At a Glance

• Issuers listed on the Nasdaq or NYSE exchanges that already have an existing clawback policy now face the decision of whether to replace the current policy with the new required policy or to implement multiple policies.
• To ensure the enforceability of the new clawback policy, companies may require covered executives to sign an acknowledgment of the policy.
• Listed companies are advised to review their indemnification arrangements to ensure that covered officers are not indemnified against the loss of incentive compensation that is recouped under the required clawback policy.
• Issuers need to make disclosures with regard to required clawback policies, and will want to review and consider appropriate updates to their disclosure controls and procedures to aid in compliance with related disclosure requirements.
• Companies subject to clawback policy requirements may consider changes to the structure of their compensation arrangements in light of these new rules.
• As companies adopt and implement the newly required clawback policies, it will be useful to carefully review existing compensation arrangements to determine what outstanding awards would be subject to clawback if triggered.

After a threatened accelerated timeline, and then several welcomed delays, the Securities and Exchange Commission (SEC) has approved final clawback policy listing requirements for both the NYSE¹ and Nasdaq² markets. The listing standards provide that these compensation recovery policies apply to compensation received on or after October 2, 2023, but listed companies have an additional 60 days, until December 1, 2023, to adopt compliant policies.

Our previous update summarized the required clawback rules. In short, issuers must adopt policies requiring the clawback of incentive compensation received by Section 16 officers, without regard to misconduct, when that compensation is based on the company’s financial results and those financial statements later require a restatement.

This article will delve into the implementation of these new clawback rules and explore the decisions that companies listed on the NYSE and Nasdaq stock exchanges need to make to satisfy the listing requirements and ensure strong corporate governance.

One Policy or Two?

Issuers listed on the Nasdaq or NYSE exchanges that already have an existing clawback policy now face the decision of whether to replace the current policy with the new required policy or to implement multiple policies.

When deciding between one or two policies, there are several factors to consider. To make this determination, issuers should first compare the listing requirements to their existing policies. If the current policy closely aligns with the new requirements, it can be updated or replaced accordingly. Companies with a discretionary policy covering a broader group than Section 16 officers, a wider set of compensation (for example, all incentive compensation, including time-based and discretionary awards, is subject to clawback, and/or the amount recovered may be all incentive compensation, not just the difference as a result of an accounting restatement), events not relating to nonmaterial financial statements, or provisions for misconduct or negligence may want to adopt a two-policy framework. Companies may also prefer to keep their policies applying to a wider group of employees confidential.

Many issuers are choosing to use two policies — the required clawback policy supplemented by a more flexible and discretionary clawback policy tailored to the company’s specific circumstances. While it is possible to have one policy with two parts, having separate policies — one that is limited to what is required and another that is tailored to the company’s particular circumstances — may provide greater flexibility to amend when circumstances change, greater clarity with respect to related disclosure requirements, and more leeway in the timing for adopting the tailored policy. Although two policies may create additional compliance burdens and potential confusion, many companies have experience with multiple policies applicable to different groups (such as an additional, separate code of ethics for senior financial officers) and will find this to be a preferred approach in this context as well.

Acknowledgements, Amendments to Existing and Future Compensation Arrangements, and Enforceability

To ensure the enforceability of the new clawback policy, companies may require covered executives to sign an acknowledgment of the policy. This may be particularly important at the initial adoption, when there is a greater likelihood that incentive compensation awards do not specifically cover the new clawback policy or include clawback provisions that are inconsistent with the new requirements. This signed acknowledgement can help serve as the explicit contractual agreement to the clawback. An acknowledgement also alerts the executive that the executive will not be indemnified by the company or its D&O insurer. Although companies will certainly take into consideration their regular practices for having employees acknowledge the company’s written policies, we expect most companies will require covered officers to sign an acknowledgement of the clawback policy in connection with the policy’s initial adoption.

In the event that executives do not sign an acknowledgement to the clawback policy, it is crucial to ensure that all relevant incentive compensation and nonqualified deferred compensation plans and arrangements specifically provide that compensation earned thereunder is subject to the company’s clawback policy (including as it may be amended in the future).

If not already covered, companies should plan on updating their incentive compensation plan documents, including for cash-based and annual incentive awards, and their form employment agreements to specifically indicate that they are subject to the clawback policy. Companies may also consider adding provisions to severance and separation agreements that all incentive compensation awards remain subject to the terms of those awards, including the applicability of the clawback policy.

