On June 9, 2023, the U.S. Securities and Exchange Commission
(SEC) approved amendments filed earlier that week by the New York Stock
Exchange (NYSE) and The Nasdaq Stock
Exchange (Nasdaq) that, among other things, provided that the
effective dates of the proposed executive compensation recovery
– or clawback – requirement listing standards filed by
the NYSE and Nasdaq in February
2023 would be October 2, 2023. The compliance date for listed
companies – that is, the date by which listed companies must
adopt a clawback policy that complies with the requirements of the
applicable stock exchange listing standards or risk delisting
– is December 1, 2023. The December 1, 2023 compliance date
replaces August 8, 2023, which was the anticipated compliance date
prior to the filing of the amendments.
As described in more detail below, the NYSE and Nasdaq listing
standards and SEC Rule 10D-1 under the Securities Exchange Act of
1934, as amended (Exchange Act) will apply to nearly all companies
with listed securities, including smaller reporting companies,
emerging growth companies and foreign private issuers. This alert
highlights the general requirements of the stock exchange listing
standards and the actions that listed companies should be taking
now to prepare for the adoption and implementation of a clawback
policy that complies with applicable stock exchange listing
standards by December 1, 2023. More detailed discussion of Rule
10D-1 and the stock exchange listing standards is available in two
Goodwin alerts, SEC Adopts Final Rules Requiring Disclosure and
Recovery of Erroneously Awarded Incentive-Based Compensation
and Mandatory Executive Compensation Clawback
Policies: The Time Is . . . Soon.
What Companies Should be Doing Now
- With the final compliance date now known, listed companies should finalize a plan for adoption of a clawback policy that satisfies the applicable stock exchange listing standards by December 1, 2023. Dealing with existing incentive compensation plans and awards, as well as existing employment-related arrangements affected by the clawback policy, may require significant attention.
- Review the company's existing timeline, or establish a timeline now, to appropriately manage the process of adopting a clawback policy that will comply with the stock exchange rules by December 1, 2023, including internal and external review and board communications and final board approval
- If the company has an existing clawback policy, determine whether to adopt a stand-alone clawback policy that complies with the stock exchange rules and a stand-alone clawback policy that is broader than the stock exchange rules, or to integrate the two policies
- Review the company's existing incentive compensation plans, policies, programs and practices and existing employment and compensation-related agreements and arrangements to determine (i) what actions may be appropriate to ensure that the company can properly enforce the clawback policy required by stock exchange listing standards and (ii) whether it would be advantageous to revise or restructure incentive compensation programs that use financial performance measures (including stock price and total shareholder return) for future periods
- Review the company's existing indemnification arrangements, including those contained in the company's organizational documents, stand-alone agreements or in employment- or compensation-related agreements, to determine whether any changes are required to comply with the prohibitions on indemnification under the stock exchange rules
- Review the company's internal control over financial reporting and disclosure controls and procedures to assure that (i) triggering events under the clawback policy can be identified in a timely manner, (ii) internal and external resources can be promptly engaged to analyze the situation and its financial and compliance impacts, including making determinations about which current or former executive officers may be affected, the amount of any required clawback, and how the company will recover any amounts subject to clawback, and (iii) relevant internal and external parties can be promptly informed that a triggering event has occurred and that they will receive all information necessary to comply with SEC and stock exchange disclosure requirements, including the disclosures required in the company's public filings
- Domestic listed companies may wish to review their determinations of which employees are designated as "officers" under Section 16 of the Exchange Act to avoid unnecessarily subjecting officers to the new clawback policy. Foreign private issuers, which are not subject to Section 16, should determine, likely for the first time, which officers will be "executive officers" for purposes of the new clawback policy
Consider Training Sessions and Tabletop Exercises
Companies should consider how they will plan for potential
application of the clawback policy. This process may be technically
complex, and Rule 10D-1 and the stock exchange listing rules
provide limited time periods for companies to make the various
necessary determinations and disclosures. The consequences of
missed deadlines and noncompliance with the company's clawback
policy and stock exchange and SEC rules can result in a variety of
serious consequences, such as loss of Form S-3 eligibility and
potential delisting.
Companies may also want to consider whether it would be beneficial
to conduct training sessions to familiarize company personnel, and
potentially the company's independent auditor, external legal
counsel and compensation consultant, with the requirements of the
company's clawback policy and stock exchange and SEC rules as
well as the various existing compensation arrangements that may be
impacted by the clawback policy. The following may be helpful for
companies:
- Develop a written playbook that (i) describes the conditions or events that would trigger the company's clawback policy, (ii) identifies the relevant parts of the clawback policy, SEC rules, compensation arrangements and any other applicable materials, (iii) describes in sequential order the actions necessary if the company's clawback policy is triggered, and (iv) identifies and assigns responsibility to appropriate internal or external persons or functions. The playbook should be updated as necessary to reflect any changes, such as a new compensation plan or changes in the company's organizational structure or roles, that would affect the playbook
- Consider internal training sessions and/or tabletop exercises that will familiarize company personnel, and possibly the company's independent auditor, external legal counsel and compensation consultant, with the clawback playbook and the company's clawback policy, and the company's relevant compensation arrangements. Tabletop exercises may be particularly useful because they may identify improvements in the company's internal control over financial reporting and its disclosure controls and procedures
Summary of Stock Exchange Clawback Policy and SEC Disclosure Requirements
The summary below highlights the most significant elements of
the stock exchange listing standards on incentive compensation
clawbacks and SEC disclosure requirements. The alerts cited earlier
include more detailed discussions.
