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A Fresh Take

Insights on M&A, litigation, and corporate governance in the US.

| 6 minutes read

SEC Adopts Final Clawback Rules for Incentive-Based Compensation

­­Executive Summary

On October 26, 2022, the U.S. Securities and Exchange Commission (the SEC) adopted final executive compensation “clawback” rules (the Final Rules), fulfilling its mandate under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) enacted more than a decade ago.  The Final Rules direct national securities exchanges, including Nasdaq and the NYSE, to establish listing standards that require each listed company to adopt and implement a clawback policy providing for the recoupment of excess incentive-based compensation received by current or former executive officers due to a material misstatement of the company’s financial reports, regardless of any actual misconduct.

The national securities exchanges must file proposed listing standards no later than 90 days following the date the Final Rules are published in the Federal Register, and the listing standards must become effective no later than one-year following that same publication date.  Listed companies will then have 60 days following the effective date of the applicable listing standards to adopt a compliant clawback policy.  Based on this anticipated timeline, full compliance will be required no later than early 2024.  Failure of a company to comply with the clawback rules could result in the company being delisted by the applicable exchange.  

In More Detail

Although the Final Rules are substantially similar to the rules first proposed by the SEC in 2015 (the Proposing Release), they also extend beyond the Proposing Release in certain key respects.

  • Covered Companies — U.S. Listed Companies.  With limited exceptions, the Final Rules apply to all companies with securities listed on Nasdaq, NYSE, or another U.S. national securities exchange.  This includes foreign private issuers (FPIs), smaller reporting companies, emerging growth companies, and controlled companies that are exempt, in whole or in part, from other compensation-related disclosure regimes such as the “say-on-pay” rules and the recently enacted “pay vs. performance” rules we discuss in a separate post available here.

  • Covered Individuals — Current and Former Executive Officers. The clawback policy must apply to any current or former executive officer who served in that capacity at any time during the covered period discussed below.

    For this purpose, “executive officer” consists of all “officers” as defined under Section 16 of the Securities and Exchange Act of 1934, as amended.  This means a company’s principal executive officer, president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other officer (including officers of a parent or subsidiary) who performs a significant policy making function for the company.  While U.S. companies may have more robust processes in place to identify and designate officers, FPIs may need to carefully consider the scope of covered individuals under the Final Rules in light of potential differences between groups who are otherwise members of managerial or supervisory bodies under local law regimes.

  • Clawback Trigger — Financial Restatement (“Big R” and “Little R”).  Clawback policies must be triggered if the company is required to prepare either:

    • an accounting restatement that corrects an error in prior period financial statements that is material to those financial statements (commonly referred to as a “Big R” restatement), which typically coincides with the issuance of a Form 8-K under Item 4.02 (Non-reliance on Previously Issued Financial Statements); or

    • a revision restatement (commonly referred to as a “little r” restatement) to correct an error that is not material to prior period financial statements but would result in a material misstatement in the current period financial statements if left uncorrected or if the correction were recorded only in the current period.  The inclusion of “little r” restatements is a departure from the Proposing Release and reflects growing SEC attention to companies’ materiality analysis in determining the level of restatement required and the increase in the number of “little r” restatements in recent years. [1]

  •  Covered Compensation — Incentive-Based Compensation Recoverable.  Cash and equity incentive compensation, calculated on a pre-tax basis, that is granted, earned or vested based on the achievement of a financial reporting measure and received during the covered period must be subject to clawback to the extent it is in excess of what would have been received if the applicable financial reporting measure had been determined based on the corrected financial restatement.  Notably, where a clawback is triggered, executives would be required to return amounts greater than the after-tax amounts actually received.