Companies should review and consider whether they wish to make changes to their compensation practices in light of the new clawback requirements. For example, implementing a hold-back or deferral policy, or subjecting performance awards to additional time-based vesting following the end of the award’s performance period would mitigate the risk of inability to recover compensation as a result of enforceability challenges and other issues. Holding periods are viewed favorably by Institutional Shareholder Services (ISS).

Indemnification Arrangements

Listed companies are not permitted to indemnify covered officers against the loss of incentive compensation that is recouped under the required clawback policy. Companies are advised to review their indemnification arrangements to determine whether they conflict with this prohibition and whether amendments are necessary or appropriate. Although many more recent forms of indemnification agreements specifically exclude clawback-related liabilities, some are silent on this topic, so companies could consider updating their form agreements used going forward to explicitly exclude clawback-related liabilities from coverage.

Disclosure Requirements and Timing

A copy of the issuer’s policy implementing the new clawback requirements must be filed as an exhibit to the issuer’s Forms 10-K (or Form 20-F for foreign private issuers or Form 40-F for certain Canadian issuers), beginning with filings on or after the effective date of October 2, 2023. For companies that do not have a calendar year-end for their fiscal year and file their 10-K after October 2 but before December 1, 2023, the requirement will not apply if they have not yet adopted the required policy. Of course, if a clawback policy is not adopted by December 1, 2023, then the issuer will be out of compliance with its exchange’s listing requirements; therefore, any 10-K filed on or after December 1, 2023, must include the adopted clawback policy as an exhibit.

For those companies that maintain more than one policy, only the clawback policy required by listing rules is required to be filed as an exhibit; any other policy does not need to be disclosed.

In addition, in the event of any accounting restatement during any fiscal year, detailed disclosures must be included in the company’s next Form 10-K and proxy statement (as well as any other filing that requires inclusion of Regulation S-K Item 402 compensation disclosure). In the event that compensation that must be clawed back is not recovered by the end of a fiscal year, that outstanding amount must be reported in each proxy statement until the compensation has been recouped.

Accordingly, companies will want to review and consider appropriate updates to their disclosure controls and procedures to aid in compliance with the clawback-related disclosure requirements.

Considering the Structure of Compensation Arrangements

Companies may consider changes to the structure of their compensation arrangements in light of these new clawback rules. For example, they may wish to explore the possibility of providing discretionary bonuses or using personal, rather than financial, performance criteria to their compensation arrangements to avoid application of the clawback requirements to some compensation. However, there are pros and cons to any such changes. Only compensation that is purely subjective, discretionary or subject to service/time-based vesting will be exempt from the SEC clawback rules. If a bonus is based on financial metrics but may be adjusted in the discretion of the compensation committee, then the bonus would be recoverable compensation, even if discretion was exercised. On the other hand, in making its voting recommendation on say-on-pay votes, ISS considers the ratio of performance-based to other awards and generally believes a CEO’s equity awards should be at least 50% performance-based, and it does not view incentives based on subjective or personal performance to be “performance-based,” which may weigh against major changes.

Recoverable Compensation

As companies adopt and implement the newly required clawback policies, it will be useful to carefully review existing compensation arrangements to determine what outstanding awards would be subject to clawback if triggered. The new listing requirements apply to compensation “received” during the performance period of an annual incentive or equity performance award, but any compensation “received” before becoming a Section 16 officer is not required to be recovered.

Note that an award of incentive-based compensation granted to an individual before the individual becomes a Section 16 officer will be subject to the recovery policy, so long as the incentive-based compensation was received by the individual at any time during the performance period after beginning service as an executive officer. The clawback rules also apply to former Section 16 officers who were Section 16 officers at any time during the performance period.

Conclusion

With the December 1, 2023, deadline for policy adoption approaching, issuers must carefully consider the structure of their compensation arrangements and the enforceability of their policies. By taking these considerations into account, companies can proactively address clawback-related issues and demonstrate their commitment to strong corporate governance.

FOOTNOTES

1. See NYSE Listed Company Manual Section 303A.14 (Recovery of Erroneously Awarded Compensation).
2. See Nasdaq Listing Rule 5608 (Recovery of Erroneously Awarded Compensation).