Clawback Policies – FAQs on Listing Standards Proposed by Nasdaq and the NYSE
In October 2022, the SEC adopted rules implementing the incentive-based compensation recovery (clawback) mandated by Section 954 of the Dodd-Frank Act. New Rule 10D-1 of the Securities Exchange Act of 1934 (the Exchange Act) directed U.S. stock exchanges to adopt listing standards requiring all listed companies, including foreign private issuers, emerging growth companies and smaller reporting companies, to adopt and comply with a written clawback policy, to disclose the policy and to file the policy as an exhibit to its annual report, as well as to include other disclosures in the event a clawback is triggered under the policy. On February 22, 2023, the Nasdaq Stock Market (Nasdaq) and the New York Stock Exchange (NYSE) released their proposed listing standards that implement the SEC’s clawback rule.
Both proposals closely track the requirements of Rule 10D-1, with a few limited variations between the two. The remainder of this client alert addresses a set of hypothetical frequently asked questions (FAQs) summarizing the principal features of the proposals.
What awards will the company be required to recover under its clawback policy?
Both Nasdaq and NYSE – Every company must have a written clawback policy that provides that the company will "reasonably promptly" recover the amount of erroneously awarded incentive-based compensation if the company is required to prepare an accounting restatement due to the material noncompliance of the company with any financial reporting requirement under the securities laws.
Consistent with Rule 10D-1, both proposed rules would require that the company’s adopted clawback policy be triggered by any required accounting restatement to correct an error in previously issued financial statements that is material to the previously issued financial statements (referred to as a "Big R" restatement), or that would not be material to previously issued financial statements but that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period (referred to as a "little r" restatement).
What types of compensation are covered by the clawback rule?
Both Nasdaq and NYSE – The clawback rule applies to all "incentive-based compensation" that is "received" by executive officers on or after the date that the applicable exchange adopts the proposed listing standard (the Effective Date) that results from attainment of a "financial reporting measure" based on or derived from financial information for any fiscal period ending on or after the Effective Date.
- "Incentive-based compensation" is defined as any compensation that is granted, earned or vested based wholly or in part upon the attainment of a financial reporting measure.
- Incentive-based compensation is "received" in the company’s fiscal period during which the financial reporting measure specified in the compensation award is attained, even if the payment or grant of the compensation occurs after the end of that period.
- "Financial reporting measures" are measures that are determined and presented in accordance with the accounting principles used in preparing the company’s financial statements, and any measure that is derived wholly or in part from such measures. Financial reporting measures also include stock price and total shareholder return (TSR).
Who is required to be covered by the clawback policy?
Both Nasdaq and NYSE – The policy is required to cover the company’s executive officers, subject to the time periods described in the FAQ below.
The final rules adopt the same definition of "executive officer" used to determine a listed company’s officers under Section 16 of the Exchange Act. As such, officers covered by the clawback policy include the company’s president, principal financial officer, principal accounting officer (or, if there is no such accounting officer, the controller), any vice president in charge of a principal business unit, division or function (such as sale, administration or finance) or any other officer or person who performs a "policy-making function" for the company. Executive officers of the company’s parent(s) or subsidiaries are deemed executive officers of the company if they perform such policy-making functions for the company. The term "policy-making function" is not intended to include policy-making functions that are not significant.
What compensation received by executive officers is required to be subject to recovery?
Both Nasdaq and NYSE – The clawback rule applies 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 company has a listed class of securities; and
- During the three completed fiscal years immediately preceding the date that the company is required to prepare an accounting restatement. In addition to the last three completed fiscal years, the clawback policy must also apply to any transition period (that results from a change in the company’s fiscal year) within or immediately following those three completed fiscal years; however, a transition period between the last day of the company’s previous fiscal year end and the first day of its new fiscal year that comprises a period of 9-12 months would be deemed a completed fiscal year.
A company’s obligation to claw back erroneously awarded compensation is not dependent on if or when the restated financial statements are filed.
When is the restatement deemed to have occurred for purposes of determining what compensation is to be recovered?
Both Nasdaq and NYSE – The relevant date is the earlier of:
- The date the company’s board of directors, a committee thereof or the officer(s) authorized to take such action if board action is not required, concludes, or reasonably should have concluded, that the company is required to prepare an accounting restatement; or
- The date a court, regulator or other legally authorized body directs the company to prepare an accounting restatement.
What is the amount of incentive-compensation to be clawed back?
Both Nasdaq and NYSE – The amount that must be subject to the company’s clawback policy ("erroneously awarded compensation") is the amount of incentive-based compensation that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the restated amounts and must be computed without regard to any taxes paid.
For incentive-based compensation based on stock price or TSR:
- The amount to be clawed back must be based on a reasonable estimate of the effect of the accounting restatement on the stock price or TSR upon which the incentive-based compensation was received; and
- The company must maintain documentation of the determination of that reasonable estimate and provide such documentation to the applicable exchange.
Are there any exceptions to the clawback requirement?
Both Nasdaq and NYSE – The new listing standards provide for limited exceptions to the company’s obligation to enforce the application of the clawback policy due to impracticability of recovery. Such exceptions are only available where the company’s committee of independent directors responsible for executive compensation (or, in the absence of such a committee, a majority of the independent directors of the board) has determined that clawback would be impracticable and one of the three conditions below is satisfied:
- The direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered (before doing so, the company must make a reasonable attempt to recover the erroneously awarded compensation, document such reasonable attempt(s) and provide that documentation to the applicable exchange).
