable listing standards and only during periods the issuer has a class of securities listed on an exchange, notwithstanding the general three-year look-back requirement.

How do the new rules compare to existing clawback requirements and proxy advisor guidance?

See below for a high-level comparison of the new rules against Section 304 of the Sarbanes-Oxley Act of 2002 and the current voting guidelines of ISS and Glass Lewis (“GL”).  Note, the ISS and GL guidelines have not yet been updated to reflect SEC adoption of the new rules.

 

 

New Exchange Act Rule 10D-1

SOX 304

ISS Guidance

GL Guidance

Trigger

“Big R” or “little r” restatements, regardless of misconduct.

“Big R” restatements caused by misconduct.

“Big R” restatements, regardless of misconduct.

At a minimum, “Big R” restatements or similar revision of performance indicators upon which bonuses were based.

Officers Covered

CEO, CFO, PAO, unit vice presidents and all other policy making officers.

CEO and CFO.

All NEOs.

Not specified, but generally disfavors policies that simply satisfy the minimum legal requirements.

Recovery Period

Three years preceding the date a company determines restatement is required.

12 months after the financial information was initially reported.

Not specified, but generally disfavors policies that contain only the limited requirements under SOX.

Not specified, but generally disfavors policies that simply satisfy the minimum legal requirements.

Compensation Covered

Erroneously awarded performance-based cash and equity compensation.

Any bonus or other incentive-based or equity-based compensation received, and any profits realized from the sale of company securities.

Not specified, but generally disfavors policies that contain only the limited requirements under SOX.

All performance-related bonuses and awards.

 

What should a compensation clawback policy look like?

See the next page for a sample compensation clawback policy addressing the requirements of new Exchange Act Rule 10D-1. This sample policy only includes required content and does not reflect additional requirements that may be imposed by the national securities exchange listing standards to be ultimately adopted. Some companies may also choose to use their clawback policies to address a broader range of corporate misconduct, particularly given the Department of Justice's recent increased attention to clawbacks as part of compliance programs.

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We will continue to monitor developments under these new requirements. Stay tuned for updates, or feel free to reach out to our team with additional questions, comments, or thoughts.

 

SAMPLE COMPENSATION CLAWBACK POLICY

[Company Name]

Effective [Date]

 

1. Recoupment

If [Company Name] (the “Company”) is required to undertake a Restatement, then the Company shall recover, reasonably promptly, all Recoverable Compensation from any Covered Person during the Applicable Period (including those Covered Persons who are not Executive Officers at the time of the Restatement), unless the Compensation Committee determines it Impracticable to do so, after exercising a normal due process review of all the relevant facts and circumstances.  Such recovery shall be made without regard to any individual knowledge or responsibility related to the Restatement or the Recoverable Compensation. Further, if the achievement of one or more Financial Reporting Measures was considered in determining the Incentive-Based Compensation Received by a Covered Employee, but the Incentive-Based Compensation was not paid or awarded on a formulaic basis, the Compensation Committee will in its good faith discretion determine the amount of any Recoverable Compensation that must be recouped with respect thereto.

The Compensation Committee has sole discretion to administer this Policy and, subject to applicable law, may seek to recoup such Recoverable Compensation by requiring any Covered Person to repay such amount to the Company; an adjustment to future cash or equity-based compensation payments or awards; by set-off of a Covered Person’s other compensation; or by such other means or combination of means as the Compensation Committee, in its sole discretion, determines to be appropriate[; provided that any decisions with respect to the Chief Executive Officer’s compensation shall be subject to ratification by the Board].

2. Definitions

For purposes of this Policy, the following terms shall have the following meanings:

Applicable Period. “Applicable Period” means the three completed fiscal years of the Company immediately preceding the earlier of (i) the date the Board, a committee of the Board, or the officer or officers of the Company authorized to take such action if Board action is not required, concludes (or reasonably should have concluded) that a Restatement is required or (ii) the date a regulator, court or other legally authorized entity directs the Company to undertake a Restatement. The “Applicable Period” also includes any transition period (that results from a change in the Company’s fiscal year) within or immediately following the three completed fiscal years identified in the preceding sentence.