Companies Subject to the Stock Exchange Listing Standards
and SEC Rules. The clawback listing standards and
disclosure rules apply to nearly all listed companies, including
smaller reporting companies, emerging growth companies, foreign
private issuers and controlled companies, with very limited
exceptions. The listing standards also apply to private companies
that have listed debt or preferred securities and, with limited
exceptions, to investment companies with exchange-listed
securities. There are no deferred compliance provisions for smaller
reporting companies or emerging growth companies.
Executive Officers Covered. The stock exchange
listing standards and final SEC rules apply to "executive
officers," which is defined as a 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 or function
(e.g., sales, administration or finance), any other officer of the
company who performs a policy-making function, and any other person
who performs similar policy-making functions for the company. For
domestic issuers, this definition is consistent with the definition
of "officer" in Rule 16a-1(f) of the Exchange Act, often
referred to as "Section 16 officers." There is no
requirement that an executive officer had a direct role in
financial reporting. The listing standards do not require recovery
of incentive-based compensation received by a person before the
individual became an executive officer.
Indemnification and Reimbursement Prohibited.
Companies may not indemnify any executive officer or former
executive officer against loss of erroneously-awarded compensation
under the company's clawback policy. The SEC stated In the
adopting release that it views this requirement as also prohibiting
companies from paying for or reimbursing a current or former
executive officer for the cost of any third-party insurance policy
intended to fund potential recovery obligations or modifying
current compensation arrangements or taking other actions that
would amount to de facto indemnification, such as by providing an
executive officer a new cash award which the issuer would then
"cancel" to effect recovery of outstanding recoverable
amounts.
Fiscal Years Covered; When Compensation is
"Received." The stock exchange listing standards
require listed companies' clawback policies to apply to
compensation received on or after October 2, 2023. Compensation
will be deemed "received" for purposes of the recovery
policy in the fiscal period during which the applicable financial
reporting measure is attained, even if the payment or grant occurs
after the end of that period. For instance, an equity award that is
earned based on the company's total shareholder return for the
three-year period ending December 31, 2024, would be deemed
received in 2024 even though the shares are not issued until early
2025, and even if the shares are subject to additional time-based
vesting. As a result, the shares would be subject to potential
clawback if the company was required to prepare an accounting
restatement in 2025, 2026 or 2027.
Compensation Covered by Clawback Policies. The
stock exchange listing standards provide that clawback policies
must require the recovery of erroneously awarded
"incentive-based compensation," which means any
compensation that is granted, earned or vested based wholly or in
part on the attainment of any "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 company's
financial statements, and measures derived from such measures,
including stock price and total shareholder return. Financial
reporting measures may include non-GAAP financial measures.
The adopting release includes a non-exhaustive list of examples
that include, among many others, measures such as accounts
receivable turnover and other ratios, sales per square foot or same
store sales (if sales is subject to an accounting restatement),
revenue per user (if revenue is subject to an accounting
restatement), cost per employee (if cost is subject to an
accounting restatement), and any financial reporting measures
relative to a peer group (if the company's financial reporting
measure is subject to an accounting restatement). The definition of
financial reporting measure does not require that a measure be
presented in the company's financial statements or included in
an SEC filing.
Amounts Subject To Recovery. Clawback policies
must require recovery of 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 financial statements, without adjustment for
any taxes paid on the compensation. To the extent that the amount
of erroneously awarded compensation is based on the company's
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, the amount of erroneously awarded compensation must be
calculated based on a reasonable estimate of the effect of the
restatement on the stock price or total shareholder return upon
which the compensation was received.
Exceptions To The Recovery Requirement. The stock
exchange listing standards require companies to recover erroneously
awarded compensation in compliance with their recovery policy,
except in the following limited circumstances:
- The direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered
- For companies incorporated outside the U.S., recovery would violate a home country law adopted prior to November 28, 2022, and the company provides an acceptable opinion of home country counsel to the stock exchange
- Recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code
In addition, the compensation committee of the company's
board of directors (or a majority of independent directors, in the
absence of a compensation committee) must make the determination
that recovery would be impracticable.
Disclosure Requirements. The stock exchange
listing standards require listed companies to file all disclosures
related to a company's clawback policy as required by SEC
rules.
Listed companies are required to file their clawback policy as an
exhibit to a company's Form 10-K or Form 20-F annual
report.
There are new check boxes on the cover page of Form 10-K and Form
20-F to indicate (i) whether the company's financial statements
included in the annual report reflect correction of an error to
previously issued financial statements and (ii) whether any of
those error corrections are restatements that required a recovery
analysis of incentive-based compensation pursuant to Rule
10D-1(b).
If, during the prior fiscal year, there was a restatement that
triggered a company's clawback policy or there are unrecovered
amounts of incentive compensation that are subject to the
company's clawback policy, Item 402(w) of Regulation S-K
requires the company to provide disclosures about its financial
restatement(s), its clawback policy and how it has applied the
policy. The disclosure required by Item 402(w), will be required in
the company's annual report and in its proxy or information
statements that call for Item 402 disclosure, and will not be
deemed to be incorporated by reference into any filing under the
Securities Act of 1933 unless the company specifically incorporates
it by reference. Form 20-F provides essentially identical
disclosure requirements for foreign private issuers. Companies must
tag disclosures that relate to clawback policies in compliance with
the SEC's Inline XBRL requirements.
SOX Clawback Requirements. The clawback requirements of
the Sarbanes-Oxley Act of 2002 (SOX), which require a company's
chief executive officer and chief financial officer to reimburse
the company for any incentive or equity-based compensation and any
profits from selling securities received during the year after the
company issued inaccurate financial statements if the company is
required to prepare an accounting restatement as a result of
"misconduct," continue to apply. To the extent that the
clawback policy required by the stock exchange listing standards
and the SOX clawback provisions apply to the same compensation, any
amounts recovered by the company under the SOX clawback provision
will be credited to the recovery required by the clawback policy
required by the stock exchange listing standards.
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.