Decisions, Decisions: The SEC’s Clawback Rules Call for Lots of Them

In October 2022, the SEC adopted final rules regarding the “recovery of erroneously awarded compensation,” or “clawbacks,” consistent with the requirements of the Dodd-Frank Act. (A summary of the rules can be found here, and a more complete description has been posted on our blog.) The new rules direct the national securities exchanges to establish listing standards requiring companies to adopt, enforce, and disclose policies implementing the rules. It currently appears that listed companies will be required to adopt compliant clawback policies by December 1, 2023.

The new rules are complex and require a listed company to take a number of steps in order to amend existing clawback policies or provisions (contained in compensation plans or otherwise) or, if none, to adopt and implement one or more compliant policies in a timely manner. The following is a summary of the key steps to be taken and decisions to be made.

If your company has an existing clawback policy, you will need to compare the existing policy to the requirements of the new rules, including any additional requirements in the applicable listing standards. For example:
- Existing policies may apply to a narrower or broader employee population than is required under the new rules, which applies to current and former Section 16 officers.
- Existing policies may be tied to a specific type of restatement or may apply only in cases of misconduct. The new rules require recoupment for two types of restatements and apply whether or not the restatements are the result of misconduct.
- Existing policies may apply to different forms of compensation. The new rules apply to all “incentive-based compensation,” which is broadly defined as any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any “financial reporting measure.”
- Existing policies may be discretionary, whereas under the new rules clawbacks are mandatory except in three limited circumstances.

You may need to consider whether to maintain one clawback policy that complies with the new rules, or to maintain multiple policies, some of which may apply to a different subset of employees or provide for different circumstances for recoupment. Some key considerations are as follows:
- Multiple policies will afford the company greater discretion in determining whether and under what circumstances to recover compensation from non-executive officers.
- Multiple policies will enable the company to maintain the confidentiality of any policy that applies to individuals other than executive officers.
- A separate discretionary clawback policy that is triggered by material misconduct, a violation of company’s code of conduct, or other types of misconduct may serve to help resolve criminal investigations.
- However, multiple policies may create administrative and other challenges, such as uncertainty on the part of both the company and its executives as to which policy applies in certain circumstances.

If your company has any existing clawback provisions, including provisions in plans, specific grants under plans, employment agreements, or otherwise, you will need to consider how to treat them vis-à-vis the new rules. Some key considerations are as follows:
- You may want to retain the existing provisions. However, this may entail changing the provisions so that they do not conflict or are not inconsistent with the new rules.
  - As is the case with multiple policies, having provisions that are inconsistent with the policy may create administrative and other challenges, such as uncertainty on the part of both the company and its executives as to which policy or provision applies in certain circumstances.
  - Another possibility is to specify that the SEC-compliant policy overrides conflicting provisions in other documents/agreements. However, such language may not be enforceable.
  - Note that the company may not be able to change provisions without the consent of the executive(s) in question.
- You may determine to eliminate the provisions to avoid conflicts or inconsistencies, subject to obtaining any necessary consents.

You need to determine whether the Compensation Committee or the Board will enforce the policy and how they will do so. Note that the SEC rules do not specify how a company must enforce its policies.

When reviewing existing incentive compensation plans and agreements, you should:
- Consider whether to adjust performance metrics or the mix of incentive and non-incentive-based compensation to better fit the clawback policy requirements.
- Consider imposing mandatory deferrals or holding requirements on earned incentive awards to facilitate implementation of the clawback policy.
- Consider having executive officers acknowledge changes to the policy that may affect previously issued awards.

When entering into new compensation arrangements, you should check that they are consistent with the clawback policy and, where applicable, include the necessary contractual links to the enforcement of the policy.

Companies need to review executive officer determinations and ensure proper classification.
- As all Section 16 officers and any other persons identified as executive officers in the company’s proxy statement or 10-K will now be subject to the clawback policy, companies should review their executive officer determinations to make sure that all individuals are properly classified.
- The determinations should be updated at least annually. The annual election of officers following each annual meeting of the board (usually held at the time of the annual meeting of shareholders) is an opportune time to make these determinations, and determinations as to which officers are “executive officers” can be reflected in the minutes of the board meeting.

Companies will need to make the required disclosures of their SEC-compliant policies.
- The clawback policy must be filed as an exhibit to the annual report on Form 10-K, Form 20-F, or Form 40-F.
- Additional disclosures may be required under certain circumstances, including:
  - Disclosure in proxy and information statements if, at any time during or after the company’s last completed fiscal year, the company either (1) was required to prepare an accounting restatement that required a clawback under the company’s clawback policy or (2) there was an outstanding balance of unrecovered excess incentive‑based compensation relating to a prior restatement.
  - If at any time during or after its last completed fiscal year a company was required to prepare an accounting restatement and concluded that recovery of erroneously awarded compensation was not required pursuant to the company’s clawback policy, the company must briefly explain why application of its clawback policy resulted in this conclusion.
  - If recovered amounts reduce amounts previously reported in the Summary Compensation Table, the amount must be deducted from the applicable column and total column for the year in which the recovered amount was originally reported, and this amount must be identified in a footnote to the table.

Thanks to Savannah Spears and Chris Seifter for their assistance with this e-alert.

Please direct any questions or observations to Gunster securities law and corporate governance practice leader Bob Lamm.

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This publication is for general information only. It is not legal advice, and legal counsel should be contacted before any action is taken that might be influenced by this publication.

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