December 22, 2022

SEC Adopts Rule to Require Listed Companies to Adopt Clawback Policies

In October, the Securities and Exchange Commission (SEC) adopted Exchange Act Rule 10D-1, directing securities exchanges to adopt listing standards requiring listed companies to adopt and implement policies to recover erroneously awarded incentive-based compensation from current or former executive officers (so-called, clawback policies). Listed issuers will also be required to file copies of their clawback policies and provide periodic disclosure regarding the implementation of those policies.1

A listed company that fails to adopt a clawback policy, comply with its policy or disclose its policy in compliance with SEC rules would be subject to delisting.

The idea of compensation clawbacks is not new. Section 304 of the Sarbanes-Oxley Act of 2002 — enacted following the dot-com meltdown and accounting scandals at WorldCom and Enron — requires an issuer’s CEO and CFO to reimburse the issuer for any bonus or incentive or equity-based compensation received in the 12-month period following filing of any financial statement that the issuer is required to restate because of misconduct — as well as any profits realized from the sale of securities of the issuer during such period.

Eight years later — this time responding to the 2007-09 economic crisis — Congress passed Section 954 of the Dodd-Frank Act, directing the SEC to adopt the rule now known as Exchange Act Rule 10D-1. 

Clawback Policy Requirements

Under the listing standards required by the new rule, a listed company will be required to adopt and comply with a written policy providing that, if:

  • the company is required to prepare an accounting restatement due to the company’s material noncompliance with any financial reporting requirements under the securities laws, and
  • the noncompliance resulted in overpayment of the incentive compensation within the three completed fiscal years preceding the date the restatement was required,

then, the company will recover from its executive officers, on a reasonably prompt basis, the amount of any such erroneously awarded incentive-based compensation.

Unlike the Sarbanes-Oxley clawback statute, the clawback policies required by the new rule: (i) apply to all executive officers of a listed company (rather than just the CEO and CFO); (ii) will be triggered by any accounting restatement resulting from non-compliance with GAAP, whether or not resulting from “misconduct”; and (iii) apply to any incentive compensation inflated as a result of the noncompliance corrected in the restatement during a three-year look back period (rather than all bonuses, incentive-based, and equity-based compensation received during a twelve month period following the filing of the restated financial statements).

Financial Restatement

Under the listing standards to be required by the new rule, a listed company’s clawback policy must be triggered if a listed company is required to prepare an accounting restatement that:

  • corrects an error in previously issued financial statements that is material to the previously issued financial statements (often referred to as a “Big R” restatement); or
  • would result in a material misstatement if the error was left uncorrected, or if correction of the error was recorded only in the current period (often referred to as a “little r” restatement).

Materiality in this context is determined by the company based on the totality of the facts and circumstances, in accordance with Staff Accounting Bulletin No. 99 and other applicable SEC guidance, and any such determination should take into consideration both quantitative and qualitative factors.

In the adopting release, the SEC identified certain types of changes to a company’s financial statements that would not constitute a clawback-triggering restatement. These changes include retrospective application of a change in an accounting principle, retrospective revision to reportable segment information due to a change in a company’s internal organization, and retrospective revision for changes in capital structure.

Requiring clawback policies to apply to “little r” restatements may have a significant impact on the visibility of these restatements. Under current SEC rules, an issuer that identifies a “Big R” restatement must file a Form 8-K notifying investors that they can no longer rely on the affected financial statements and must promptly amend its prior quarterly and annual reports to restate the affected financial statements; “little r” restatements do not require Form 8-K and can be corrected the next time the affected financial statements are filed with the SEC. By contrast, the current rulemaking amends Form 10-K to add cover page check boxes indicating (a) whether the company financial statements included therein reflect correction of an error to previously issued financial statements, and (b) whether any such error correction is a restatement that required recovery analysis under the issuer’s required clawback policy.

Compensation Subject to Clawback

Listed companies will be required to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount that would have been received had the amount been determined based on the restated accounts, without adjustment for taxes paid on the compensation.

“Incentive-based compensation” means “any compensation that is granted, earned or vested based wholly or in part upon the attainment of a financial reporting measure.” “Financial reporting measure” is broadly defined to include any measures determined and presented in accordance with accounting principles used in preparing the company’s financial statements and any measures derived wholly or in part from those measures, as well as stock price and total shareholder return. Financial reporting measures include both GAAP and non-GAAP measures, as well as metrics and ratios that are neither GAAP nor non-GAAP measures (such as stock price and total shareholder return). The adopting release provides a non-exhaustive list of examples of financial measures including profitability of certain segments, funds from operations, sales/revenue per foot/store/user and cost per employee.

Examples of incentive-based compensation that could be covered include:

  • non-equity incentive plan awards earned wholly or in part on satisfying a financial reporting measure performance goal;
  • bonuses paid from a bonus pool, the size of which is determined based wholly or in part on satisfying a financial reporting measure performance goal;
  • equity awards that are granted or become vested based wholly or in part on satisfying a financial reporting measure performance goal; and
  • proceeds received upon the sale of shares acquired through an incentive plan that were granted or vested based wholly or in part on satisfying a financial reporting measure performance goal.

