On June 9, 2023, the Securities and Exchange Commission (SEC) approved proposed amendments of the New York Stock Exchange (NYSE) and the Nasdaq Stock Market LLC (Nasdaq) to their respective listing standards to implement the SEC’s previously adopted recoupment rules. These listing standard amendments extended the effective date for the new clawback listing standards to October 2, 2023, meaning that companies listed on either exchange will need to adopt a compliant clawback policy no later than December 1, 2023.

Prior to these proposed listing standard amendments, it appeared that listed companies would need to adopt clawback policies by early August 2023, and many companies are taking advantage of this extended timeline to delay the adoption of a compliant clawback policy until the fall of 2023.

Background on Adoption of Clawback Rules

In October 2022, the SEC adopted final clawback rules to implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The SEC’s clawback rules required each national securities exchange to adopt rules that will require any company listed on its exchange to adopt a clawback policy within 60 days from the date on which the exchange’s final listing standards become effective, providing for the mandatory recoupment of “incentive-based compensation” paid to executive officers in the event of an accounting restatement.

For a summary of the key feature of these SEC rules and the associated NYSE and Nasdaq listing standards (which listing standards closely track each other), see Appendix A to this blog post.

General Observations

As a starting point, while a supermajority of large-cap companies had clawback policies (voluntarily) in place before the adoption of the SEC recoupment rules, there have continued to be a significant number of public companies (often small-cap or micro-cap companies) that did not have a recoupment policy in place at the time that such rules were adopted.

The challenges public companies face in considering how to implement and respond to the SEC’s recoupment rules and associated listing standards differ depending on whether a company already has a recoupment policy. In this regard, perhaps ironically, companies without a preexisting recoupment policy or other substantive recoupment provisions generally will have fewer complications in connection with adopting a compliant clawback policy in comparison to companies that already have a recoupment policy in place (as these companies will need to consider how to meld their preexisting recoupment policy with the clawback provisions required under SEC rules).   While practice will differ, we expect that many listed companies that do not currently have a recoupment policy will adopt a compliant recoupment policy that does not significantly go beyond the requirements of SEC rules and associated listing standards.

Considerations in Connection with Adopting a Compliant Policy

See below for key considerations for  companies in connection with the adoption of a compliant clawback policy (irrespective of whether the company currently has an existing recoupment policy in place):

• Consider whether oversight and enforcement of the policy should be assigned to the full board of directors or the compensation committee. The SEC’s recoupment rules do not generally mandate a particular approach, except that reliance on impracticability considerations (i.e., where there is no mandatory enforcement because certain impracticability criteria are met) must generally be made by a company’s compensation committee. Considering this backdrop, we expect that most companies will designate their compensation committee as the governing body overseeing their recoupment policy.
• Consider whether the policy should apply only to executive officers or a broader group of employees. We expect that most listed companies without a clawback policy in place will limit the scope of their new recoupment policy to apply only to Section 16 officers as required by SEC rules, at least for the mandatory aspects of such policy adopted to comply with such rules (see below for a discussion of considerations with respect to companies that have a preexisting recoupment policy in place).
• Consider whether the policy will apply to scenarios beyond a restatement. There is a good amount of variability in terms of the types of scenarios where recoupment is triggered among public companies that currently have a recoupment policy (voluntarily) in place, with some public companies limiting their recoupment policy to restatements (or similar financial statement inaccuracy scenarios) with others providing for recoupment against individuals where they have engaged in various forms of bad actions impacting the company. For companies that do not have a recoupment policy in place, we expect that some companies in this category will provide for (discretionary) recoupment in scenarios (such as bad actor scenarios) that go beyond a restatement, while many other public companies in this category will simply providing for recoupment where there is a restatement as required by SEC rules (see below for a discussion of considerations with respect to companies that have a preexisting recoupment policy in place).
• Consider what forms of compensation will be subject to recoupment. The SEC’s recoupment rules apply to “incentive-based compensation” (defined to mean “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure), which in most cases will apply to short-term cash incentive awards as well as performance-based equity awards but will not generally apply to time-based equity awards. Whether or not companies have existing recoupment provisions in place, we expect that most companies will not expand the scope of mandatory recoupment as required by SEC rules to compensation that is not “incentive-based compensation”  (see below for a discussion of considerations with respect to companies that have a recoupment policy in place).
• Consider whether to take into account ISS Policy when assessing scope of compensation subject to policy. Under ISS’s equity plan scorecard, a clawback policy applicable to restatements that adheres to the minimum requirements of the SEC rules will not receive any points due to the fact that (contrary to ISS’s preference) the SEC rules generally do not include time-based equity within the scope of compensation that is subject to recoupment. We expect that many companies will conclude that the (generally, moderate) benefit of receiving points under ISS’s equity plan scorecard will not outweigh the administrative and other potential downsides of including time-based equity awards within the scope of compensation that is subject to mandatory recoupment in connection with a restatement.

