On October 26, 2022, the SEC adopted new rules that will require publicly traded companies to “claw back” incentive-based executive compensation that a company awarded to the executive based on materially misreported financials, which later required an accounting restatement. The rules apply to compensation an executive received during the three-year period preceding a financial restatement. While the SEC has had the ability to claw back incentive-based compensation since the enactment of Sarbanes-Oxley, these new rules provide a clawback mechanism, regardless of whether the restatement was caused by fraud, error, or any other factor, whereas Section 304 of the Sarbanes-Oxley Act only allowed a clawback where a restatement was the result of misconduct

The New Exchange Act Rule 10D-1 is the final version of a rule that was first proposed in 2015 to implement clawback provisions contained in the Dodd-Frank Act. After receiving significant public comments in 2021 and 2022, the Commission voted 3-2, along party lines, in favor of the rule. SEC Chairman Gensler, who voted in favor of the rule, stated he believes the rules will “strengthen the transparency and quality of corporate financial statements, investor confidence in those statements, and the accountability of corporate executives to investors.”¹ The two dissenting Commissioners criticized the Rule for being overly broad, and noted that the inclusion of “little r” restatements represented a “dramatic shift in the Commission’s interpretation” of the Dodd Frank Act’s clawback provision.

The final Rule is broader than the initial proposal. The proposed rule would only have permitted clawbacks for restatements to correct errors that were material to the previously issued financial statements at the time they were made, so-called “big R” restatements. However, the adopted Rule applies any time a company issues a restatement, even if the error was not material when made, but is at the time of restatement. The SEC justified this broader application on the grounds that “both types of restatements address material noncompliance of the issuer with financial reporting requirements.”²

Additionally, Rule 10D-1 requires national securities exchanges to establish listing standards mandating issuers to (1) adopt and comply with a policy for recovery of erroneously awarded executive compensation in the event of an accounting restatement due to material noncompliance with securities laws and (2) disclose those compensation clawback policies, as well as any actions taken pursuant to the policies. The rules will become effective 60 days after the final rule is published in the Federal Register, and the exchanges then have 90 days to propose listing standards. The Rule mandates that the listing standards become effective no later than one year following those proposals.

Issuers that fail to adopt and comply with compensation clawback policies meeting the listing standards will be subject to delisting. While many companies may have implemented voluntary policies already, it will be important for companies with and without existing policies to carefully examine the rule’s requirements and ensure their policy complies.

This new Rule has the potential to greatly impact executive compensation for public companies dealing with restatements. If you have questions concerning compliance with the new Rule, please contact Ballard Spahr partners David Axelrod or John Grugan.