Clawback policies for foreign private issuers must be in place by
December 1

Publicly traded companies in the United States, including foreign private issuers, must adopt and implement an incentive-based executive compensation clawback policy compliant with Rule 10D-1 of the Securities and Exchange Commission by no later than December 1, 2023. 

This rule expands executive compensation clawback requirements dramatically: under the rule, a company must now enforce a clawback almost any time it restates its financials, regardless of whether the restatement was caused by fraud, mistake or any other error. The rule also requires each listed company to disclose its policy and all clawbacks that occur as a result of the policy.

Background

Rule 10D-1 requires US exchanges to establish listing rules incorporating the clawback requirements set out in 10D-1 and it is from these exchange rules that the requirement for issuers to adopt 10D-1 compliant policies arises. Both NYSE and NASDAQ have published their rules with approval of the SEC and with effect on October 2, 2023. Listed issuers have 60 days from that date (until December 1, 2023) to adopt compliant clawback policies.

Many existing clawback policies (a) grant discretion to the board when applying clawbacks; (b) only apply in the event financial statements have to be refiled as the result of a restatement; or (c) require misconduct on the part of the subject executive. None of these permissive features will be allowed in policies under Rule 10D-1.

Executive officers

Rule 10D-1 applies to both current and former executive officers. An executive officer of an issuer for purposes of Rule 10D-1 and the exchange rules is:

• the president;
• the principal financial officer;
• the principal accounting officer (or if there is none, the controller);
• a vice-president in charge of a principal business unit, division, or function (such as sales, administration, or finance); or
• an officer who performs a policy-making function, or any other person who performs similar policy-making functions. Policy-making function is not intended to include policy-making functions that are not significant.

Executive officers of the issuer’s parent(s) or subsidiaries are deemed executive officers of the issuer if they perform such policy-making functions for the issuer.

When the issuer is a limited partnership, officers or employees of the general partner(s) who perform policy-making functions for the limited partnership are deemed officers of the limited partnership.

When the issuer is a trust, officers or employees of the trustee(s) who perform policy-making functions for the trust are deemed officers of the trust.

Clawback triggers and look-back

Under a Rule 10D-1 compliant policy, a clawback is triggered any time a material accounting error is discovered in the preceding three years' financial statements. This covers both restatements that correct errors that are material to the previously issued financial statements and restatements that correct errors that are not material to previously issued financial statements, but which would result in a material misstatement if the errors were left uncorrected in the current report, or if the error correction was recognized in the current period. 

These are commonly known as big "R" and little "r" restatements, respectively. Big “R” restatements typically require the refiling of financial statements while little “r” restatements are generally dealt with in the notes to the current financial statements. Many existing clawback policies are not triggered by little “r” restatements, absent misconduct on the part of an executive officer.

Compensation subject to clawback

 The compensation subject to clawback under a Rule 10D-1 compliant policy includes any cash, shares or stock options awarded over the last three years that would not have been paid to the executive officer had the company filed correct financial statements ("covered compensation"). Covered compensation includes any incentive-based compensation tied to stock price. Neither salaries nor incentive-based bonuses tied to non-financial data, such as overall business growth, hours worked, leadership, etc., are considered covered compensation. Rule 10D-1 only applies to covered compensation received by an executive officer after October 2, 2023. Corporations are allowed to use their own "reasonable methods" to calculate the level of over-compensation.

Conclusion

While many corporations already have clawback policies in place, they will need to re-examine those policies to ensure they comply with Rule 10D-1. Corporations will need to create clear policies that provide proper notification to executives and that allow companies to enforce clawbacks while mitigating potential litigation risk.