With a Little Help From My Friends … New Clawback Rule Requires Coordination of Finance, Securities, HR, and Benefits Personnel

Holland & Hart - The Benefits Dial

Holland & Hart - The Benefits Dial

Many aspects of benefits and executive compensation require coordination between a company’s benefits, HR, finance and securities compliance personnel. One topic currently responsible for many such “all hands” planning sessions is the SEC’s new clawback rule. This rule has been a long time in the making, and the final compliance deadline of December 1, 2023 is now fast approaching.

In 2010, the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC and U.S. securities exchanges to require listed companies to implement clawback policies. After delays, proposed rules and other preliminary actions, in October 2022 the SEC issued its final rule (called “Rule 10D-1”) laying out the requirements for clawback policies. The NYSE and Nasdaq followed up by developing listing standards in line with Rule 10D-1. The SEC approved those listing standards on June 9, 2023. Public companies now have their marching orders – the rules are effective October 2, 2023 and listed companies must have clawback policies in place no later than December 1, 2023.

Compliance with Rule 10D-1 and the related listing standards will require input from many roles across the company. Here are a few aspects of compliance to keep in mind:

  • Clawback will be required if an accounting restatement (either a “big-R” or a “little-r”) shows that a current or former executive officer received incentive compensation in excess of what would have been received under the corrected accounting restatement. Of note, this standard is strict liability, unlike the Sarbanes-Oxley rule requiring clawback only when a restatement was the result of misconduct.
  • Recoverable payments include any incentive-based compensation that was based in whole or in part on the attainment of any financial reporting measure used in preparing financial statements, including stock price and total shareholder return.
  • The window of recovery is any incentive-based compensation that was received within the three completed fiscal years immediately preceding the date that the accounting restatement is required.
  • Compensation is “received” for this purpose not necessarily when it is awarded, and not necessarily when it is paid. Instead, compensation is received when the financial measure on which it was based was achieved.
  • The clawback rule applies to nearly all companies with debt or equity listed on an exchange in the U.S., including smaller reporting companies, emerging growth companies, and foreign private issuers.

Here is an example of how the clawback rule might apply:

  • Assume a performance RSU was granted January 2023, to be vested if the company’s stock price reaches $20/share in 2024. Payout is scheduled for 2025. The stock price does, in fact, reach $20 in 2024, and the executive is paid and taxed in 2025.
  • The RSU is deemed, for clawback purposes, to have been received in 2024 (that’s when the relevant financial measure was attained).
  • If the company has to restate 2024 financials in 2026, the RSU might be subject to clawback since it was received in the three-year window preceding that restatement.

Of course, there are many administrative and technical issues that must be resolved by companies looking to implement and apply a clawback policy. For example, it probably won’t be easy to calculate the extent to which an award payment is affected by an accounting restatement, and there could be significant practical barriers to recoupment.

As the technicalities of Rule 10D-1 compliance are being evaluated, benefits and HR personnel should play an important role. Most companies understand that equity incentive arrangements like options and RSUs are within the scope of a clawback policy. But issuers may have other benefits or programs that should be included as well. For example, the rule may apply to bonus programs like LTIPs, or employment agreement incentive payments that condition payment on achievement of some financial reporting measure. Those programs should be identified and either brought within the rule’s scope, or perhaps amended to take them out of scope.

Obviously, compliance with Rule 10D-1 will prompt companies to confirm that their equity incentive plans and award agreements have appropriate language. If amendments are necessary, consider whether there are other revisions or clarifications that might be worth addressing at the same time.

In addition, the conversations over compliance with Rule 10D-1 might prompt consideration of other adjacent programs or processes. For example, the company may have recoupment clauses in deferred compensation agreements for breach of noncompetes or other restrictive covenants. This might be a good time to revisit those arrangements and confirm that they are still appropriate and enforceable. And check for language that might permit the company to offset future deferred compensation payments by the amount of any Rule 10D-1 clawbacks.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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