• Consider the level of detail with respect to the mechanics of recovery. While any policy should make clear that companies may elect to recover erroneously awarded compensation via such means as determined by the company, we expect that some policies will state this right generally, while others will include illustrative (and non-exclusive) examples of the types of compensation that may be recovered (we think that either drafting approach is reasonable).
• Consider whether the policy should provide that company may recover its fees and expenses from an executive in connection with enforcing its rights under this policy. While this is not required by SEC rules or exchange listing standards, we expect some policies to include this recovery concept.
• Consider whether executive and other employees should be required to acknowledge or agree to clawback provisions. In addition to language which may already be included in award agreements and other documentation signed by an executive or other employee whereby there is a contractual agreement that compensation may be recouped from an individual, companies should consider whether an executive or other employee should sign an acknowledgment to their recoupment policy making clear that such individuals are contractually bound by the terms of such policy. We believe that the execution of such an acknowledgment is advisable to make clear that there is contractual privity, at least for executive officers, in relation to a company’s compliant clawback policy, given that a company may be subject to delisting if it does not enforce such policy in accordance with SEC rules and applicable listing standards (which in particular could become an issuer where a company is required to recover recoupment from a former executive who is no longer in the employ of the company).
• Assess whether any revisions will be needed regarding recoupment language in corporate governance documents. While a comprehensive review of a company’s governance documents should happen regularly in any event as a matter of good practice, particular focus should be given to whether any governance documents (e.g., language in a compensation committee charter) should be updated in light of the SEC’s clawback rules and/or the provisions included in a newly adopted or revamped recoupment policy.
• DOJ Pilot Program. Companies should consider whether to include any broader recoupment provisions taking into account the pilot program initiated by the DOJ in early 2023, whereby the DOJ may reduce fines in criminal cases where companies seek to recoup compensation from culpable employees and others who both (1) had supervisory authority over the employees or business engaged in the misconduct, and (2) knew of, or were willfully blind to, the misconduct. In this regard, adopting a clawback policy that meets the threshold standards of the SEC’s recoupment rules will not satisfy the DOJ’s criteria. In our experience, most companies are not (at least yet) expanding their clawback policy terms in a manner that would meet the criteria set forth by the DOJ.

Considerations for Companies with Preexisting Clawback Policies

For listed companies that already have recoupment policies or other substantive recoupment provisions in place, there will be additional considerations that need to be taken into account, including the following:

