SEC Compensation Clawback Rules
- October 27, 2022
It took 12 years post Dodd Frank and a 3-2 political party divided vote, but the SEC has finally adopted new clawback rules. Here is an early summary, and for those that love the details, see the full release below.
Summary: Recovery of Erroneous and Excessive Executive Compensation
Following the adoption and guidance of the US Exchanges, all exchange-listed companies must adopt compliant clawback policies that will require the Company to recover incentive-based compensation that was erroneously and excessively paid to its current or former executive officers in the three year period preceding a restatement event stemming from both “little r” and “Big R”.
Which Companies Must Adopt The SEC's Compensation Clawback Rules?
All listed exchange companies – there are no exceptions for small reporting companies or emerging growth companies.
What is Required?
New Exchange Act Rule 10D-1 directs the exchanges to establish listing standards that require companies to:
- “Develop and implement written policies for recovery of incentive-based compensation based on financial information required to be reported under the securities laws, applicable to the companies’ Sec. 16 executive officers, during the three completed fiscal years preceding the date that the issuer is required to prepare an accounting restatement: and
- Disclose those compensation recovery policies in accordance with Commission rules, including providing the information in tagged data format.”
What is Incentive Based Compensation?
Short answer: “Specifically, we are defining “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 measure.”
The long answer: the final rules define “incentive-based compensation” as “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of a financial reporting measure.” “Financial reporting measures” are defined as “measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, and any measures that are derived wholly or in part from such measures. Stock price and total shareholder return are also financial reporting measures. A financial reporting measure need not be presented within the financial statements or included in a filing with the Commission. As such, any incentive-based compensation recovered under the final rules is compensation that an executive officer would not have been entitled to receive had the financial statements been accurately presented.”
Who is Covered?
For exchange listed companies, covered executives are current and former Section 16 executive officers in the applicable period who received incentive-based compensation in excess of the amount that otherwise would have been received had it been determined based on the restated financial measure.
When Do Restatements Trigger a Clawback?
Short answer: when either a “little r” or “Big R” occurs and it results in an executive officer receiving incentive–based compensation that would not have otherwise been awarded.
The long answer: the new rule will apply the clawback policy to both “little r” and “Big R” restatement events. If a listed 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, the issuer would be required to recover from any current or former executive officers incentive-based compensation that was erroneously awarded during the three years preceding the date such a restatement was required. The recoverable amount is the amount of incentive-based compensation received in excess of the amount that otherwise would have been received had it been determined based on the restated financial measure.”
Are There Exceptions?
There are “3 Impracticability Exceptions”:
- Direct expenses paid to third parties to assist in enforcing the policy would exceed the amount to be recovered and the company 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 company provides an opinion of counsel to that effect to the exchange; or
- Recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code.
When is it Effective?
Short answer: realistically, companies will need to have compliant policies implemented by midyear fiscal 2023.
Long answer: The new rule will become effective 60 days following publication of the release in the Federal Register. However, 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 proposed listing standards must be effective no later than one year after Federal Register publication. Each listed Issuer will be required to adopt a clawback policy no later than 60 days after the effective date of the applicable exchange standards.
What and Where Do Companies File?
All exchange listed companies will be required to file their written compensation recovery policies as exhibits to their Form 10K, and indicate in check boxes on their annual reports (i) whether their financial statements included in the filing reflect a correction of an error to previously issued financial statements and (ii) whether these corrections are restatements that required a clawback recovery analysis.
A company will also be required to disclose the following:
- “The date it was required to prepare an accounting restatement and the aggregate dollar amount of erroneously awarded compensation attributable to such accounting;
- the aggregate amount that remains outstanding and any outstanding amounts due from any current or former named executive officer for 180 days or more;
- details regarding any reliance on the impracticability exceptions; and
- Companies will be required to use Inline XBRL to tag their compensation recovery disclosure.”
Other Interesting Observations:
Finally, we thought it would be interesting to also note the current state of clawback policies across the public markets:
- Based on recent analysis, a strong majority of companies in the S&P 500 have policies in place today that cover incentive compensation (cash & equity), but that prevalence drops off within the Russell 3000.
