The SEC adopted long-pending rules requiring the recovery of erroneously awarded compensation as required by Congress in the Dodd-Frank Act. The rules will, among other things, require securities exchanges to adopt listing standards that require issuers to develop and implement a policy (usually called a “clawback policy”) providing for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers. The rules require a listed issuer to file the policy as an exhibit to its annual report and to include disclosures related to its recovery policy and recovery analysis where a recovery is triggered.
The new rules implement Section 10D of the Securities Exchange Act of 1934, a provision added by the Dodd-Frank Act. New Exchange Act Rule 10D-1 directs national securities exchanges (e.g., NYSE and Nasdaq) and associations to establish listing standards that require a listed issuer to: (1) adopt and comply with a written policy for recovery of erroneously awarded incentive-based compensation received by its current or former executive officers in the event it is required to prepare an accounting restatement due to its material noncompliance with any financial reporting requirement under the securities laws, during the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement; and (2) disclose those compensation recovery policies in accordance with Commission rules, including providing the information in tagged data format.
More specifically, if an issuer is required to prepare an accounting restatement, including to correct an error that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period, the issuer must recover from any current or former executive officers incentive-based compensation that was erroneously awarded during the three years preceding the date such a restatement was required. The recoverable amount is the amount of incentive-based compensation received in excess of the amount that otherwise would have been received had it been determined based on the restated financial measure. Notably, the rules do not require that the officers from whom compensation is being recovered have any culpability or direct involvement with the restatement or underlying issued causing the restatement. Many companies with existing clawback policies will need to revise those policies to comply with the new rules.
The rules will apply to all listed issuers, including smaller reporting companies, foreign private issuers and emerging growth companies. The rule contains only limited exceptions where: (1) direct expenses paid to third parties to assist in enforcing the policy would exceed the amount to be recovered and the issuer has made a reasonable attempt to recover; (2) recovery would violate home country law that existed at the time of adoption of the rule, and the issuer provides an opinion of counsel to that effect to the exchange; or (3) recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code.
Further, the final rules require specific disclosure of the listed issuer’s policy on recovery of incentive-based compensation and information about actions taken pursuant to such recovery policy. The amendments also require all listed issuers to: (1) file their written recovery policies as exhibits to their annual reports; (2) indicate by check boxes on their annual reports whether the financial statements included in the filings reflect correction of an error to previously issued financial statements and whether any of those error corrections are restatements that required a recovery analysis; and (3) disclose any actions they have taken pursuant to such recovery policies. Issuers will be required to use Inline XBRL to tag their compensation recovery disclosure.
There will be some transition time - as a next step, stock exchanges will be required to file proposed listing standards no later than 90 days following publication of the release of the SEC rules in the Federal Register, and the listing standards must be effective no later than one year following such publication. 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 standards become effective.
