On October 26, 2022, the US Securities and Exchange Commission (SEC) adopted new Rule 10D-1, directing national securities exchanges to establish listing standards that prohibit the listing of any security of a company that does not adopt and implement a written policy requiring the recovery, or "clawback," of certain incentive[1]based executive compensation.1 Recovery under a clawback policy must be the amount of incentive compensation that is shown to have been paid in error, based on an accounting restatement that is necessary to correct a material error of a financial reporting requirement.

In a significant expansion of the rule as originally proposed, Rule 10D-1 will require the recovery policy to apply to any accounting restatement to correct not only an error in previously issued financial statements that is material to the previously issued financial statements (also called a "Big R" restatement) but also 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 (also called a "little r" restatement).

If a current or former executive officer received erroneously awarded incentive-based compensation within the three fiscal years preceding the date of determination that a restatement is required, the company must recover the excess incentive-based compensation on a "no-fault" basis. The rule also specifies disclosure requirements under newly created Item 402(w) relating to clawback policies and clawbacks.

Background

Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) added Section 10D to the Securities Exchange Act of 1934, requiring the SEC to direct national securities exchanges to establish listing standards that prohibit the listing of any security of a company that does not adopt and implement a written policy requiring the recovery, or "clawback," of certain incentive-based executive compensation payments.

The Dodd-Frank Act clawback requirement set forth in Section 10D contains key differences from the clawback requirement that was implemented by Section 304 of the Sarbanes Oxley Act of 2002 (Sarbanes-Oxley Act). For example, the Dodd-Frank Act requirement applies to all current and former executive officers while the Sarbanes-Oxley Act provision applies only to the chief executive officer and the chief financial officer. In addition, the Dodd-Frank Act requirement applies to any accounting restatement that is due to material noncompliance, whether or not there is misconduct, while the Sarbanes-Oxley Act requirement applies only to accounting restatements resulting from misconduct. The SEC first proposed rules setting forth the Dodd-Frank Act clawback requirements in 2015 (2015 Proposal); however, the 2015 Proposal was never adopted. On October 14, 2021, the SEC issued a release reopening the 2015 Proposal (Reopening Release). Developments in clawback policies since 2015 provided an impetus for the SEC to reopen the comment period. In particular, the Reopening Release noted "an increase in the number of companies disclosing information about their ability to recoup performance-based awards in the event of fraud, restatement of financial statements, or other reasons, and adopting and implementing executive compensation clawback policies addressing these circumstances." (See our October 18, 2021, Legal Update "SEC Reopens Comment Period for Clawback Listing Standard.")

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Footnote

1. Release Nos. 33-11126; 34-96159 available at: Final Rule: Listing Standards for Recovery of Erroneously Awarded Compensation (sec.gov)

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