Listing Standards for Recovery of Erroneously Awarded Compensation

A Small Entity Compliance Guide[1]

Introduction

On October 26, 2022, the U.S. Securities and Exchange Commission (“Commission”) voted to adopt a new rule and rule amendments to implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which added Section 10D to the Securities Exchange Act of 1934 (See Listing Standards for Recovery of Erroneously Awarded Compensation, Release No. 33-11126 (the “Adopting Release”). Section 10D requires the Commission to adopt rules directing the national securities exchanges to establish listing standards that require listed issuers to adopt and comply with a compensation recovery policy, often known as a clawback policy. The rules and listing standards also require listed companies to provide disclosure about such policies and how they are being implemented.

Who is affected by the amendments?

The amendments affect domestic and foreign issuers with securities listed on a national securities exchange. There are only limited exceptions for listings of certain security futures products, standardized options, and securities issued by unit investment trusts. In addition, certain registered investment companies that have not awarded incentive-based compensation in the past three fiscal years are not required to adopt compensation recovery policies or provide the related disclosure.

What changes were made by the amendments?

New Exchange Act Rule 10D-1 sets forth the requirements that exchanges are directed to establish. Under the rule and rule amendments, a listed issuer is required to develop and implement a clawback policy that provides for the recovery of incentive-based compensation from current or former executive officers in the event the issuer is required to prepare an accounting restatement. The recoverable amount is the difference between the amount actually received by the executive and the amount that would have been received based on the restated amount. The policy must provide for recovery of any erroneously awarded compensation received during the three completed fiscal years immediately preceding the date the issuer is required to prepare the accounting restatement. New Exchange Act Rule 10D-1 also requires disclosure of the policy in accordance with Commission rules, including providing the information in tagged data format.

The changes are discussed in more detail below.

1. Required Listing Standards and Compliance

Each listed issuer (except certain listed funds, as described above) is required to adopt a compensation recovery policy, comply with that policy, and provide the required disclosures. An issuer will be subject to delisting if it does not adopt a compensation recovery policy that meets the requirements of the listing standards, once they are in effect. Issuers may also be delisted if they fail to comply with their compensation recovery policy.

New Exchange Act Rule 10D-1 specifies that an issuer’s compensation recovery policy must:

• Provide 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, including any required accounting restatement 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.
• 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; and
  • during the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement.

The amount of incentive-based compensation subject to the issuer’s recovery policy is 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, computed pre-tax.

The issuer is prohibited from indemnifying any executive officer or former executive officer against the loss of erroneously awarded compensation.

New Exchange Act Rule 10D-1 requires that an issuer recover any erroneously awarded compensation, subject only to the following limited instances in which recovery would be impracticable:

• The direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered after the issuer has made and documented a reasonable attempt to recover;
• Recovery would violate home country law where that law was adopted prior to November 28, 2022, and the issuer provides an opinion of home country counsel to the exchange; or
• Recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code.

2. Disclosure Requirements

The amendments to Item 402 of Regulation S-K, Form 40-F, and Form 20-F (and for listed funds, Form N-CSR) require listed issuers to disclose how they have applied their recovery policies.

If at any time during or after its last completed fiscal year an issuer was required to prepare an accounting restatement that triggered a clawback under the issuer’s recovery policy, or there was an outstanding balance of such compensation to be recovered as of the end of the last completed fiscal year from the application of the policy to a prior restatement, an issuer is required to disclose and tag using Inline eXtensible Business Reporting Language (“Inline XBRL”):

• The date on which the listed issuer was required to prepare an accounting restatement and the aggregate dollar amount of erroneously awarded compensation attributable to such accounting restatement (including an analysis of how the recoverable amount was calculated);
  • If the amount has not yet been determined, disclose that fact, explain the reasons and disclose the amount and related disclosures in the next filing that is subject to the disclosure requirements;
  • If the financial reporting measure related to a stock price or total shareholder return metric, the estimates that were used to determine the amount of erroneously awarded compensation attributable to such accounting restatement, and an explanation of the methodology used for such estimates;
• The aggregate dollar amount of erroneously awarded compensation that remains outstanding at the end of its last completed fiscal year;
• For each current and former named executive officer from whom, as of the end of the last completed fiscal year, erroneously awarded compensation had been outstanding for 180 days or longer since the date the issuer determined the amount owed, disclose the dollar amount outstanding due from each such individual; and
• If recovery would be impracticable, for each current and former named executive officer and for all other current and former executive officers as a group, disclose the amount of recovery forgone and briefly describe the reason that the issuer decided not to pursue recovery.

If at any time during or after its last completed fiscal year an issuer was required to prepare an accounting restatement, and the issuer concluded that recovery of erroneously awarded compensation was not required pursuant to the issuer’s recovery policy, briefly explain why application of the recovery policy resulted in that conclusion.

What are the compliance dates of the amendments?

The rule and rule amendments are effective as of January 27, 2023.

Exchanges will be required to file proposed listing standards no later than February 27, 2023, and the listing standards must be effective no later November 28, 2023. Issuers subject to such listing standards will be required to adopt a recovery policy no later than 60 days following the date on which the applicable listing standard is effective and must begin to comply with and provide the required disclosures on or after the effective date of the listing standard.

Other Resources

The adopting release for these rule and rule amendments can be found on the Commission’s website at https://www.sec.gov/rules/final/2022/33-11126.pdf.

The Commission’s disclosure forms can be accessed on the agency’s website at https://www.sec.gov/forms.

Contacting the SEC

The Commission’s Division of Corporation Finance is happy to assist small companies and others with questions regarding the rule and rule amendments. You may contact the Division for this purpose at (202) 551-3500 or https://www.sec.gov/forms/corp_fin_interpretive.

Questions on other Commission regulatory matters concerning small companies may be directed to the Division’s Office of Small Business Policy at (202) 551-3460 or smallbusiness@sec.gov.

The Commission’s Division of Investment Management’s Chief Counsel’s Office is also available to assist small companies and others with questions regarding the amendments applicable to investment companies. You may contact the Office for this purpose at (202) 551-6825 or IMOCC@sec.gov.