On October 26, 2022, the Securities and Exchange Commission (the “SEC”), implementing a requirement of the Dodd-Frank Act, adopted a final rule requiring the recovery of erroneously awarded incentive-based executive compensation. Rule 10D-1 of the Securities Exchange Act of 1934, as amended (“Rule 10D-1”) directs national securities exchanges and associations to establish listing standards that require a listed issuer to:

• adopt and comply with a written policy for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers in the event the issuer is required to prepare an accounting restatement (a “Clawback Policy”); and
• file the Clawback Policy as an exhibit to its annual reports, indicate whether any restatements require a recovery analysis, and disclose any actions it has taken pursuant to such recoveries.

Each exchange is required to file its proposed listing standards within 90 days of the publication of Rule 10D-1 in the Federal Register, with the listing standards required to be effective no later than one year following such publication date. Issuers must adopt a Clawback Policy within 60 days after the applicable exchange’s listing standards implementing Rule 10D-1 become effective.

Overview

• Rule 10D-1 applies to all listed issuers, including foreign private issuers, controlled group companies, smaller reporting companies, emerging growth companies, debt-only issuers and business development companies, as well as registered investment companies (including those internally managed) that have awarded incentive-based compensation to any executive officer within the last three fiscal years.
• The Clawback Policy must seek a recovery whenever there is a “Big R” restatement (which restates historical financial statements to correct errors that were material to those previously issued financial statements, and which requires an Item 4.02 Form 8-K to be filed), as well as when there is a “little r” restatement (which restates errors in a prior period that were not material to the previously issued financial statements but which would result in a material misstatement if either the errors were left uncorrected in the current report or the error correction was recognized in the current period).
• The Clawback Policy must apply to incentive-based compensation awarded during the three-year period preceding the date that the issuer concluded (or reasonably should have concluded) that a restatement is required, or the date that a court or regulator directs the issuer to prepare a restatement.
• The Clawback Policy must require recoupment of incentive-based compensation mistakenly paid based on erroneous financial statements from all current and former executive officers of the issuer, regardless of whether the executive was at fault for the error, during the three-year lookback period.

Five Key Components

• Covered individuals. Current and former “executive officers” are subject to the Clawback Policy. An “executive officer” includes the company’s president, principal financial officer, principal accounting officer, any vice president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company (including officers of a parent or subsidiary). For a limited partnership, executive officers are officers or employees of the general partner who perform policy-making functions. Rule 10D-1 would not require recovery of incentive-based compensation that was received prior to the time such person became an executive officer of the issuer.
• Incentive compensation. “Incentive-based compensation” is any compensation (including cash and equity) granted, earned or vested based in whole or in part on the attainment of a “financial reporting measure.” “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 measures derived in whole or in part from such measures, as well as stock price and total shareholder return (“TSR”).
• Receipt of incentive compensation. Incentive-based compensation is “received,” and therefore subject to clawback, in the fiscal period during which the applicable financial reporting measure is attained, even if the payment or grant occurs after the end of that period; the date of “receipt” of such compensation is therefore tied to the satisfaction of the financial reporting measurement goal, irrespective of applicable vesting, grant or payment dates. An award subject to both time and performance-based vesting conditions is considered received upon satisfaction of the performance metric even if the award continues to be subject to vesting.
• Amount of clawback. The amount of the clawback is the amount of incentive-based compensation received by the executive officer in excess of what would have been received if the incentive-based compensation was determined based on the restated financial statements. The calculation of erroneously awarded compensation must be calculated on a pre-tax basis.
• Recovery. An issuer must seek to recover erroneously awarded compensation in compliance with its Clawback Policy; however, the issuer will not be required to seek recovery if its compensation committee (or, in the absence of a compensation committee, a majority of the board’s independent directors) determines that recovery is impracticable for one of three reasons: (i) the company provides to the exchange documentation of its having a reasonable attempt to recover but the direct expenses paid to third parties to assist in enforcing the recovery would exceed the amount to be recovered; (ii) in the case of a foreign private issuer, the issuer provides an opinion of counsel to the exchange that pursuing the recovery would violate home country law in effect prior to the date of publication of Rule 10D 1 in the Federal Register; or (iii) recovery would be from a tax-qualified retirement plan. Additionally, executives may not be indemnified for any amounts recovered under the Clawback Policy, nor may issuers pay premiums for insurance policies that would cover an executive’s potential obligations.

