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SEC Adopts New Executive Clawback Requirements For Erroneously Awarded Compensation – Securities

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On October 26, 2022, the Securities and Exchange Commission
(SEC) adopted final rules that will ultimately require issuers to
adopt plans to recover erroneously awarded incentive-based
compensation and make disclosures in relation to such policies.

Introduction

The adopted rules implement Section 954 of the Dodd-Frank Act,
which added Section 10D to the Securities Exchange Act of 1934, as
amended. New Rule 10D-1 requires exchanges to adopt listing
standards that establish requirements for issuers to:

  1. Adopt and implement written clawback policies to recover
    erroneously awarded incentive-based compensation to executive
    officers, and

  2. Make disclosures regarding those policies and their use in
    clawing back compensation, subject to limited exceptions.

Clawback Policies

Issuers are required to adopt a clawback policy to recover any
equity and cash based incentive compensation received by current or
former executive officers that was erroneously awarded during the
three years immediately preceding the year in which the issuer is
required to prepare an accounting restatement due to a
“triggering event” as described further below. The rule
defines “executive officer” to include an issuer’s
president, certain vice-presidents, principal financial officer,
principal accounting officer or controller, and any other officer
or person who performs a policymaking function for the issuer, as
well as executive officers of the issuer’s parents or
subsidiaries if they perform policymaking functions for the issuer.
Officers will be required to return any amounts in excess of what
should have been awarded if the error had not occurred, regardless
of whether the officer was at fault or had knowledge of the error.
The clawback policy covers any incentive-based compensation that is
based, at least in part, on the achievement of any financial
reporting measure. Any issuer that does not adopt and comply with
its clawback policy may be subject to delisting.

Triggering Events

Under the adopted rules, the clawback policy shall be triggered
by the preparation of an accounting restatement due to the material
noncompliance of the issuer with any financial reporting
requirement under the securities laws. Examples of such
restatements include any required accounting restatement to correct
an error in previously issued financial statements that is material
to the previously issued financial statements (commonly known as
“Big R” restatements) or a restatement 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 (commonly known as “little r” restatements).

Exceptions to Recovery

The rule permits three circumstances under which an issuer would
not be required to recover from officers pursuant to its clawback
policy, due to impracticability:

  1. The direct expense paid to a third party to assist in enforcing
    the policy would exceed the amount to be recovered, determined
    after the issuer makes a reasonable attempt to recover the
    erroneously awarded compensation, documents such reasonable
    attempt(s) to recover, and provides that documentation to the
    exchange;

  2. Recovery would violate home country law where such law was
    adopted prior to the rule’s adoption and after issuer obtains
    an opinion of that home country’s counsel that recovery would
    result in such a violation and provides that opinion to the
    exchange; and

  3. Recovery would likely cause an otherwise tax-qualified
    retirement plan to fail to meet the requirements of the Internal
    Revenue Code.

Disclosure Requirements

The adopted rules also add new disclosure requirements relating
to the clawback policies through amendments to Items 402 and 601 of
Regulation S-K, Schedule 14A, and Forms 10-K, 40-F, and 20-F (and
Form N-CSR for listed funds). Each listed issuer must file its
clawback policy as an exhibit to its annual report and disclose how
it has applied the policy, including, as applicable:

  1. The date on which the issuer was required to prepare an
    accounting restatement and the aggregate dollar amount of
    erroneously awarded compensation attributable to such accounting
    restatement (including the estimates used in calculating the
    recoverable amount in the case of awards based on stock price or
    total shareholder return);

  2. The aggregate dollar amount of erroneously awarded compensation
    that remains outstanding at the end of the issuer’s last
    completed fiscal year;

  3. The aggregate dollar amount from each current or former named
    executive officer that had been outstanding for 180 days or more
    since the date the issuer determined the amount owed; and

  4. Details regarding any reliance on the impracticability
    exceptions.

Issuers will have to use Inline XBRL to tag their compensation
recovery disclosures. Additionally, the cover page to the Annual
Report on Form 10-K will include additional check boxes to indicate
whether the financial statements included in the filings reflect
the correction of an error to previously issued financial
statements and whether any of those error corrections are
restatements requiring a recovery analysis of incentive-based
compensation under their clawback policies.

Timing and Implementation

The adopted rules were published in the Federal Register on
November 28, 2022 and will become effective on January 27, 2023.
The affected exchanges must file their proposed listing standards
no later than February 26, 2023, and the standards must become
effective no later than November 27, 2023. Upon effectiveness of
the standards, affected issuers must adopt recovery policies within
60 days of the standards becoming effective, and must begin to
comply with the related disclosure requirements in all proxy
statements, information statements, and annual reports filed on or
after the adoption of the policy. Noncompliant issuers will be
subject to delisting by the exchanges.

Recommendations and Best Practices

To prepare for the changes described above, listed companies
should consider taking steps in anticipation of the upcoming
additions to the exchanges’ listing standards including the
following:

  1. Review existing clawback policies and consider implementing
    changes and updates.

  2. Review clawback provisions in agreements with current and
    former executive officers including incentive compensation
    designs;

  3. Advise Board members, audit committee members, and other
    relevant officers on the procedural requirements and implications
    of the adopted rules, emphasizing the disclosure requirements;

  4. Take steps to ensure that internal and external accountants
    accurately report potential clawback obligations, especially upon
    the occurrence of a triggering event that requires the preparation
    of an accounting restatement.

A complete copy of the SEC release regarding the adopted rule
can be found here.
A brief fact sheet covering the new requirements on a broad level
can be found here.
We will continue to monitor the adopted rules and other SEC actions
as they develop.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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