• Consider whether to adopt multiple clawback policies. Taking into account the fact that listed companies will only be required to file as a Form 10-K exhibit their recoupment policy adopted to comply with SEC rules, some public companies will be electing to adopt two (or more) recoupment policies, one policy that is compliant with SEC rules and applicable listing standards (and will need to be publicly filed), and one or more additional policies that may cover a broader group of employees and/or more expansive recoupment scenarios and do not need to be publicly filed. In this regard, some public companies may prefer not having to file clawback terms that go beyond the threshold standards of SEC rules, and we believe that in most cases, the administrative challenges of having multiple policies will be manageable.
• Consider the extent to which existing clawback provisions will be superseded by the new compliant policy or will continue in effect. There will be varying approaches followed by listed companies in this regard, depending on what preexisting recoupment provisions are in place. Key considerations in this regard may include the following:
  • Scope of Employees. For companies that already have recoupment policies in place that apply to a broader group of employees than executive officers, we expect that many of these companies will not want to use the rollout of the SEC recoupment rules as an opportunity to reduce the scope of their employees subject to recoupment provisions, but will want to specify that the mandatory aspects of their policy only apply to Section 16 officers as required by SEC rules.
  • Triggering Events for Recoupment. To the extent that companies have an existing clawback policy that applies in a restatement context or similar financial statement inaccuracy scenario, these companies will want to consider whether there are administrative and other reasons to conform their existing recoupment language to the definition of a restatement as set forth in the SEC rules. For the companies that have clawback policies in place which provide for potential recoupment against individuals where they have engaged in bad actions or in other scenarios that go beyond a restatement, we think that many of these companies will leave the substantive aspects of these recoupment provisions (which generally provide for discretionary rather than mandatory enforcement) in place.
  • Forms of Compensation Subject to Recoupment. The applicability of the SEC’s recoupment rules to “incentive-based compensation” (as defined above) gives rise to a paradigm where the compensation subject to required recoupment under SEC rules may be more narrow than the compensation subject to recoupment under existing clawback policies in certain respects (e.g., because recoupment under the SEC rules generally does not apply to time-based options or other time-based equity awards, which awards are often covered by existing policies) and broader in other respects (e.g., because recoupment under the SEC rules may apply to severance or deferred compensation arrangements to the extent that payments under such arrangements are based on prior cash incentive payments that would constitute “incentive-based compensation,” which forms of compensation are often not subject to recoupment under existing policies). Companies with existing clawback provisions that apply in scenarios beyond a restatement will need to consider whether, in these non-restatement circumstances, the companies should retain their existing forms of compensation subject to recoupment in these circumstances or alternatively whether to conform the definition of compensation subject to recoupment in these circumstances to mirror the “incentive-based compensation” definition set forth in the SEC’s rules.
• Consider whether to amend or eliminate substantive recoupment provisions included in documents outside of the clawback policy. If a company has substantive clawback provisions in documents outside of a clawback policy (e.g., that might conflict with or be different from the SEC’s recoupment rules), the listed company will need to consider whether, and how to amend such recoupment provisions in connection with the adoption of a compliant clawback policy. In this regard, while it may not be optimal to have conflicting clawback provisions strewn through multiple documents, in some instances, a company may be hesitant to amend clawback provisions in certain documents, such as in an equity incentive plan where the material amendment of such plan would require stockholder approval under exchange listing standards.
• Consider the extent to which recoupment terms should apply in relation to performance periods ending before the effective date of listing standards. While the SEC’s recoupment rules generally require recoupment in connection with incentive-based compensation received after the effective date of exchange listing standards, a separate issue will arise in relation to the manner in which preexisting recoupment provisions (for example, that may apply where there is a restatement) will apply with respect to incentive-based compensation received before the effective date of exchange listing standards (i.e., where this compensation is not subject to required recoupment under the SEC’s rules). While approaches may differ, companies may determine that while their preexisting policy should generally be superseded (and/or amended and restated) by the company’s new (compliant) recoupment policy, the terms of the preexisting policy should continue to apply in connection with restatements applicable to incentive-based compensation received prior to the effective date of the final exchange listing standards.

Appendix A

Key Features of Clawback Rules and Listing Standards

Persons Covered by Clawback Policy

Rule 10D-1 and the NYSE and Nasdaq listing standards (collectively, the Clawback Rules) require that a company’s clawback policy cover all executive officers. The definition of “executive officer” is substantially similar to the definition used for officer under Rule 16a-1 in that it encompasses 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, division or function (such as sales, administration or finance), and any other officer or person who performs significant policy-making functions for the company.

