It was just November last year when the SEC finally adopted rules to implement Section 954 of Dodd-Frank, the clawback provision. (Remember that Dodd-Frank dates to 2010 and the clawback rules were initially proposed by the SEC back in 2015.)  The new rules directed the national securities exchanges to establish listing standards requiring listed issuers to adopt and comply with clawback policies and to provide disclosure about their policies and implementation. Under the rules, the clawback policy must provide that, in the event the listed issuer is required to prepare an accounting restatement—including a “little r” restatement—the issuer must recover the incentive-based compensation that was erroneously paid to its current or former executive officers based on the misstated financial reporting measure. (See this PubCo post.) The final rules required any covered exchanges to file proposed listing standards with the SEC no later than February 27, with the listing standards to be effective no later than one year after publication. On Tuesday, the SEC posted the listing standards proposed by Nasdaq and by the NYSE. They’re largely the same, with some differences, both tracking the SEC requirements closely. Both proposals are open for comment until 21 days after publication in the Federal Register.

Exchange Act Rule 10D-1 directs the exchanges to establish listing standards that require issuers 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 issuers’ executive officers, during the three completed fiscal years immediately 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.”

As stated in the related fact sheet, each listed issuer will “be required to adopt a compensation recovery policy, comply with that policy, and provide the required compensation recovery policy disclosures.”  An issuer that does not do so will be subject to delisting.

Proposed Nasdaq Listing Rule 5608

Nasdaq proposed Rule 5608(a) requires listed companies “to adopt a compensation recovery policy, comply with that policy, and provide the compensation recovery policy disclosures required by this rule and in the applicable Commission filings.”

Written policy.  Proposed Rule 5608(b) would require listed companies to adopt and comply with a written policy providing that the company will recover “reasonably promptly” the amount of erroneously awarded incentive-based compensation if required to prepare an accounting restatement due to the company’s material noncompliance with any financial reporting requirement under the securities laws. 

The recovery policy must apply to

“all incentive-based compensation received by a person:

• (A) After beginning service as an executive officer;
• (B) Who served as an executive officer at any time during the performance period for that incentive-based compensation;
• (C) While the Company has a class of securities listed on a national securities exchange or a national securities association; and
• (D) During the three completed fiscal years immediately preceding the date that the Company is required to prepare an accounting restatement as described in paragraph (b)(1) of this Rule.”

The policy must also apply to transition periods in connection with changes of fiscal year.  The listing standard notes that the recovery obligation does not depend “on if or when the restated financial statements are filed.”

Restatements. Restatements include both “Big R” restatements (restatements that correct errors that are material to previously issued financial statements) and “little r” restatements (restatements that “correct errors that are not material to previously issued financial statements but would result in a material misstatement if the errors were left uncorrected in the current report or the error correction was recognized in the current period”). The determination of materiality of an error “should be based on facts and circumstances and existing judicial and administrative interpretations.” 

For purposes of determining the recovery period, the date of the restatement is the earlier to occur of the date the board, committee or authorized officers “concludes, or reasonably should have concluded, that the Company is required to prepare an accounting restatement”; or the “date a court, regulator, or other legally authorized body directs the Company to prepare an accounting restatement.”

Executive officers. Under the proposed listing standards, the recovery policy must apply to current and former executive officers. Proposed Rule 5608(d) defines executive officer as the “president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice-president of the Company in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policymaking functions for the Company,” including executive officers of parents or subs who perform policy-making functions for the company. At a minimum, executive officers would include those identified under Reg S-K Item 401(b). The term “policy-making function” is not intended to include policy-making functions that are not significant.

No fault. The recovery is required whether or not any misconduct occurred and whether or not the executive was at fault or even had any responsibility for the erroneous financial statements.

Incentive-based compensation.  Incentive-based compensation means any compensation that is “granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.” “Financial reporting measures” are measures that are “determined and presented in accordance with the accounting principles used in preparing the Company’s financial statements,” and any measures that are derived from those measures, as well as a company’s stock price and TSR. A measure does not need to be presented within the financial statements or included in a filing with the SEC to be considered a financial reporting measure. The release makes clear that 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.” In addition, incentive-based compensation received by an executive officer before the issuer had a listed class of securities would not be subject to the compensation recovery policy.