Board. “Board” means the Board of Directors of the Company.

Compensation Committee. “Compensation Committee” means the Company’s committee of independent directors responsible for executive compensation decisions, or in the absence of such a committee, a majority of the independent directors serving on the Board.

Covered Person. “Covered Person” means any person who is, or was at any time, during the Applicable Period, an Executive Officer of the Company. For the avoidance of doubt, Covered Person may include a former Executive Officer that left the Company, retired, or transitioned to an employee role (including after serving as an Executive Officer in an interim capacity) during the Applicable Period.

Executive Officer. “Executive Officer” means the Company’s president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice-president 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 (including an officer of the Company’s parent(s) or subsidiaries) who performs similar policy-making functions for the Company.

Financial Reporting Measure. “Financial Reporting Measure” means a measure that is determined and presented in accordance with the accounting principles used in preparing the Company’s financial statements (including “non-GAAP” financial measures, such as those appearing in the Company’s earnings releases or Management Discussion and Analysis), and any measure that is derived wholly or in part from such measure. Examples of Financial Reporting Measures include measures based on: revenues, net income, operating income, financial ratios, EBITDA, liquidity measures, return measures (such as return on assets), profitability of one or more segments, sales per square foot, same store sales, revenue per user, and cost per employee. Stock price and total shareholder return are also Financial Reporting Measures.

Impracticable. The Compensation Committee may determine in good faith that recovery of Recoverable Compensation is “Impracticable” if: (i) pursuing such recovery would violate applicable law and the Company provides an opinion of counsel to that effect to the Company’s listing exchange; (ii) the direct expense paid to a third party to assist in enforcing this Policy would exceed the Recoverable Compensation and the Company has (A) made a reasonable attempt to recover such amounts and (B) provided documentation of such attempts to recover to the Company’s applicable listing exchange; or (iii) recovery would likely cause an otherwise tax-qualified retirement plan, under which benefits are broadly available to employees of the Company, to fail to meet the requirements of the Internal Revenue Code of 1986, as amended.

Incentive-Based Compensation. “Incentive-Based Compensation” means any compensation that is granted, earned, or vested based wholly or in part upon the attainment of a Financial Reporting Measure. Incentive-Based Compensation does not include any base salaries (except with respect to any salary increases earned wholly or in part based on the attainment of a Financial Reporting Measure performance goal); bonuses paid solely at the discretion of the Compensation Committee or Board that are not paid from a “bonus pool” that is determined by satisfying a Financial Reporting Measure performance goal; bonuses paid solely upon satisfying one or more subjective standards and/or completion of a specified employment period; non-equity incentive plan awards earned solely upon satisfying one or more strategic measures or operational measures; and equity awards that vest solely based on the passage of time and/or attaining one or more non-Financial Reporting Measures.

Policy. “Policy” means this [Company Name] Clawback Policy.

Received. Incentive-Based Compensation is deemed “Received” in the Company’s fiscal period during which the Financial Reporting Measure specified in the Incentive-Based Compensation award is attained, even if the payment or grant of the Incentive-Based Compensation occurs after the end of that period.

Recoverable Compensation. “Recoverable Compensation” means the amount of any Incentive-Based Compensation (calculated on a pre-tax basis) Received by a Covered Person during the Applicable Period that is in excess of the amount that otherwise would have been Received if the calculation were based on the Restatement. For the avoidance of doubt, Recoverable Compensation does not include any Incentive-Based Compensation Received by a person (i) before such person began service in a position or capacity meeting the definition of a “Covered Person,” (ii) if such person did not meet the definition of a “Covered Person” at any time during the Applicable Period, or (iii) during any period the Company did not have a class of its securities listed on a national securities exchange or a national securities association. For the avoidance of doubt, Recoverable Compensation may include Incentive-Based Compensation Received by a person while serving as an employee if such person previously served as an Executive Officer and then transitioned to an employee role. For the avoidance of doubt, if the subject Incentive-Based Compensation (calculated on a pre-tax basis) was based on stock price or total shareholder return, where the Recoverable Compensation is not subject to mathematical recalculation directly from the information in a Restatement, the Recoverable Compensation must be based on a reasonable estimate of the effect of the Restatement on the stock price or total shareholder return upon which the Incentive-Based Compensation was Received, and documentation of such reasonable estimate must be provided to the Company’s applicable listing exchange.

