On October 26, 2022, the SEC adopted final rules on listing standards for the recovery of erroneously awarded incentive-based executive compensation (“Clawback Rules”) (see HERE). The Clawback Rules implement Section 954 of the Dodd-Frank Act and require that national securities exchanges require disclosure of policies regarding and mandating clawback of compensation under certain circumstances as a listing qualification. The proposed rules were first published in July 2015 (see HERE) and have moved around on the SEC semiannual regulatory agenda from proposed to long-term and back again for years.
The Clawback Rules add a check box to Forms 10-K, 20-F and 40-F to indicate whether the form includes the correction of an error in previously issued financial statements and a related recovery analysis. Although the check box has already been added to the Forms, the new Clawback Rules are not effective until November 28, 2023. As such, the SEC has issued guidance regarding compliance with the check box in the interim. Also, in late February, both the NYSE and Nasdaq published initial rules implementing the new listing standards as directed by the SEC. This blog covers the checkbox guidance and new NYSE and Nasdaq Rules.
Interestingly a few practitioners have pointed out that although the rules are not required to be effective until November 28, 2023, the SEC adopting release, and Exchange proposed rules also provide that the Rules will be effective as soon as 60 days after the Exchange Listing Standards are finalized, as those standards have already been proposed, the final Rules could be adopted and implemented before the November 28 deadline.
SEC Guidance on Check Box
In three identical C&DI issued under different categories of C&DI, the SEC confirmed that it does not expect compliance with the disclosure requirements under the new Clawback Rules, including the check box on Forms 10-K, 20-F and 40-F, until companies are required to have a recovery policy under the applicable exchange listing standard.
Background on Clawback Rules
New Exchange Act Rule 10D-1 directs national securities exchanges and associations to establish listing standards that require a listed company to: (i) adopt and comply with a written policy for recovery of erroneously awarded incentive-based compensation received by its current or former executive officers in the event it is required to prepare an accounting restatement due to its material noncompliance with any financial reporting requirement under the securities laws, during the three completed fiscal years immediately preceding the date that the company is required to prepare an accounting restatement; and (ii) disclose those compensation recovery policies in accordance with SEC rules, including providing the information in inline XBRL format.
The final rules also require disclosure of the listed company’s policy on recovery of incentive-based compensation and information about actions taken pursuant to such policy. In addition, the rules also require all listed companies to: (i) file their written recovery policies as exhibits to their annual reports; (ii) indicate by check boxes on their annual reports whether the financial statements included in the filings reflect correction of an error to previously issued financial statements and whether any of those error corrections are restatements that required a recovery analysis; and (iii) disclose any actions they have taken pursuant to such recovery policies.
The Rules require national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that does not develop and implement a policy providing for the recovery of erroneously awarded incentive-based compensation and for disclosure of that policy. Under the Clawback Rules, a company is subject to delisting if it does not (i) adopt a compensation recovery policy that complies with the rules; (ii) disclose the policy in accordance with the rules, including XBRL tagging; and (iii) comply with its written compensation recovery policy.
The Clawback Rules:
- Require national securities exchanges and associations to establish listing standards that require listed companies to adopt and comply with a compensation recovery policy in which recovery is required from current and former executive officers who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement to correct a material error. The recovery must be on a “no fault” basis without regard to whether any misconduct occurred, or whether the executive officer had responsibility for the misstated financial statements.
- Require that the amount of incentive-based compensation to be recovered be the amount the executive received over what they would have received based on the restated financial statement.
- Require a company to seek recovery except to the extent it would be impracticable to do so, such as where the recovery cost would exceed the amount to be recovered, or for foreign issuers, where recovery would violate home country laws.
- Prohibit companies from indemnifying current and former executive officers against the loss of recoverable incentive-based compensation.
- Require the filing of the compensation recovery policy as an exhibit to the company’s Exchange Act annual report.
- Require specific disclosure in the executive compensation disclosure section of annual reports and proxy statements, with XBRL tagging, if the company completed a restatement that required recovery in the past fiscal year or there is any recoverable amounts outstanding from any prior year.
The implementation and impact of the rule will rest on the definitions of incentive-based compensation and executive officers. The rule defines “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 measure” is defined as a measure that is determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measure derived wholly or in part from such financial information, and stock price and total shareholder return. For incentive-based compensation based on stock price or total shareholder return, issuers are permitted to use a reasonable estimate of the effect of the restatement on the applicable measure to determine the amount to be recovered.
The rule defines an “executive officer” to include the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policymaking functions for the company and otherwise conforms to the full scope of the Exchange Act Section 16 definition.
The Clawback Rules apply to all listed issuers and all securities, with limited exceptions. The rules’ limited exemptions include security future products, standardized options and the securities of certain registered investment companies.
