How to implement the SEC"s Mandatory Clawback Policy

Listed companies must adopt the policy by December 1, 2023. In connection with such adoption, consider:

Using forfeiture provisions to maximize enforcement of clawback terms that go beyond the rule.
Reviewing what compensation will and won’t be impacted by the new rule, broken out by grant year, type, and the applicable performance metric;
Adopting a standalone policy that layers on top of any existing clawback terms;
Obtaining implicit (instead of explicit) consent for prior awards and including express consent in go forward incentive grant documents; and
Including clawback oversight in compensation committee charters.

All listed companies (including foreign private issuers, emerging growth companies and smaller reporting companies) are required to adopt clawback policies under which erroneously awarded incentive-based compensation received by current and former executive officers based on incorrect financial reporting must be recovered.

Outlined below are the details of the new rule, and the process we recommend for adopting a compliant clawback policy. We have also include with this article and an example clawback policy that complies with the NYSE listing rule.

Clawback Rules and Background

On November 28, 2022, the SEC adopted the final clawback rule mandated by the Dodd-Frank Act covering the clawback requirements. The final rule became effective January 27, 2023 and directed NYSE and Nasdaq to adopt listing standards implementing the SEC's clawback requirements. On February 22, 2023, both the NYSE and Nasdaq published their proposed listing standards which. The exchanges then amended those rules to extend the effective date and new requirements for curing non-compliance. In sum, the new rules become effective October 2, 2023. Companies are required to adopt compliant policies by December 1, 2023.

We provide a high-level overview of the clawback rules below.

Effective Date	The effective date is October 2, 2023 and the clawback policy would apply to performance-based incentive cash or equity compensation for which the financial reporting measure is attained on or after that date.
Trigger	Mandatory clawback upon big and little “r” restatements (excluding retrospective revisions not attributable to errors); regardless of misconduct.Out of period adjustments correcting immaterial errors in prior periods that are also not material to the current period are not considered accounting restatement.
Exceptions	Recovery is not required if: the direct costs of seeking recovery exceeds the recoverable amount; or recovery would violate the company’s home country laws; or recovery compromise the tax status of a tax-qualified retirement plan.
Executive Officers Covered	Current and former executive officers
Recovery Period	Three full fiscal years preceding the date a restatement is required (plus any interim stub year due to a change in a company’s fiscal year).
Compensation Covered	Erroneously awarded performance-based incentive cash or equity compensation, recouped on pre-tax basis.

The remainder of our discussion focuses on practical implementation considerations. For a detailed analysis of the black-letter differences between the NYSE and NASDAQ rules, we have found the following helpful:

Implementation Considerations

Forfeiture - Enforcement & Misconduct.

As has long been reported, enforcement of clawback provisions is an untested issue generally given state-level prohibitions on wage recoupment. While the SEC’s mandatory policy has the blessing of a federal mandate to overcome such hurdles, many will need to grapple with enforcement issues if seeking to expand their clawback policies beyond financial restatements into, for example, instances of misconduct. To maximize enforceability, we recommend allowing for clawback via nonpayment of cash bonuses and forfeiture of equity awards in case of misconduct and/or financial restatements. These policies are often more effective than clawback and just as investor friendly. Nonpayment and forfeiture provisions are commonly included in cash and equity incentive plans and award agreements.

For more information on forfeiture and clawbacks, see our prior article on the topic - The State of Play on Clawbacks and Forfeitures Based on Misconduct.

Compensation Types Impacted

As stated above, the new policy applies only to compensation for which the applicable financial reporting measure is attained on or after October 2, 2023.

We recommend compensation committees assess the applicability of the new rules on each type of compensation provided to executives (broken out by compensation type, performance metric, and time of grant)

For example, the below reviews a somewhat typical compensation program for a calendar year filer that incorporates a mix of strategic and financial measures in their short-term incentive, and a mix of time-based RSUs and PSUs based on financial metrics in their long-term incentive.

Cash/Short-Term Incentive Plan (1-year performance period):

Compensation	New Clawback Rule Impact
2022 STI and prior	Not covered because all financial performance measures were achieved prior to October 2, 2023.
2023 STI and following:	Financial components covered. For example:
Free Cash Flow (30%)	Covered.
Revenue (50%)	Covered.
Strategic (20%)	Generally not covered, except to the degree financial metrics are used to support the strategic component. E.g., where revenue from a business segment is considered when measuring strategic attainment.

Equity/Long-Term Incentive Plan:

Compensation	New Clawback Rule Impact
2020 PSUs and earlier (3-year performance period)	Not covered because financial performance measures were achieved prior to October 2, 2023.
2021 PSUs and following (3-year performance period)	Financial components covered (generally all of the award).
RSUs (time-based vesting)	Not covered because time-based vesting awards are not subject to financial performance measures.

Preexisting clawback policies and clawback provisions.

Companies that already have clawback policies in place must decide whether to integrate them into a single policy or adopt a standalone policy. Consistent with the example policy included with this article, we favor the latter nonintegrated approach which can be accomplished by stating that the standalone policy will apply only to the extent they do not conflict with, or are not inconsistent, with the standalone clawback policy.

This approach offers the advantage of allowing a company to limit the clawback policy’s scope to mandatory situations covered by the SEC rule, while giving the Compensation Committee discretion and flexibility in applying the preexisting policies in other situations.

Executive Officer Consent.

In terms of enforcement, we do not see obtaining consent from the executive officers in a separate agreement as necessary as the SEC clawback rule is mandatory. Moreover, such consent may potentially create ill-will among the executive officers. Instead, we recommend a company’s Dodd-Frank compliant policy be circulated to all impacted individuals (or any individuals that become covered by the policy), notifying such individuals that they are subject to the new rules. Records should be retained documenting that notice. In addition, adding consent provisions in future award agreements would simplify the enforcement process and avoid lengthy disputes.

Compensation Committee Charter

Given the growing importance off clawback provisions, the board may consider updating their compensation committee charter to include express oversight and unilateral authority with respect to clawback provisions applicable to executive officers.

Exhibit to Annual Report.

After the listing standards become effective on October 2, 2023, the clawback policy must be included as an exhibit in the company’s 10-K.