    “Financial reporting measures” are measures that are determined and presented in accordance with the accounting principles used in preparing a company’s financial statements, and any measures that are derived wholly or in part from such measures.  This includes GAAP and non-GAAP figures, other metrics and ratios such as same store sales, and measures such as stock price and total shareholder return (TSR), whether or not actually presented within the financial statements or included in SEC filings.  For incentive compensation based on stock price or TSR metrics where the amount of excess compensation is not readily ascertainable, the Final Rules direct companies to use “a reasonable estimate” of the effect of the accounting restatement on the relevant metrics and provide documentation of that determination to the applicable securities exchange. In these situations, companies may be obliged to engage in costly analyses to explain inherently uncertain data.

  • Covered Period — 3-Year Look-Back. Clawback policies must provide for the recoupment of excess incentive-based compensation received by a covered individual within the three completed fiscal years immediately preceding the earlier of (i) the date the company concludes, or reasonably should have concluded, that the company is required to prepare a restatement; and (ii) the date a court or authorized agency mandates a restatement.

    Incentive-based compensation will be deemed to be received upon the attainment of the applicable financial reporting measure, regardless of whether the grant or payment occurs on a later date. As a result, incentive-based compensation awards that are subject to the achievement of multiple performance conditions may require portions of the award to be recovered (or forfeited) prior to the completion of the entire performance or vesting period.

    Any incentive-based compensation received on or after the effective date of the applicable listing standard is subject to clawback under the Final Rules.  This includes incentive-based compensation governed by arrangements or contracts in place before the effective date of the applicable listing standard but that is received following the effective date.

  • Limited Discretion. Company boards of directors are required to seek recovery reasonably promptly after the company’s clawback policy is triggered, except in limited circumstances where recovery would be impracticable because (i) the cost of enforcement exceeds the amount to be recovered, (ii) recovery violates the pre-existing home-country laws of a foreign company as in effect on the publication date of the Final Rules based on the opinion of counsel, or (iii) recovery would likely cause the loss of tax-qualified status of a broad-based employee benefit plan. Before concluding that recovery is impracticable, a company must make a “reasonable attempt” to recover the incentive-based compensation.

    The Final Rules do not prescribe the manner or deadline by which companies must recover excess incentive-based compensation, leaving these decisions to the discretion of the company.  However, the listing standards may set forth more specific rules for recovery.

  • No Indemnification. The Final Rules prohibit companies from indemnifying executives against the losses of recovered amounts and from paying premiums on an insurance policy that would cover executives’ potential clawback obligations. Companies may need to review existing officer indemnification policies and agreements, which customarily require the company to advance legal fees or otherwise reimburse executives for losses incurred in the event of corporate disputes, in order to comply with the Final Rules.

  • Increased Disclosure. Companies will be required to file their written clawback policies as an exhibit to their annual reports (e.g., 10-K, 20-F, 40-F, or N-CSR, as applicable), and, following any financial restatement, disclose in their proxy, among other matters, (i) the amount of excess incentive-based compensation recoverable under the company’s clawback policy, (ii) an analysis of how the amount was calculated, and (iii) to the extent the company’s board determined recovery was impracticable, an explanation of the determination not to pursue recovery.  The additional disclosure rules will be required in any annual report or proxy statement filed after the effective date of the listing standards applicable to the company.

Next Steps:

Company representatives are encouraged to discuss the application of the Final Rules with their boards of directors and management teams.  Many companies that have already voluntarily adopted compensation clawback policies in recent years in response to enhanced scrutiny from investors may need to modify those policies or adopt additional policies in order to comply with the anticipated listing standards. 

As companies re-examine their existing governance and compliance frameworks in light of the Final Rules, it remains to be seen whether some companies will also re-examine their executive compensation design (including the mix of fixed vs. incentive compensation, or the use of operational metrics over “financial reporting measures”) to provide executive officers additional security and ease increased administrative burdens under the new clawback regime.

[1] In March 2022, the SEC Acting Chief Accountant expressed skepticism with respect to materiality determinations made by companies regarding the appropriate level of financial restatement required, pointing to statistics indicating a 35% increase in the number of “little r” restatements relative to all restatements between 2005 – 2020.   


corporate, corporate governance