Restatements Triggering Application of Recovery Policy
The Clawback Rules require issuers to adopt and comply with policies that require recovery “in the event 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.” The SEC includes any error that is material to the financial statements as “material noncompliance.” Accordingly, the Clawback Rules provide that issuers adopt and comply with a written policy providing that in the event the issuer is required to prepare a restatement to correct an error that is material to previously issued financial statements, the obligation to prepare the restatement would trigger application of the recovery policy.
The Clawback Rules will include “little r restatements” which refers to restatements that materially impact the current period but are immaterial to prior financial statements. A “little r” restatement generally does not require an Item 4.02 Form 8-K for non-reliance on previously issued financial statements. In recent years, full-blown accounting restatements have not been happening quite as often as they once did, for a variety of reasons, but the occurrence of little r restatements has grown dramatically.
When Dodd-Frank was enacted in 2010 on the heels of the Enron crisis, the concern was that executives should not be able to keep incentive compensation paid based on misstated financial statements that had to be restated as a result of fraud or other misconduct. Many industry participants are concerned with the broad scope of the new rules which are likely to result in compensation recovery policies being invoked much more often where there has been a mundane accounting error and for smaller amounts. The cost-benefit analysis may not be supported with such a broad scope.
The SEC clarifies that the following changes to financial statements would not trigger the recovery policy: (i) the retrospective application of a change in accounting policy; (ii) retrospective revision to a reportable division due to a company’s internal reorganization; (iii) retrospective reclassification due to a discontinued operation; (iv) retrospective application of a change in reporting entity such as from a reorganization or change in control; (v) retrospective adjustment to provisional amounts in connection with a prior business combination; or (vi) retrospective revision for stock splits.
Applicable Date and Time Period
The Clawback Rules require the recovery of incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement. The date on which the company is required to prepare an accounting restatement is the earlier of (i) the date the board of directors or officers of the company, if board authorization is not required, conclude that the company’s previously issued financial statements contain a material error; or (ii) the date a court, regulator or other legally authorized body directs the company to restate its previously issued financial statements to correct a material error.
SEC Guidance on Scope
On the same day that the SEC issued C&DI guidance on the check box application prior to the full compliance period, it also issued a new C&DI on the intended scope of the rules. That is, the SEC confirmed that the rules are intended to apply broadly, including compensation that is in any sort of plan, other than tax-qualified retirement plans, including long term disability, life insurance, SERPs, and any other compensation that is based on the incentive-based compensation.
Nasdaq Clawback Rules
Nasdaq has proposed to add Listing Rule 5608 titled, recovery of erroneously awarded compensation. The language conforms closely to Rule 10D-1 and the SEC release, including explanations on materiality and “litte r” restatements that are material based on facts and circumstances and existing judicial and administrative interpretations, as described above.
In line with Rule 10D-1, Nasdaq proposes to define the term “executive officer” to include the issuer’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function and any other person (including executive officers of a parent or subsidiary) who performs similar policy-making functions for the issuer. The term “policy-making function” is not intended to include policy-making functions that are not significant.
Likewise, Nasdaq proposes to define the term “Incentive-based compensation” to mean any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.
The term “financial reporting measures” is defined as measures that are determined and presented in accordance with the accounting principles used in an issuer’s financial statements, and any measures that are derived wholly or in part from such measures, as well as an issuer’s stock price and total shareholder return. Equity awards that vest exclusively upon completion of a specified employment period, without any performance condition, and bonus awards that are discretionary or based on subjective goals or goals unrelated to financial reporting measures, do not constitute incentive-based compensation. Incentive based compensation received by an executive officer before the issuer had a class of securities listed on a national securities exchange or a national securities association would not be subject to the compensation recovery policy.
The Nasdaq rules cover all listed companies that issue incentive based compensation including foreign private issuers, emerging growth companies, smaller reporting companies, controlled companies and issuers of listed debt whose stock is not also listed.
As allowed by Rule 10D-1, the Nasdaq proposal provides that a company would not be required to pursue recovery if it would be impracticable because: (i) the direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered, (ii) recovery would violate home country law, where that law was adopted prior to November 28, 2022, based on an opinion of counsel acceptable to Nasdaq or (iii) recovery would cause a broad-based retirement plan to fail to meet the tax-qualification requirements. Before concluding that pursuit is impracticable, a company must first make a reasonable attempt to recover the incentive-based compensation and provide that documentation to Nasdaq. The listed company’s board is required to apply on a “no fault” basis any recovery policy consistently to executive officers and a listed company is prohibited from indemnifying any current or former executive officer for recovered compensation.
The Nasdaq proposed rules require disclosure, under Item 402 of Regulation S-K of the following items, among others, if, during the prior fiscal year, either a triggering restatement occurred or any balance of excess incentive-based compensation was outstanding:
- The date on which the listed company 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 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 total shareholder return 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 Rule 10D-1, 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.