Recovery. Companies would be required to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the officer would have received had the incentive-based compensation been determined based on the accounting restatement, computed without regard to any taxes paid—in essence, the amount of incentive comp attributable to the error. Compensation is deemed “received” in the “fiscal period during which the financial reporting measure specified in the incentive-based compensation award is attained, even if the grant or payment of the incentive-based compensation occurs after the end of that period.”  If the measure is based on stock price or TSR—where the amount of erroneously awarded compensation is not subject to mathematical recalculation directly from the restatement—the proposed rules permit companies to “use a reasonable estimate of the effect of the restatement on the applicable measure to determine the amount to be recovered,” with documentation provided to Nasdaq. The recovery policy must be applied consistently, on a “no fault” basis, to executive officers; indemnification for recovered compensation is prohibited.

Limited discretion. Companies would have limited discretion not to recover compensation in some circumstances where the company’s comp committee concludes that “pursuit of recovery would be impracticable” because: (1) after first making a reasonable attempt at recovery and providing related documentation to Nasdaq, the direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered, (2) 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 (3) recovery would cause a tax-qualified broad-based retirement plan to fail to meet specified tax-qualification requirements.

Disclosures.  Listed companies are required to file all mandated disclosures regarding their recovery policies, including filing their compensation recovery policies as exhibits to their Forms 10-K and complying with the new Reg S-K Item 402 disclosure requirements related to compensation recovery if, during the prior fiscal year, either a triggering restatement occurred or any balance of excess incentive-based compensation was outstanding.  The additional disclosure requirements would apply immediately following the effective date of the listing standards.

Covered companies. The proposed listing standards would apply to all listed companies (including FPIs, EGCs, SRCs, controlled companies and issuers of listed debt whose stock is not also listed) except for certain registered investment companies to the extent they do not provide incentive-based compensation to their employees. Nasdaq is proposing exemptions for securities issued by a unit investment trust and securities issued by registered management companies that have not awarded incentive comp to executives in the last three years. Nasdaq is proposing to amend Listing Rule 5210 to make clear that any company newly listing on Nasdaq must comply with the requirements of proposed Listing Rule 5608.

Delisting.  Companies will be subject to delisting if they do not adopt, disclose and comply with compensation recovery policies that meet the listing standard. The standard requires the recovery to be “reasonably prompt,” without more specificity; it will be up to Nasdaq to assess compliance. The assessment will be conducted on a “holistic basis with respect to each such accounting restatement,” taking into account “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.” Companies that fail to comply will be required to submit to Nasdaq Staff a plan to regain compliance, with the administrative process for deficiencies thereafter following the “established pattern.”

Implementation.  Each company will be required to (i) adopt a recovery policy no later than 60 days following the effective date of this rule, and (ii) provide the required disclosures on or after the effective date of this rule. In addition, notwithstanding the three-year look-back requirement in Rule 5608(b)(1)(i)(D), “Nasdaq proposes to provide that a company is only required to apply the recovery policy to incentive-based compensation received on or after the effective date of this rule.”

Proposed NYSE Manual Section 303A.14

The new Section of the NYSE Manual would prohibit the initial or continued listing of any security of an issuer that does not comply with any portion of the requirements.

Written policy. As proposed, 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.

The recovery policy must apply to

“all incentive-based compensation received by a person:

• After beginning service as an executive officer;
• Who served as an executive officer at any time during the performance period for that incentive-based compensation;
• While the issuer has a class of securities listed on a national securities exchange or a national securities association; and
• During the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement.”

The policy must also apply to transition periods in connection with changes of fiscal year. The listing standard notes that the recovery obligation does not depend “on if or when the restated financial statements are filed.”

Restatement. A restatement includes both “Big R” and “little r” restatements; that is, accounting restatements “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.”

For purposes of determining the recovery period, the date of the restatement is the earlier to occur of the date that the board, committee or authorized officers “concludes, or reasonably should have concluded, that the issuer is required to prepare an accounting restatement”; or the “date a court, regulator, or other legally authorized body directs the issuer to prepare an accounting restatement.”

