Companies listed on the New York Stock Exchange (NYSE) and Nasdaq have until Dec. 1, 2023, to adopt clawback policies that comply with the listing standards mandated by the Securities and Exchange Commission (SEC) in Rule 10D-1 (the SEC Clawback Rules). Compliant policies will require companies to clawback incentive-based compensation erroneously received by current or former executive officers after an accounting restatement. Companies must also publicly disclosure their policies as part of their first annual report filed on or after Dec. 1, 2023.

As the deadline to adopt compliant policies approaches, here are several key things to know about the SEC Clawback Rules.

1. Nearly all listed issuers are subject to the new clawback rules.

Generally, all listed companies on the NYSE and Nasdaq must comply with the SEC Clawback Rules, including listed foreign private issuers (FPIs) and emerging growth companies. The limited issuers exempt from the rules are issuers of security futures products, standardized options, unit investment trust securities, and certain registered investment company securities.

2. Misconduct or knowledge is not required for the clawback rules to apply.

The SEC Clawback Rules require recovery of the erroneously awarded incentive-based compensation (calculated based on the error that was subsequently corrected in the accounting restatement), regardless of any misconduct or knowledge of the officer who received the compensation. But recovery is not required if the compensation was received before the person began serving as an officer, or the person did not serve as an officer at any time during clawback period. 

3. Companies cannot indemnify or insure officers against required clawbacks.

The SEC Clawback Rules prohibit listed companies from indemnifying or insuring a current or former officer against the loss of the erroneously awarded compensation. While officers can purchase related insurance from third parties, companies cannot directly or indirectly reimburse them for premiums on those policies.

4. Both “Big R” and “little r” restatements will trigger a clawback.

Compliant clawback policies will be triggered by both a “Big R” restatement — one that corrects an error in previously issued financial statements that is material to the previously issued financial statement and requires a Form 8-K filing — as well as a “little r” restatement — one that corrects an error that would result in a material misstatement if the error was corrected in the current period or left uncorrected in the current period and generally does not require filing a Form 8-K.  

5. There are new disclosure requirements for when a clawback is triggered.

The SEC Clawback Rules include new disclosure requirements related to clawbacks. For example, if a clawback policy is triggered, companies must disclose during or after the end of the most recent fiscal year: (1) the date an accounting restatement was required and the amount of erroneously awarded incentive-based compensation related to the restatement; (2) the aggregate amount of the clawback that remains outstanding; (3) any amounts due from an officer subject to the clawback that are outstanding for 180 days or more, separately identified for each named officer; and (4) if recovery is impracticable, for each current and former officer and for all other current and former officers as a group, the amount of recovery forgone and a brief description of the reason the company decided in each case not to pursue recovery.

6. The new rules will likely impact internal investigations related to accounting restatements.

A key aspect of company internal investigations is ensuring independence of the investigative committee and its conclusions by avoiding potential conflicts of interest. In the shareholder litigation context, for example, conflicts can arise due to potential or alleged misconduct of an officer, and good practice is to exclude that officer from participating in the investigation. The SEC Clawback Rules create a new category of potential conflicts for internal investigations related to potential financial reporting errors, as officers seeking to avoid a clawback may have an interest in finding that no accounting error occurred or that a restatement should not be issued.

7. There are exceptions to the clawback requirements, but they are limited.

The SEC Clawback Rules provide only limited exceptions that permit a company to forego the clawback requirements due to impracticality. To apply, a committee of the company’s independent directors responsible for executive compensation decisions (or a majority of independent directors if no such committee exists) must determine that recovery would be impractical and one of the following conditions are met:

• the direct costs of recovery would exceed the amount of recovery (and only if the company has made and documented reasonable attempts to recover the compensation and provided that documentation to the exchange);
• recovery would violate home country law where that law was adopted prior to Nov. 28, 2022 (and only if the company has obtained an opinion of home country counsel acceptable to the applicable exchange that recovery would result in such a violation and provided that opinion to the exchange); or,
• recovery would likely cause an otherwise tax-qualified retirement plan to fail the requirements of the Internal Revenue Code.

8. The compensation could be deemed “received” and subject to clawback even before payment.

Under the SEC Clawback Rules, the incentive-based compensation is deemed “received” in the fiscal period during which the related financial reporting measure is obtained. This means the compensation remains subject to clawback even if the actual payment will not occur until after that fiscal period ends.

Nelson Mullins’ experienced securities litigation team will be publishing more on this topic soon. In the meantime, if you are interested in learning more, please contact the authors.

This alert was published by The National Law Review on Nov. 15, 2023. Read more here.