The adopting release clarifies that salary is not incentive-based compensation and that bonuses or equity rewards not contingent on achieving any financial reporting measure performance goal also do not count as incentive-based compensation. For example, awards based solely on discretion or satisfying subjective standards (e.g., demonstrated leadership), or awards based on achieving strategic goals (e.g., M&A, opening new stores, increasing market share), or completion of a specified employment period (time-vesting awards) are not considered incentive-based for these purposes.

To determine the amount of recoverable compensation, the company will be required to determine the portion of an award subject to the achievement of a financial reporting measure performance goal and recalculate that portion based on the restated financial measure. The difference between the two would be the recoverable amount. Where positive or negative discretion was an element in establishing the original amount of the award, the company must take that discretion into effect in determining the portion of the award subject to achievement of a financial reporting measure, as well as the amount of the award that is recoverable as erroneously paid. For cash awards paid from bonus pools, the size of the aggregate bonus pool would be recalculated applying the restated measures and the individuals’ bonuses would be reduced on a proportional basis to the overall reduction in the pool. For incentive compensation based on TSR or stock price, the company must recover an amount based on a reasonable estimate of the effect of the accounting restatement on the stock price or TSR and maintain and provide documentation of that estimate to the securities exchange.

Limited Exceptions to the Recovery Requirements

There are three limited exceptions to the requirement to recover erroneously awarded compensation where it would be impracticable to do so:

  1. The direct expense paid to a third party to recover the amount would exceed the amount of recovery (although a company must make a reasonable attempt to recover the compensation before determining that recovery of the full amount is impracticable).
  2. The recovery would violate home country law, and the company provides the exchange with an acceptable opinion of counsel to that effect.
  3. The recovery would cause an otherwise tax-qualified retirement plan to fail to meet the requirements of tax-qualified retirement plans under the Internal Revenue Code.

Any determination that recovery is impracticable must be made by the compensation committee of independent directors or a majority of the independent directors. Companies may not settle for less than the full recovery amount unless they satisfy the conditions that demonstrate recovery is impracticable. A company may, however, exercise discretion regarding the method of recovering the erroneous compensation. For example, the adopting release identifies that a company may be acting reasonably promptly if it establishes a deferred payment plan that allows the executive officer to repay owed erroneous compensation as soon as possible without unreasonable economic hardship to the executive officer, depending on the particular facts and circumstances.

Companies are prohibited from indemnifying executives against the loss of erroneously awarded compensation. Executives may purchase an insurance policy to protect against clawback risk, but the company is not permitted to secure such a policy or to reimburse the premiums.

Executive Officers Covered by the Rule

The clawback policy must apply to executive officers, defined in a manner consistent with the definition of Section 16 officers, meaning the company’s president, principal financial officer, principal accounting officer (or controller), vice president in charge of a principal business unit, division or function, and any officer performing policy-making function for the company.

Executive officers would be subject to clawback of covered compensation regardless of their roles in preparation of the financial statements and regardless of any responsibility or involvement in the activity that led to the restatement. Clawback is not dependent on any allegation of misconduct, whether by the affected officer or any other person.

Fiscal Years Covered in the Event of a Financial Restatement

To comply with the required listing standard, the clawback policy must apply to incentive compensation received during the three completed fiscal years immediately preceding the earlier of:

  • the date the company’s board of directors, a board committee or an officer or officers authorized to take such action if board action is not required, concludes or reasonably should have concluded that the company is required to prepare an accounting restatement, or
  • a court, regulator or other legally authorized body directs the company to prepare an accounting restatement.

For example, if the company determines in November 2027 that a restatement is required, regardless of when that restatement is completed, the clawback policy would apply to incentive compensation received in 2024, 2025 and 2026. The clawback policy must apply to all incentive compensation earned or received (i) after the recipient has become an executive officer, and (ii) during the period that the company has a class of securities listed on an exchange but need not apply to compensation earned or received prior to the recipient becoming an executive officer or any time that the company’s securities were not listed.

As incentive compensation is considered received when it is earned under the terms of the award, not when it is granted, vested or paid, performance awards subject to both financial performance measures and time-vesting will be considered received when the performance measure is satisfied even if the award is paid after the end of that fiscal period or remains subject to further time-based service vesting.

Disclosure Requirements

Listed companies will be required to file copies of their exchange-mandated compensation recovery policies as exhibits to their annual report on Form 10-K (or Form 20-F for foreign private issuers or Form 40-F for certain Canadian issuers). This requirement does not extend to other clawback policies may have in place – only to the stock exchange mandated policy. Forms 10-K, 20-F and 40-F will have two new check boxes on the cover page. The first check box will indicate whether the financial statements in the report reflect the correction of an error to previously issued financial statements, and the second will indicate whether any of these error corrections are restatements that triggered a compensation recovery analysis during the covered fiscal year.

