What boards need to know about the SEC’s new executive compensation recovery (clawback) rule 

Just two months after issuing new pay for performance rules, the Securities and Exchange Commission (SEC) fulfills another Dodd-Frank Act mandate and adopts final executive compensation recovery rules.  

The final rule (“Rule 10D-1”) implements section 10D of the Securities Exchange Act of 1934 as required by the Act. Rule 10D-1 specifies that national securities exchanges must establish listing standards that require listed issuers to adopt and comply with a compensation recovery policy, often known as a clawback policy. That policy must provide that, in the event the issuer is required to prepare an accounting restatement, the issuer will recover incentive-based compensation paid to its current or former executive officers based on any misstated financial reporting measure. Issuers are required to “look-back” during the three-year period preceding the date the issuer is required to prepare the accounting restatement in considering the amount of compensation subject to clawback. Listed issuers will also need to provide disclosure about their compensation recovery policies and how they are being implemented. An issuer will be subject to delisting if it does not adopt and comply with a compensation recovery policy that meets the requirements of the listing standards. 

Who is affected?

With limited exceptions, the final amendments will affect all entities that list securities on U.S.-registered securities exchanges. This includes emerging growth companies, smaller reporting companies and foreign private issuers.

When does the rule become effective?

The final amendments become effective on Jan. 27, 2023. To comply with Rule 10D-1, national securities exchanges will be required to file proposed listing standards no later than April 27, 2023. These listing standards will be required to be effective no later than Jan. 27, 2024. 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 exchange standards become effective and must begin to comply with these disclosure requirements in proxy and information statements and the issuer’s annual report filed on or after the issuer adopts its recovery policy.

What does and does not trigger application of the issuers’ compensation recovery policy?

Under Rule 10D-1, an issuers’ compensation recovery policy will be triggered in the event the issuer is required to prepare an accounting restatement. This includes restatements that correct an error in previously issued financial statements that is material to the previously issued financial statements (i.e., a “Big R” restatement) or corrects an error that is not material to prior period financial statements, but that would result in a material misstatement if the error were left uncorrected in the current report or if the error correction was recognized only in the current period (i.e. a “little r” restatement). Correction of errors in the current period financial statements that are immaterial to the previously issued financial statements and immaterial to the current period- commonly referred to as “out-of-period adjustments”- would