Executive officers. The new Section defines executive officer as the “president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), and any vice-president of the issuer in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer,” including executive officers of parents or subs who perform policy-making functions for the issuer. At a minimum, executive officers would include those identified under Reg S-K Item 401(b). The term “policy-making function” is not intended to include policy-making functions that are not significant.

Incentive-based compensation. Incentive-based compensation is 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 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 from those measures, as well as an issuer’s stock price and TSR. A measure does not need to be presented within the financial statements or included in a filing with the SEC to be considered a financial reporting measure.

Recovery. Issuers would be required to recover “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.” Compensation would be deemed “received” in the “issuer’s fiscal period during which the financial reporting measure specified in the incentive-based compensation award is attained, even if the payment or grant of the incentive-based compensation occurs after the end of that period.” For compensation based on stock price or TSR—where the amount of erroneously awarded compensation is not subject to mathematical recalculation directly from the restatement—the amount to be recovered 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 the issuer would be required to document the determination of the estimate and provide the documentation to the NYSE.

Limited discretion.  Issuers would have limited discretion not to recover compensation in some circumstances where the company’s comp committee concludes that “recovery would be impracticable” because: (1) after first making a reasonable attempt at recovery and providing related documentation to the NYSE, the direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered, (2) recovery would violate home country law, where that law was adopted prior to November 28, 2022, based on an opinion of counsel acceptable to the NYSE or (3) recovery would cause a tax-qualified broad-based retirement plan to fail to meet specified tax-qualification requirements.

Disclosures.  Issuers would be required to file all mandated disclosures regarding their recovery policies  in accordance with the requirements of the Federal securities laws, including in SEC filings.

Indemnification. Issuers would be prohibited from indemnifying any executives against the loss of erroneously awarded compensation.

Exemptions. The new requirements would not apply to the listing of certain security futures products, standardized options, securities issued by unit investment trusts, and securities issued by management companies that have not awarded incentive-based compensation to any executive officer in any of the last three fiscal years.

Delisting. New Section 802.01F would provide that, if the NYSE determines that a listed issuer is non-compliant with any of the provisions of Section 303A.14 (other than delayed adoption of a policy), the NYSE will immediately suspend trading in all of the issuer’s listed securities and immediately commence delisting procedures. (A discrepancy here with the release, which refers only to failure to recover.) With regard to the required “reasonably prompt” recovery, the NYSE would  “determine whether the steps an issuer is taking constitute compliance with its compensation Recovery Policy.” The assessment will be conducted on a “holistic basis with respect to each such accounting restatement,” taking into account “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.” A listed issuer would not be able to follow the procedures to submit a plan to come into compliance (Sections 802.02 and 802.03), and any such listed issuer would be subject to delisting procedures as set forth in Section 804.

The NYSE proposes a separate process for listed issuers that fail to timely adopt the required recovery policy. An issuer would be required to notify the NYSE within five days of the effective date if it fails to adopt its recovery policy by that date. An issuer would fall below the standards if it failed to adopt the policy within 60 days after the effective date. (A discrepancy here with the release, which does not include the additional 60 days.) In the event of a delinquency in adoption, the NYSE will notify the issuer of the procedures.  Among the procedures, within five days of that delinquency notice, the listed issuer must contact the NYSE to discuss status and issue a press release disclosing the delinquency, the reason for the delinquency and the anticipated date of cure. The NYSE will then monitor for six months and, if the issuer fails to cure, the NYSE may, in its discretion monitor for an additional six months. In its discretion, the NYSE may truncate this process and immediately commence suspension and delisting procedures. In no event would the NYSE continue to trade an issuer’s securities if the issuer has failed to cure its delinquency within 12 months.

Implementation. As proposed, each listed company must adopt the required recovery policy no later than 60 days from the effective date of the proposed listing standard and must comply with policy for all incentive-based compensation “received” by executive officers on or after the effective date where the compensation results from achievement of a financial reporting measure based on financial information for any fiscal period ending on or after the effective date.  Required SEC disclosures must be provided on or after the effective date.

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