United States: SEC Adopts Final Dodd-Frank Act Clawback Rules: An A-to-Z Explanation

As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, on October 26, 2022, the Securities and Exchange Commission adopted final rules directing the national securities exchanges and national securities associations that list securities to establish clawback listing standards. These clawback listing standards will require each listed issuer to adopt a written compensation recovery (clawback) policy providing for the recovery, in the event of a required accounting restatement, of incentive-based compensation received by current or former executive officers (generally Section 16 officers) that is based on erroneously reported financial information. The final rules also require disclosure regarding the clawback policy, including filing it as an exhibit to the listed issuer's annual report and providing (where applicable) certain disclosure regarding the operation of the clawback policy.

Importantly, the SEC's final rules do not permit listed issuers to condition clawback 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.

REQUIREMENTS UNDER THE FINAL RULES

The final clawback rules ("Final Rules") adopt new Rule 10D-1 (the "Clawback Rule") under the Securities Exchange Act of 1934, as amended. Under the Clawback Rule, the national securities exchanges and national securities associations that list securities (each, a "Stock Exchange") must adopt clawback listing standards (the "Clawback Listing Standards") prohibiting the initial or continued listing of any security of an issuer that fails to timely develop and adopt—and provide required disclosure regarding—a written compensation recovery policy (a "Clawback Policy"). In turn, the Clawback Policy must require the listed issuer to recover, or claw back, in a reasonably prompt manner, when triggered by certain accounting restatements as described in the Clawback Listing Standards, incentive-based compensation received by certain current or former executive officers that is in excess of what such executive officers should have otherwise received, subject to narrow exceptions described in the Clawback Listing Standards. In addition, a listed issuer must provide certain disclosures related to its Clawback Policy and its operation after it is adopted, in accordance with the Final Rules (the "Clawback Disclosure").

Public companies and their advisers have been waiting since 2010 for the SEC to implement the clawback policy requirements under the Dodd-Frank Act. The SEC provided a first look at its intended approach when it published proposed DoddFrank Act clawback rules in July 2015 but took no further action until it reopened the comment period on those proposed rules in October 2021 and June 2022. The Final Rules are now here, and generally reflect adoption of the proposed rules substantially as proposed, but with certain modifications primarily to broaden the scope of covered accounting restatements to include so-called "Little r" accounting restatements (as more fully described below) and to clarify the applicable rules.

Despite these changes, the Final Rules remain very convoluted, and the SEC's approach on Clawback Policies continues to remain out of step with the approach that much of corporate America has taken to adopt appropriate and practical clawback arrangements during the past 12 years. Importantly, the Final Rules do not permit listed issuers to condition clawback 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 received 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.

EFFECTIVENESS

The Stock Exchanges must file their proposed Clawback Listing Standards with the SEC no later than 90 days after the Final Rules are published in the Federal Register, and the Clawback Listing Standards must become effective no later than one year following such publication. Affected issuers then must: (i) adopt a Clawback Policy no later than 60 days after the applicable Clawback Listing Standards become effective (such date, the "Clawback Deadline"); and (ii) comply with new clawback disclosure requirements under the Final Rules on and after the Clawback Deadline. Under this timetable, the Clawback Deadline for issuers to adopt Compliant Clawback Policies will likely occur during late 2023 or early 2024.

A-TO-Z EXPLANATION OF THE FINAL RULES

The following questions and answers explain the key elements or operation of the Final Rules:

A. Which Issuers Will Need to Comply with the Clawback Listing Standards?

Almost every issuer listed on one of the Stock Exchanges (including, in particular, emerging growth companies, smaller reporting companies, foreign private issuers, controlled companies, and issuers of only debt or preferred securities) must comply with the Clawback Listing Standards.

B. Which Issuers Are Exempt from Complying with the Clawback Listing Standards?

The only issuers excluded from complying with the Clawback Listing Standards are: (i) those that list only certain securities futures products cleared by a registered (or Exchange Actexempt) clearing agency, standardized options issued by a registered clearing agency, securities issued by unit investment trusts, and securities issued by certain registered investment companies; and (ii) registered management companies that have not awarded incentive-based compensation to any Executive Officer (as explained below) of the management company in any of the three previously completed fiscal years (or, if a shorter period, since the initial listing of the management company).

C. In General, What Is the Clawback Process Under a Clawback Policy?

If a listed issuer operating a Clawback Policy is required to prepare an Accounting Restatement, the issuer must claw back:

• Within a reasonably prompt period of time;
• From each Executive Officer;
• All Excess Incentive-Based Compensation;
• Received by the Executive Officer;
• During the Recovery Period;
• Provided that a Clawback Exception does not apply; and
• Provide required Clawback Disclosure, including information about the clawback.

Each of these elements or steps is further explained or described below.

D. What Kinds of "Accounting Restatements" Will Trigger the Clawback?

Under the Clawback Listing Standards, a clawback ("Clawback") will be triggered under a Clawback Policy when the listed issuer becomes required to prepare either a "Big R" accounting restatement or a "Little r" accounting restatement.

E. What Is a "Big R" Accounting Restatement?

A "Big R" accounting restatement is an accounting restatement that corrects errors that are material to previously issued financial statements, as considered under U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards, as applicable (a "Big R Restatement").

F. What Is a "Little r" Accounting Restatement?

A "Little r" accounting restatement is an accounting restatement that corrects errors that are not material to issued financial statements, but that would result in a material misstatement if: (i) the errors were left uncorrected in the current period; or (ii) the error correction was recognized in the current period (a "Little r Restatement" and, together with the Big R Restatement, "Accounting Restatements"), as considered under U.S. GAAP or IFRS, as applicable. The SEC's determination that the kinds of Accounting Restatements that will trigger Clawback under a Clawback Policy will include Little r Restatements represents a significant change from the proposed rules.