Key Takeaways

• Nasdaq and the New York Stock Exchange (NYSE) have submitted their respective proposed rules regarding a “compensation recovery policy” that would apply to exchange-listed companies regardless of size or home country, including accelerated filers, emerging growth companies, smaller reporting companies, foreign private issuers and controlled companies.
• The new proposed listing standards have remained analogous to the standards released by the Securities and Exchange Commission (SEC).
• These rules are just part of a broader effort by the federal government to encourage accountability within corporate compensation systems.

Rulemaking Background

The Dodd-Frank Act of 2010 added Section 10D to the Exchange Act, which requires the SEC to direct national securities exchanges[1] to prohibit the listing of issuers that do not develop and implement a policy for the recoupment of compensation as specified in Section 10D. On Oct. 26, 2022, the SEC announced that it adopted a final rule (the Release) implementing Section 10D that will impact more than 5,300 exchange-listed companies. This rule requires listed companies to implement, disclose and enforce a compensation recovery policy to claw back or otherwise recover excess incentive-based compensation that executive officers received based on financial reporting measures that are later restated. Thereafter, national securities exchanges were obligated to submit by Feb. 27 proposed listing standards that require listed companies to adopt, disclose and enforce a “compensation recovery policy.” You can see our previously published client alert regarding the Release here.

Overview of Proposed Rules

On Feb. 22, Nasdaq and the NYSE submitted proposed rules for the recovery of current and former executive officers’ incentive-based compensation received during the three fiscal years preceding the date the issuer is required to prepare an accounting restatement to correct a material error.

The Nasdaq and NYSE proposals generally align and provide, consistent with the Release, that:

• Listed companies will be required to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the executive officer would have received had the incentive-based compensation been determined based on the accounting restatement.
• The recovery of erroneously awarded compensation is required on a “no fault” basis, without regard to whether any misconduct occurred or an executive officer’s responsibility for the erroneous financial statements.
• An executive officer is the company’s 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 policymaking function; or any other person who performs similar significant policymaking functions for the listed company.
• A company is required to recover compensation in compliance with its recovery policy, except to the extent that pursuit of recovery would be impracticable because (1) 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 Nov. 28, 2022, based on an opinion of counsel acceptable to the national securities exchange or (3) recovery would cause a broad-based qualified retirement plan to fail to meet the tax-qualification requirements of Section 401(a) of the Internal Revenue Code and regulations thereunder.
• Each listed company is required to file its compensation recovery policy as an exhibit in its Exchange Act annual report.
• In evaluating whether an issuer is recovering erroneously awarded incentive-based compensation reasonably promptly, each of the national securities exchanges 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 who owes a recoverable amount.
• Notwithstanding generally applicable look-back requirements, a listed company is only required to apply its recovery policy to incentive-based compensation that is received on or after the ultimate effective date of the proposed rules.

What’s Next?

There is a 21-day comment window for both the NYSE’s and Nasdaq’s proposed listing standards once they are published in the Federal Register. Once the time for comments has elapsed, the final listing standards will be subject to final approval by the SEC. Upon receiving final SEC approval:

• Each listed company is required to adopt a compliant policy governing the recovery of erroneously awarded compensation as required by the new rules within 60 days.
• Listed companies must provide the disclosures required by the new rules and in their applicable annual reports that are filed on or after the effective date of the new rules.

Companies should take time now to review these proposed rules, which may remain at or near their current versions, and their existing clawback policies since compliance will be required within 60 days following final approval of the new Nasdaq and NYSE rules.

Issuers should also review existing award agreements for incentive-based compensation to confirm that their terms account for Rule 10D-1 and amend incentive plans and model award agreements, as necessary, to protect the company’s clawback rights. Issuers might also consider (1) tracking incentive-based compensation separately from other compensation to minimize the scope of clawback risk and (2) evaluating the use of time-based, discretionary, and milestone-based compensation in addition to incentive-based awards. Issuers must be mindful, however, that executive compensation programs that are not performance based may be inconsistent with the expectations of many institutional investors.

Additionally, companies must assess their compliance with these new SEC compensation recovery policy requirements within the broader context of the federal government’s desire that companies develop compliance-promoting criteria within their compensation systems. To that end, the U.S. Department of Justice just announced its first-ever pilot program on compensation incentives and clawbacks that launched on March 15. As further discussed here, this pilot program requires that companies prohibit bonuses for employees who do not satisfy compliance performance requirements and incentivize employees who demonstrate full commitment to compliance.

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