Exclusions

Rule 10D-1 does not apply to the following types of issues:

•  security futures products cleared by a registered clearing agency or an exempt clearing agency;
• standardized options issued by a registered clearing agency;
• securities issued by a unit investment trust; and
• securities issued by a registered investment company that has not awarded incentive-based compensation to an executive officer in the prior three fiscal years.

New Disclosure Requirements

• Annual report. Each listed company must file its Clawback Policy as an exhibit to its annual report on Form 10-K, 20-F, 40-F or N-CSR, as applicable. Rule 10D-1 also requires information mirroring the Item 402 disclosures (described below) to be included in annual reports on Form N-CSR, in proxy statements and information statements relating to the election of directors, on Form 20-F or, if the foreign private issuer elects to use the registration and reporting forms that U.S. issuers use, on Form 10-K; and on Form 40-F.
• Item 402 disclosures. Item 402 of Regulation S-K requires issuers to disclose how they have applied their Clawback Policies. If, during its last completed fiscal year, the issuer restated its financial statements which required recovery, or there was an outstanding balance of recovery relating to a prior restatement, the issuer must disclose the following information: (i) the date on which the issuer was required to prepare the restatement and the aggregate dollar amount of excess incentive-based compensation attributable to the restatement (the “Recoverable Amount”) and an analysis of how the Recoverable Amount was calculated or, if the Recoverable Amount has not been determined, an explanation of the reasons why it has not; (ii) if the compensation is related to a stock price or TSR metric, the estimates used to determine the Recoverable Amount and an explanation of the methodology used for such estimates; (iii) the aggregate dollar amount of all Recoverable Amounts outstanding at the end of the company’s last completed fiscal year and the Recoverable Amounts that are outstanding for more than 180 days since the date the issuer determined the amount owed; and (iv) where an impracticability exception is being applied, the amount of the Recoverable Amount exempted for each identified executive officer and for all executive officers as a group and a brief description of the reason the issuer’s board of directors decided not to pursue recovery.
• Check boxes on Forms 10-K, 20-F and 40-F. Issuers must indicate by check boxes on their annual reports whether the financial statements included in the filings reflect a correction of an error to previously issued financial statements and whether any such corrections are restatements that necessitate a recovery analysis.

Recommended Action Steps for Issuers

There are several steps that an issuer should consider taking at this time.

• Identify covered executives. Issuers should identify the covered executives in the entities and document, specifically, their policy-making engagements.
• Evaluate incentive compensation arrangements. Issuers should evaluate their existing compensation arrangements to determine which, if any, have elements that relate to a financial performance metric and whether there are any clawback mechanisms provided therein.
• Incorporate clawback provisions in executive incentive compensation arrangements. For new arrangements, issuers should incorporate language into the documents accommodating clawbacks, to the extent necessary under applicable law. If necessary, issuers should consider amending their existing incentive compensation plans and/or award agreements to enhance the enforceability of their Clawback Policy once it is adopted and to permit clawbacks going forward, to the extent necessary under applicable law.
• Begin to prepare for additional required disclosure. Issuers should begin the operational preparation that will be required to (x) add required disclosure, as may be determined once the exchange listing requirements have been finalized and the Clawback Policy established, (y) disclose necessary clawbacks, if and when made, and (z) carry out the recovery of Recovery Amounts, when and if necessary.
• Governance enhancements. Issuers should review governing documents, including bylaws and committee charters, and other statements of board policy or operations, to determine the need for adding provisions in regard to the new clawback requirements and procedures to implement the policy. This review may require engagement with audit and accounting staff with respect to the “little ‘r’” restatement so that directors can appropriately understand their obligations.

If you have any questions or would like additional information regarding Rule 10D-1, please contact your primary Seward & Kissel contact or S. John Ryan at (212) 574-1679, Michael O’Brien at (212) 574-1505, or Bradley Fay at (212) 574-1429 in Seward & Kissel’s Executive Compensation Group.