Restatement. “Restatement” means an accounting restatement of any of the Company’s financial statements filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, due to the Company’s material noncompliance with any financial reporting requirement under U.S. securities laws, regardless of whether Company or Covered Person misconduct was the cause for such restatement. “Restatement” includes any required accounting restatement to correct an error in previously issued financial statements that is material to the previously issued financial statements (commonly referred to as “Big R” restatements), or that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period (commonly referred to as “little r” restatements).

3. Other Actions

In addition, the Compensation Committee may, in its sole discretion and in the reasonable exercise of its business judgment, determine whether and to what extent additional action is appropriate to address the circumstances surrounding a Restatement to minimize the likelihood of any recurrence and to impose such other discipline as it deems appropriate.

4. No Indemnification or Reimbursement

Notwithstanding the terms of any other policy, program, agreement or arrangement, in no event will the Company or any of its affiliates indemnify or reimburse a Covered Person for any loss under this Policy and in no event shall the Company or any of its affiliates pay premiums on any insurance policy that would cover a Covered Person’s potential obligations with respect to Recoverable Compensation under this Policy.

5. Administration of Policy

The Compensation Committee shall have full authority to administer this Policy. Actions of the Compensation Committee pursuant to this Policy shall be taken by the vote of a majority of its members. The Compensation Committee shall, subject to the provisions of this Policy, make such determinations and interpretations and take such actions in connection with this Policy as it deems necessary, appropriate or advisable. All determinations and interpretations made by the Compensation Committee shall be final, binding and conclusive.

6. Acknowledgement by Covered Persons

The Company shall provide notice and seek written acknowledgement of this Policy from each Executive Officer, provided that the failure to provide such notice or obtain such acknowledgement shall have no impact on the applicability or enforceability of this Policy.

7. Other Laws

The remedies under this Policy are in addition to, and not in lieu of, any legal and equitable claims the Company or any of its affiliates may have or any actions that may be imposed by law enforcement agencies, regulators, administrative bodies or other authorities. Further, the exercise by the Compensation Committee of any rights pursuant to this Policy shall be without prejudice to any other rights that the Company or the Compensation Committee may have with respect to any Executive Officer or other Covered Person subject to this Policy. To the extent applicable, this Policy will be administered in a manner that complies with applicable law and listing exchange requirements and shall be interpreted and construed accordingly.

8. Amendment; Termination

The Board or the Compensation Committee may amend or terminate this Policy at any time.

9. Interpretation; Enforcement

This Policy will be interpreted and enforced, and appropriate disclosures and other filings with respect to this Policy will be made, in accordance with Rule 10D-1 of the Securities Exchange Act of 1934, as amended, and the Company’s applicable exchange listing standards.

10. Effectiveness

Except as otherwise determined in writing by the Compensation Committee, this Policy shall apply to any Incentive-Based Compensation that is Received by Covered Persons prior to or following the effectiveness of this Policy.


[1] An example of compensation that is based in part upon a financial reporting measure is an award in which 60% of the target amount is earned if a certain revenue level is achieved, and 40% of the target amount is earned if a certain number of new stores are opened.

[2] See Exchange Act Rule 16a-1(f).  These persons are commonly known as “Section 16 officers” because they must file with SEC beneficial ownership reports under Section 16 of the Exchange Act.

[3] In the event a company is required to make a reasonable estimate of such effect, the company must document how the reasonable estimate was determined and provide such documentation to the exchange.

[4] This would be the same fiscal year for which the non-equity incentive plan award earnings are reported in the summary compensation table.

[5] Such disclosures will not be deemed incorporated by reference into any Securities Act of 1933 filings unless a company specifically incorporates it by reference.