The SEC Issued Final Dodd-Frank Clawback Rules

By Dina Bernstein, Samantha Nussbaum


On October 26, 2022, the SEC published final clawback rules to implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). The rules, which were originally proposed in 2015, were adopted substantially as proposed and require companies to adopt policies for the recoupment of erroneously awarded incentive-based compensation in the event of a triggering restatement, regardless of whether the executive was at fault or engaged in any misconduct.  New disclosures are also required.

The SEC voted 3-2 in favor of the final rules. Mr. Gensler, the Chair of the SEC, stated that he believes that the final rules will “strengthen the transparency and quality of corporate financial statements, investor confidence in those statements, and the accountability of corporate executives to investors.” Commissioner Uyeda, who voted against the rules, criticized the final rules as overly broad in coverage of “little r” restatements and its definition of covered executives, stating that “the final rules may increase misalignments between the interests of shareholders and corporate executives.” Similarly, Commissioner Pierce, who also voted against the rules, noted that the rules are inflexible, overly broad, and too complex.

As discussed further below, stock exchanges must adopt listing standards no later than 90 days after the rules are published in the Federal Register (“publication date”), and in turn the listing standards must be effective within one year of the publication date. Affected issuers will then have 60 days following the date on which their applicable listing standards become effective to adopt compliant clawback policies.  Our prediction is that the earliest companies will need to adopt the new rules will be in the second half of 2023.

Below is a high-level summary of the final rules, which can be found here.

Companies Covered

All public companies are covered, with very limited exceptions for the listing of certain security futures products, standardized options, securities issued by unit investment trusts, and securities issued by certain registered investment companies.  Smaller reporting companies, emerging growth companies and foreign private issuers are subject to the new rules.

Persons Covered

The definition of current or former executive officers tracks the definition of “officers” for Section 16 purposes. Specifically, current or former executive officers are defined as: “the issuer’s president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer.” 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. 

In a change from the proposed rules, the rules apply to an executive officer’s incentive-based compensation received only after such person initially began service as an executive officer.

Compensation Covered

Incentive-based compensation is “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of a financial reporting measure.” Financial reporting measures are defined as “measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, and any measures that are derived wholly or in part from such measures.” Importantly, stock price and total shareholder return are considered to be financial reporting measures.

Per the rules, incentive-based compensation is deemed “received” in the fiscal period during which the financial reporting measure specified in the incentive-based compensation award is attained, even if the payment or grant of the incentive-based compensation occurs after the end of that period. For awards with time- and performance-based vesting, the award is received when the performance measure is attained, even if still subject to time-based vesting.

In a modification from the proposed rules, the final rules provide that only incentive compensation received by current or former executive officers on or after the effective date of the applicable stock exchange rules is required to be covered by the clawback policy.

Specific examples of “incentive-based compensation” include:

  • Non-equity incentive plan awards that are earned based 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;
  • Other cash awards based on satisfaction of a financial reporting measure performance goal;
  • Restricted stock, restricted stock units, performance share units, stock options, and stock appreciation rights 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.

Examples of compensation that is not “incentive-based compensation” for this purpose include:

  • Salaries;
  • Bonuses paid solely at the discretion of the compensation committee or board that are not paid from a “bonus pool” that is determined by satisfying a financial reporting measure performance goal;
  • Bonuses paid solely upon satisfying one or more subjective standards (e.g., demonstrated leadership) and/or completion of a specified employment period;
  • Non-equity incentive plan awards earned solely upon satisfying one or more strategic measures (e.g., consummating a merger or divestiture), or operational measures (e.g., opening a specified number of stores, completion of a project, increase in market share); and
  • Equity awards for which the grant is not contingent upon achieving any financial reporting measure performance goal and vesting is contingent solely upon completion of a specified employment period and/or attaining one or more nonfinancial reporting measures.
Amount of Compensation Subject to Clawback – Erroneously Awarded Compensation

The amount of incentive compensation received that exceeds the amount that otherwise would have been received had it been determined based on the restated amounts (this amount is the “erroneously awarded compensation”) is subject to clawback under the final rules. This excess amount must be determined on a pre-tax basis, such that the burden of recovering any already-paid taxes on clawed back compensation is on the executive.

For incentive-based compensation based on stock price or total shareholder return, where the amount of erroneously awarded compensation is not subject to recalculation directly from the restated results, the amount of erroneously awarded compensation must be based on a reasonable estimate of the effect of the restatement on the stock price or total shareholder return upon which the compensation was received. The SEC notes in the rule release that “[t]o reasonably estimate the effect on the stock price, there are a number of possible methods with different levels of complexity of the estimations and related costs, and under the final rules, issuers will have flexibility to determine the method that is most appropriate based on their facts and circumstances.”