- Clawback would violate home country law if the law was adopted prior to November 28, 2022.
- Clawback would likely cause an otherwise tax-qualified retirement plan, under which benefits are broadly available to employees, to fail to meet the requirements of Sections 401(a)(13) or 411(a) of the Internal Revenue Code and regulations thereunder (addressing the security and vested status of qualified plan benefits).
By when does a company need to adopt its clawback policy?
Both Nasdaq and NYSE – Once published in the Federal Register, there will be a public comment period of 21 days, and then the SEC must approve both listing standards.
- Under the SEC’s rule, the listing standards of each stock exchange are required to be effective no later than November 28, 2023. The exchanges have requested that the SEC approve their proposals within 45 days of publication in the Federal Register (which had not occurred at the date of this Client Alert). We expect that the Effective Date will be well before November 28, 2023.
- Companies will be required to adopt their clawback policy no later than 60 days following the Effective Date.
How quickly must a company recover erroneously awarded incentive compensation?
Rule 10D-1 requires the company to recover "reasonably promptly" the amount of erroneously awarded incentive compensation. Neither Rule 10D-1 nor the proposed listing standards provide any definition or specific timeframes for what constitutes "reasonably promptly." However, the exchanges do provide additional guidance regarding how each will assess whether a recovery is reasonably promptly made. In evaluating whether an issuer is recovering erroneously awarded incentive-based compensation reasonably promptly, both Nasdaq and the NYSE will consider whether the company is pursuing an appropriate balance of cost and speed in determining the appropriate means to seek recovery, and whether the company is securing recovery through means that are appropriate based on the particular facts and circumstances of each executive officer that owes a recoverable amount.
What happens if a listed company does not comply with the requirements of its clawback policy?
Nasdaq – Amended Listing Rule 5810(c)(2)(A)(iii) would provide that a company that failed to comply with Listing Rule 5608 is required to submit to Nasdaq Staff a plan to regain compliance.
NYSE – Under new Section 802.01F, noncompliance would result in the immediate suspension of trading and immediate commencement of delisting procedures for any company that has not recovered erroneously awarded compensation reasonably promptly after a clawback obligation is incurred.
What should a listed company be doing before the Effective Date?
In advance of the compliance deadline, companies should consider taking the following steps:
- Discuss the new requirements for clawback policies with the company’s board of directors and its compensation committee.
- Consider preparing a draft of your company’s policy beginning now given the relatively short time between the Effective Date (once determined) and the date by which adoption of the policy will be required (60 days following the Effective Date).
- Review controls and procedures to confirm that relevant internal stakeholders (including accounting/finance, legal, and HR) are prepared to coordinate in the event of a restatement.
- Given the short transition period and the fact that the policies will only be required to be filed on the next annual report (meaning most companies will likely not have to file their policies until months after the Effective Date), there will be a delay in market practices coalescing. This may favor staying more general in the first iteration of your company’s policy.
- The exhibit filing requirement only applies to policies developed in response to Rule 10D-1. This may lead companies to approve a stand-alone policy rather than incorporate the provisions into a broader policy or compensation arrangements which would then need to be filed. Even if a stand-alone policy is adopted, existing and new compensation policies will need to be reviewed to confirm that no adjustments are necessary to support recovery under the clawback policy.
If you have any questions regarding this Client Alert or the requirements for a clawback policy for your company, please do not hesitate to contact a member of the Public Companies group or your regular Smith Anderson lawyer.
 Nasdaq expressly notes that the clawback of erroneously awarded compensation is required on a "no fault" basis, without regard to whether any misconduct occurred or an executive officer’s responsibility for the erroneous financial statements. While not expressly noted, this is assumed to be the case for NYSE-listed companies as well.
 Nasdaq expressly notes that equity awards that vest exclusively upon completion of a specified employment period, without any performance condition, and bonus awards that are discretionary or based on subjective goals or goals unrelated to financial reporting measures, do not constitute incentive-based compensation. While not expressly noted, this is assumed to be the case for NYSE listed companies as well. The adopting release for Rule 10D-1 and related rule amendments lists the following additional examples of compensation that do not meet the definition of "incentive-based compensation": salaries; bonuses paid solely upon completion of a specified employment period; and non-equity incentive plan awards earned solely upon satisfying one or more strategic measures (e.g., consummating a merger or divestiture), or operational measures (e.g., opening a specified number of stores, completion of a project, increase in market share).
 The listing standard proposals like Rule 10D-1 note that identification of an executive officer would include at a minimum executive officers identified pursuant to Item 401(b) of Regulation S-K (i.e., those listed in the annual report or proxy statement). Additionally, the definition of executive officer under the clawback rules and Section 16 expressly includes the company’s principal financial officer and principal accounting officer (or, if there is no principal accounting officer, the controller) as compared to the definition applicable to Item 401(b) (which is based on Rule 3b-7 of the Exchange Act).
 Before concluding that it would be impracticable to recover any amount of erroneously awarded compensation based on a violation of home country law, the company must obtain an opinion of home country counsel, acceptable to the applicable exchange, that recovery would result in such a violation and must provide that opinion to the exchange.