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Understanding The SEC’s Final Clawback Rules – Securities

On October 26, 2022, the Securities and Exchange Commission
(“SEC”) adopted its final “clawback” rules
requiring securities exchanges to mandate listing standards that
require listed issuers on securities exchanges
(“Issuers”) to implement a policy providing for the
recovery of erroneously awarded incentive-based compensation under
certain circumstances (the “Final Rules”).

The Final Rules require Issuers to adopt and enforce a compensation
recovery policy that will: require recovery of incentive-based
compensation from executive officers when an accounting restatement
due to the material non-compliance with any financial reporting
requirement under the securities laws is required. The Final Rules
use a 3-year look-back period and specific disclosure requirements,
including the filing of the policy with the issuer’s Annual
Report on Form 10-K.

Under the Final Rules, an Issuer would be subject to delisting if
it does not adopt and comply with its compensation recovery policy.
The Final Rules apply to virtually all Issuers, including emerging
growth companies (“EGCs”), smaller reporting companies
(“SRCs”), foreign private issuers (“FPIs”), and
controlled companies.

The Final Rules are found in new Rule 10D-1 under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”).
The Final Rules set forth the directive that exchanges and
associations listing securities establish standards that Issuers
need to meet with respect to clawback policies.

Summary of Final SEC Clawback Rules


Disclosure of Issuer’s Policy on Recovery of
Incentive-Based Compensation

The Final Rules direct national securities exchanges and
associations to establish listing standards that require an Issuer

  • adopt and comply with a written policy for recovery of
    erroneously awarded incentive-based compensation, as described in
    this advisory; and

  • disclose the compensation recovery policy in accordance with
    SEC rules, including providing the information in tagged data
    format (Inline XBRL).

The Final Rules require (i) specific disclosure of the Issuer’s
policy on recovery of incentive-based compensation and information
about actions taken pursuant to such recovery policy, (ii) the
policy be filed as an exhibit to the Issuer’s Annual Report on
Form 10-K (new Exhibit 97), and (iii) new check boxes on Form 10-K
indicating whether the financial statements included in such
filings reflect correction of an error to previously issued
financial statements and whether any of those corrections give rise
to a recovery analysis.

Definition of Executive Officers

The Final Rules define “executive officer” as an
Issuer’s president, principal financial officer, and principal
accounting officer (or if there is no such accounting officer, the
controller), any vice-president of the issuer in charge of a
principal business unit, division, or function, any other officer
who performs a policy-making function, or any other person who
performs similar policy-making functions for the issuer, which is
consistent with the term “officer” as defined in Rule
16a-1(f). The Final Rules are not intended to cover rank-and-file
employees; the intent was to include persons who were responsible
for the errors necessitating the accounting restatement.

Restatements Triggering Recovery Policy

The Final Rules cover both types of restatements:

  • Those that correct errors that are material to previously
    issued financials (“Big R” restatements); and

  • Those that correct errors that are not material to previously
    issued financials, but would result in a material misstatement if:
    (a) the errors were left uncorrected in the current period or (b)
    the error correction was recognized in the current period
    (“little r” restatements).

The SEC acknowledged that a correction of an error that is recorded
in the current financials where the error is immaterial to both the
previous and current financials, an “out-of-period
adjustment,” would not constitute an accounting

Incentive-Based Compensation

For purposes of Rule 10D-1, the Final Rules define
“incentive-based compensation” to be “any
compensation that is granted, earned, or vested based wholly or in
part upon the attainment of any financial reporting

Specific examples of award types that could constitute
“incentive-based compensation” include, but are not
limited to:

  • Non-equity incentive plan awards;

  • Bonuses;

  • Other cash awards

  • Restricted stock, restricted stock units, performance share
    units, stock options, and stock appreciation rights
    (“SARs”); and

  • Proceeds received upon the sale of shares acquired through an
    incentive plan that were granted or vested based wholly or in part
    on satisfying a financial reporting measure performance goal.

Calculating 3-Year Lookback Period

The 3-year look-back period for the recovery policy will consist
of the three completed fiscal years immediately preceding the date
the Issuer is required to prepare an accounting restatement for a
given reporting period. Under the listing standards, the date on
which an Issuer is required to prepare an accounting restatement is
the earlier to occur of:

  • The date the Issuer’s board of directors, a committee of
    the board of directors, or the officer or officers of the issuer
    authorized to take such action if board action is not required,
    concludes, or reasonably should have concluded, that the issuer is
    required to prepare an accounting restatement due to the material
    noncompliance of the issuer with any financial reporting
    requirement under the securities laws as described in the Final
    Rules; or

  • The date a court, regulator or other legally authorized body
    directs the issuer to prepare an accounting restatement.

Calculation of Erroneously Awarded Compensation; Board

The erroneously awarded compensation under an Issuer’s
recovery policy is “the amount of incentive-based compensation
received by the executive officer or former executive officer that
exceeds the amount of incentive-based compensation that otherwise
would have been received had it been determined based on the
accounting restatement,” computed without regard to taxes
paid. Such incentive-based compensation may be in the form of cash
or equity awards. The Final Rules provide guidance about
calculating the recoverable amounts.

The Final Rules provide boards with limited discretion, subject to
certain reasonable restrictions, regarding the calculation of the
amount to be recovered and the means of recovery; however, the
Final Rules do not permit boards to settle for less than the full
recovery amount unless they satisfy the conditions that demonstrate
recovery is impracticable. The Final Rules provide circumstances
under which recovery could be impracticable.

Effective Dates

The Final Rules will become effective 60 days following
publication of the adopting release (available here) in the Federal Register.

Exchanges will be required to file proposed listing standards no
later than 90 days following publication of the release in the
Federal Register, and the listing standards must be effective no
later than one year following such publication.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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