Nasdaq also proposes to amend Listing Rule 5810(c)(2)(A)(iii) to provide that a company that failed to comply with proposed Listing Rule 5608 must submit to Nasdaq Staff a plan to regain compliance. The administrative process that will be followed is similar to other corporate governance deficiencies, allowing Nasdaq Staff to provide the issuer up to 180 days to cure the deficiency. The Nasdaq Staff would then be required to issue a delisting letter, which could be appealed to the Hearings Panel, which in turn could allow the issuer up to an additional 180 days to cure the deficiency.
In reviewing a potential delisting, the Nasdaq proposed rules state “Rule 10D-1 requires that a listed company recover the amount of erroneously awarded incentive-based compensation reasonably promptly but does not specify the time by which the issuer must complete the recovery of excess incentive-based compensation; rather, Nasdaq would determine whether the steps an issuer is taking constitute compliance with its compensation recovery policy. The issuer’s obligation to recover erroneously awarded incentive-based compensation reasonably promptly will be assessed on a holistic basis with respect to each such accounting restatement prepared by the issuer. In evaluating whether an issuer is recovering erroneously awarded incentive-based compensation reasonably promptly, the Exchange will consider whether the issuer is pursuing an appropriate balance of cost and speed in determining the appropriate means to seek recovery, and whether the issuer is securing recovery through means that are appropriate based on the particular facts and circumstances of each executive officer that owes a recoverable amount.”
NYSE Clawback Rules
The NYSE has proposed to add new Section 303A.14 to the Listing Manual, which, like Nasdaq closely conforms to Rule 10D-1 and the SEC release.
The requirements of proposed Section 303A.14 would be as follows:
- The issuer must adopt and comply with a written Recovery Policy providing that the issuer will recover reasonably promptly the amount of erroneously awarded incentive-based compensation in the event 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, including any required accounting restatement to correct an error in previously issued financial statements that is material to the previously issued financial statements, or 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’s Recovery Policy must apply to all incentive-based compensation received by a person: (i) After beginning service as an executive officer; (ii) Who served as an executive officer at any time during the performance period for that incentive-based compensation; (iii) While the issuer has a class of securities listed on a national securities exchange or a national securities association; and (iv) During the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement. In addition to these last three completed fiscal years, the recovery policy must apply to any transition period (that results from a change in the issuer’s fiscal year) within or immediately following those three completed fiscal years. However, a transition period between the last day of the issuer’s previous fiscal year end and the first day of its new fiscal year that comprises a period of nine to 12 months would be deemed a completed fiscal year.
- An issuer’s obligation to recover erroneously awarded compensation is not dependent on if or when the restated financial statements are filed.
- For purposes of determining the relevant recovery period, the date that an issuer is required to prepare an accounting restatement is the earlier to occur of: (i) 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; or (ii) The date a court, regulator, or other legally authorized body directs the issuer to prepare an accounting restatement.
- The amount of incentive-based compensation that must be subject to the issuer’s recovery policy (“erroneously awarded compensation”) is the amount of incentive-based compensation received that exceeds the amount of incentive based compensation that otherwise would have been received had it been determined based on the restated amounts, and must be computed without regard to any taxes paid. For incentive-based compensation based on stock price or total shareholder return, where the amount of erroneously awarded compensation is not subject to mathematical recalculation directly from the information in an accounting restatement: (i) The amount must be based on a reasonable estimate of the effect of the accounting restatement on the stock price or total shareholder return upon which the incentive-based compensation was received; and (ii) The issuer must maintain documentation of the determination of that reasonable estimate and provide such documentation to the Exchange.
- The issuer must recover erroneously awarded compensation in compliance with its Recovery Policy except to the extent as set forth below, and the issuer’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, has made a determination that recovery would be impracticable. Exceptions include: (i) The direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered. Before concluding that it would be impracticable to recover any amount of erroneously awarded compensation based on expense of enforcement, the issuer must make a reasonable attempt to recover such erroneously awarded compensation, document such reasonable attempt(s) to recover, and provide that documentation to the Exchange. (ii) Recovery would violate home country law where that law was adopted prior to November 28, 2022. Before concluding that it would be impracticable to recover any amount of erroneously awarded compensation based on violation of home country law, the issuer must obtain an opinion of home country counsel, acceptable to the Exchange, that recovery would result in such a violation, and must provide such opinion to the Exchange. (iii) Recovery would likely cause an otherwise tax-qualified retirement plan, under which benefits are broadly available to employees of the registrant, to fail to meet the requirements of 26 U.S.C. 401(a)(13) or 26 U.S.C. 411(a) and regulations thereunder.
- The issuer is prohibited from indemnifying any executive officer or former executive officer against the loss of erroneously awarded compensation.
The issuer must file all disclosures with respect to such Recovery Policy in accordance with the requirements of the Federal securities laws, including the disclosure required by the applicable SEC filings.
The definitions adopted by the NYSE in line with those for Nasdaq as are the delisting procedures.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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