SEC Adopts Compensation Clawback Rule with New Requirements for Public Companies

This article was updated.

The U.S. Securities and Exchange Commission (SEC) on Oct. 26 released a long-awaited final rule on incentive-compensation clawbacks, requiring publicly traded companies to have policies for recouping executive compensation if revised company financial statements show that incentive-linked goals were not met.

The SEC initially released a proposed rule in 2015 and reopened the comment period on the proposal in October 2021 and again in June 2022.

Under the final rule, Listing Standards for Recovery of Erroneously Awarded Compensation, "incentive-based compensation" includes bonus payments and equity (stock) awards based on meeting a financial reporting measure. [Update: the rule was published in the Federal Register on Nov. 28, 2022, and takes effect 60 days later on Jan. 27, 2023.]

A white paper from law firm Jones Day explained that the final rule does not allow companies to condition clawbacks of incentive compensation "in any way on the fault or culpability of an affected executive officer regarding the accounting restatement, to implement de minimis thresholds for clawbacks or recoverable amounts of erroneously awarded incentive compensation, or allow for boards of directors to exercise broad discretion in connection with determining whether certain compensation should be clawed back in light of the circumstances."

New Requirements

The final rule directs national securities exchanges to adopt listing standards that require publicly traded companies to:

• Adopt and comply with a clawback policy providing for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers following an accounting restatement.
  

• Disclose the company's clawback policy as an exhibit in its annual report filed with the SEC.
  

• Annually disclose any activity to recover erroneously awarded compensation during the company's last completed fiscal year.

Issuers that do not comply with the final rule will be subject to delisting by their national securities exchange.

Steps for Public Companies

The final rule "represents a broad interpretation of the SEC's mandate" under the Dodd-Frank Wall Street Reform and Consumer Protection Act, according to attorneys at international law firm Winston & Strawn.

The firm advised public companies and their compensation committees to begin preparing for compliance with the new clawback requirements and recommended the following steps:

• Review existing clawback policies and assess whether to amend existing policies to comply with the final rule and revised listing standards or adopt a new policy.
  

• Review existing incentive-compensation plans and award agreements and make any amendments necessary to subject future awards under these plans to clawback policies compliant with the final rule and revised listing standards.
  

• Review existing indemnification, insurance and attorneys' fees provisions, including incentive-based-compensation arrangements in which current or former executives participate to identify any provisions that would require indemnification, insurance or increased compensation to cover a compensation clawback. Revise these provisions if necessary to comply with the final rule and revised listing standards.

Going Beyond the Minimum

For some companies, "the final rule may be a floor and not a ceiling on their clawback policies," Winston & Strawn's attorneys wrote. "Many public companies have adopted policies that cover situations unrelated to financial-reporting measures, including breach of restrictive covenants and misconduct resulting in financial or reputational harm," the attorneys pointed out.

As an example, they noted that "the #MeToo movement encouraged many companies to voluntarily incorporate sexual harassment and other reputational-harm considerations as a clawback trigger on the grounds that inappropriate behavior by an executive can have an impact on [the company's] reputation and share price."