Look-Back Period

The recovery or “look-back” period is comprised of the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement (as described below). The look-back is not tied to if or when restated financial statements are filed.

An issuer is deemed to be required to prepare an accounting restatement on the earlier of: (i) the date the issuer’s board of directors, a committee of the board of directors, or the officer or officers of the issuer authorized to take such action (if board action is not required), concludes, or reasonably should have concluded, that the issuer is required to prepare an accounting restatement; or (ii) the date a court, regulator, or other legally authorized body directs the issuer to prepare an accounting restatement.

Restatement Trigger

Per the final rules, a clawback of erroneously awarded compensation is required in the event that “the issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws, including any required accounting restatement to correct an error in previously issued financial statements that is material to the previously issued financial statements, or that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period.” Clawback is not triggered by an “out-of-period adjustment” where the error is immaterial to the previously issued financial statements and the correction of the error is also immaterial to the current period. The terms “accounting restatement” and “material noncompliance” will be as defined in existing accounting standards and guidance.

This is one of the areas where the final rules differ from the originally proposed rules. While the proposed rules focused on restatements for errors that are material to the previously issued financial statements (“Big R” restatements), after further consideration and input from commenters, the final rules also cover “little r” restatements, (i.e., restatements in which a determination is made as to whether the error is not material to previously-issued financial statements and may be corrected in the current period by correcting the prior period information in the comparative financial statements).

Clawback is Non-Discretionary and Subject to Limited Exceptions

Companies do not have discretion about whether to clawback compensation upon a triggering event.  There are very limited exceptions to this where the following conditions have been met and the issuer has determined that recovery would be impracticable: (i) the direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered and the company has made a reasonable attempt to recover; (ii) recovery would violate home county law where that law was adopted prior to the publication date; or (iii) recovery would likely cause an otherwise tax-qualified plan, under which benefits are broadly available to employees, to fail to meet the applicable requirements of the tax code.

That said, companies do have discretion in the means of recovery. The final release provides that the appropriate means of recovery “may vary by issuer and by type of compensation arrangement” and that, accordingly, “the final amendments permit issuers to exercise discretion in how to accomplish recovery,” provided that “issuers should recover erroneously awarded compensation reasonably promptly, because delays in recovering excess payments allow executive officers to capture the time value of money with respect to funds they did not earn, which should instead belong to shareholders.”

No Indemnification

Issuers are prohibited from indemnifying any executive officer or former executive officer against the loss of erroneously awarded compensation.

Disclosure Requirements

The rules contain additional rules related to the disclosure of and about clawback policies.  As applicable, U.S. issuers must:

  • File the Dodd-Frank clawback policy as an exhibit to Form 10-K
  • Reflect on the cover page of Form 10-K whether financial statements included in the filing reflect correction of an error to previously issued financial statements, and whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the issuer’s executive officers during the relevant recovery period
  • Reflect a reduction in amounts reported in the Summary Compensation Table for amounts recovered pursuant to a Dodd-Frank clawback policy, with accompanying footnote disclosure
  • Provide detailed proxy disclosure regarding an action to recover compensation pursuant to a Dodd-Frank clawback policy

The rules become effective 60 days following the publication date. The stock exchanges must adopt listing standards within 90 days after the publication date and the standards must become effective within one year of the publication date. Issuers subject to such listing standards must, in turn, adopt a compliant policy no later than 60 days following the effective date of the applicable stock exchange rules. Affected issuers must also begin to comply with the disclosure requirements in the first annual report or proxy or information statement filed on or after the effective date of the new listing standards.

Next Steps

Action is not required until the stock exchanges adopt the rules. While awaiting adoption, issuers can review their existing clawback arrangements and prepare to update them in accordance with the final rules. In addition, issuers may want to review and amend any incentive arrangements as necessary to incorporate reference to the clawback policy. 

Dina Bernstein

Dina Bernstein has extensive experience advising on all aspects of executive compensation, working with companies on an ongoing basis, as well as in the context of mergers and acquisitions, spin-offs, initial public offerings, and other corporate events. Dina provides guidance to private and public companies across various industries regarding cash and equity incentive compensation arrangements, employment, severance and change in control agreements, overall compensation program design, pay governance practices, taxation, stock exchange listing requirements and securities regulation compliance.

Samantha Nussbaum

 Samantha Nussbaum has consulted on behalf of public and private companies, compensation committees, and senior management on all aspects of executive compensation. Samantha’s consulting and legal background includes advising on executive compensation in the context of mergers and acquisitions, spin-offs, and initial public offerings; executive employment, severance, and change in control agreements; equity incentive plans; deferred compensation; and securities laws, including reporting and disclosure implications.