When to Recoup

Under the Clawback Rules, a company must seek recoupment in the event of an accounting restatement that either:

• Corrects an error in previously issued financial statements that is material to the previously issued financial statements (i.e., a “Big R” restatement).
• Corrects errors that are not material to previously issued financial statements, but would result in a material misstatement if (1) the errors were left uncorrected in the current period, or (2) the error correction was recognized in the current period (i.e., a “little r” restatement).

Recoupment under the Clawback Rules is a “no fault” standard and applies regardless of whether any misconduct occurred (whether by the executive officer for whom recoupment is sought, or otherwise). When recoupment must be sought, the Clawback Rules afford a company a certain level of discretion with regard to its method of recovery, subject to certain guidelines; however, the company must act reasonably promptly in seeking recoupment.

While recoupment is generally mandatory, the Clawback Rules do provide for an exception where recoupment would be impracticable, and one of the following situations is applicable:

• Where the direct cost of recovery would exceed the amount of recovery.
• Where recovery would violate a listed company’s home country law at the time of adoption of the rule, subject to certain conditions.
• Where recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code.

If a company intends to rely on this impracticability exception, it must first make a reasonable attempt to recover incentive-based compensation. The company must also document its attempt to recover and provide documentation to the exchange on which the company is listed.

Compensation Subject to Recoupment

An executive officer’s incentive-based compensation received during the three preceding fiscal years is subject to recoupment, which is measured from the date on which the company is required to prepare an accounting restatement. Incentive-based compensation is defined in the SEC rules as “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.” This includes both cash and equity incentive compensation, using both GAAP and non-GAAP measures, and also includes stock price and TSR measures.

The definition of “incentive-based compensation” under the SEC’s rules does not include, among other things, discretionary cash awards not based on the attainment of any financial reporting measure, or equity-based awards (including options) subject to only time-based vesting.

Calculating the Recoupment Amount

An executive officer’s incentive compensation subject to recovery is calculated as the total incentive compensation received by the executive officer minus the incentive compensation the officer would have received if such incentive compensation was calculated based on the restated financial statements. This calculation is made without regard to taxes previously paid.

For incentive-based compensation based on TSR and stock price, the recovery amount must be based on a reasonable estimate of the accounting restatement’s impact on such compensation (the listed company must maintain documentation of determination and provide such documentation to the applicable exchange). Companies are also prohibited from insuring or indemnifying any executive officer against recouped compensation.

Delisting Implications

A company will be subject to delisting procedures under either the NYSE or Nasdaq listing standards in the event that the company fails to do one of the following:

1. Adopt a compliant clawback policy prior to the December 1, 2023, effective date.
2.  Provide required disclosures in its SEC filings with respect to its clawback policy.
3. Recover erroneously-awarded compensation reasonably promptly, as required by its clawback policy.

Neither SEC Rule 10D-1 nor the NYSE or NYSE listing standards specifies the time period for purposes of determining reasonably prompt recovery. Rather, the applicable exchange would determine whether the steps a company has taken is compliant with its clawback policy, which would be made on a case-by-case basis with respect to each accounting restatement.

Exchange Act Reporting Considerations

The SEC rules also set forth certain disclosure requirements for public companies beyond the requirement to adopt a compliant clawback policy. Most notably, a public reporting company will need to file its adopted clawback policy as an exhibit to the company’s first Form 10-K filed after the effective date of exchange listing standards. The Form 10-K itself has also been updated to include two new checkboxes on the cover page—one to indicate whether a company’s filing reflects a correction of an error to prior financial statements and another to indicate whether any of those error corrections are restatements that require a recovery analysis.

Additionally, these new disclosure requirements will require companies to make certain disclosures in their proxy statements if such companies are required to prepare an accounting restatement in a manner that triggers potential recovery of erroneously awarded compensation pursuant to the company’s required clawback policy.