Notably, if a company is required to recover erroneously awarded compensation during a fiscal year, then Item 402(w) of Regulation S-K (S-K Item 402) will require the following disclosures in the next proxy statement or annual report:

  1. The date on which the company was required to prepare an accounting restatement;
  2. The aggregate dollar amount of erroneously awarded compensation attributable to the accounting restatement (including an analysis of how that amount was calculated);
  3. If the financial reporting measure was stock price or total shareholder return, the estimates used to determine the erroneously awarded compensation attributable to the accounting restatement and an explanation of the methodology used for the estimates;
  4. The aggregate dollar amount of erroneously awarded compensation that remains outstanding at the end of the last completed fiscal year;
  5. If the aggregate dollar amount of erroneously awarded compensation has not yet been determined, disclose that information, the reasons and disclose the amount in the next filing required to included disclosure under S-K Item 402;
  6. If recovery would be impracticable, for each current or former executive officer (on an individual basis and as a group), the amount of foregone recovery and a description of the reasons the company decided not to pursue recovery; and
  7. For each current or former executive officer, the amount of erroneously awarded compensation still owed that has been outstanding for 180 days or longer since the date the company determined the amount was owed.

If the accounting restatement does not require recovery, the company must disclose the reason the recovery was not required.

The final rules also add a new instruction to the Summary Compensation Table that will require companies to reduce the amount that was initially reported as compensation by any amounts recovered pursuant to the required compensation policy and to identify those amounts by footnote. iXBRL tagging will apply to data points in the compensation recovery disclosure and block text.

Companies Required to Comply

The listing standards will apply to most listed companies, with no exemptions for smaller reporting companies, emerging growth companies, foreign private issuers or controlled companies. They will also apply to companies with listed debt or other non-equity securities and to business development corporations and listed funds. There are limited exceptions for registered investment companies or management companies that have not granted incentive compensation. 

Compliance Dates

Each exchange must issue proposed listing standards by February 27, 2023 (within 90 days after publication of the final rule in the Federal Register) and those listing standards must be effective by November 28, 2023 (within one year after publication of the final rule in the Federal Register). Listed companies must adopt a clawback policy no later than 60 days after the effectiveness of the exchange’s listing standard and comply with the disclosure requirements in annual reports and proxy statements and proxy statements filed after adoption of the clawback policy.

Assuming the exchanges make use of the full permitted year before making their listing standards effective, listed companies will be required to adopt a compliance policy no later than January 27, 2024. Companies with calendar year fiscal years would then be required to include disclosure in the annual reports and proxy statements they file in 2024. 

Practice Tips

Many companies have existing clawback policies in place to address misconduct or unjust enrichment, and although those policies take many different forms, they are often both more limited and more expansive than these new requirements. For example, many public companies have policies that require misconduct or fault, but would not be limited to restatements and could apply to misconduct causing other harms to the company. Further, existing policies often apply to a different subset of employees than Section 16 officers, apply to more limited types of incentive compensation, may have shorter “look-back” periods and allow the board to exercise considerably more discretion in determining to decide to clawback prior compensation. Accordingly, we expect that many companies will decide they need to adapt their practices, their clawback policies and, potentially, their compensation programs to comply with these new requirements. 

New clawback policies will not be required until the exchanges have adopted final listing standards, and we recommend companies wait until the exchanges have published their final listing standards before implementing changes as the final standards will likely include additional technical details that may bear addressing in a company’s clawback policy. Although there is time, the final rule is sufficiently detailed for companies to begin taking preparatory steps now, including:

  • Review existing clawback policies to consider what changes may be needed, as well as whether to integrate these new requirements into existing policies or to create a new or separate policy.
  • Review existing compensation arrangements and programs to determine how the clawback rule would apply to them, including to be clear on what aspects of current incentive compensation arrangements are based on financial reporting measures.
  • Review the company’s internal controls and disclosure controls and procedures related to its ability to recalculate incentive-based compensation.
  • Review the company’s incentive awards plans and documents to ensure they are clear that awards are subject to the company’s clawback policy in effect from time to time, as well as employee termination release language to ensure it does not conflict with the company’s obligation to recover erroneously awarded compensation.
  • Review the company’s executive officer determinations in light of the applicability of this clawback policy.
  • Consider implications for structuring incentive compensation arrangements and payouts in the future.
  • Brief the board and audit and compensation committees on these developments and add reviewing a new or revised policy to the board and committee agendas for 2023.


  1. The new rule and rule amendments were published in the Federal Register on November 28, 2022.

Related Legal Services

The Faegre Baker Daniels website uses cookies to make your browsing experience as useful as possible. In order to have the full site experience, keep cookies enabled on your web browser. By browsing our site with cookies enabled, you are agreeing to their use. Review Faegre Baker Daniels' cookies information for more details.