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Freshfields Transactions

| 6 minutes read

US SEC adopts rules requiring mandatory recovery of excess executive incentive pay including for non-US companies listed in the US

Executive Summary

The SEC has adopted new rules on claw back of incentive pay for US listed companies following a restatement of results due to the company’s material noncompliance with any financial reporting requirements under US securities laws. Unlike most SEC governance and US stock exchange requirements, these rules also apply to UK and other non-US companies (foreign private issuers) that are listed on a US exchange. Full compliance is expected to be required by end of 2023 or early 2024 at the latest. Failure to comply could result in the company being delisted.  This means that companies will need to review their existing annual bonus and long-term incentive arrangements and take steps to ensure compliance with the new standards.

For UK companies in particular, the new rules differ in several areas from the requirements of the UK Corporate Governance Code that UK companies are familiar with (although the UK claw back provisions are also under review). Further detail is outlined below but the key points are:

  • Claw back is mandatory – although the triggers for claw back are more limited under the SEC’s rules than under the UK Corporate Governance Code, once triggered, companies have very limited discretion over whether to claw amounts back or how much to claw back.
  • Scope of covered restatements is broader in the new rules than in the original proposal and now covers all restatements including so-called little “r” restatements, and not just those that correct an error in prior period financial statements that is material to those financial statements.
  • The rules apply to a company’s ‘current and former executive officers who received erroneously awarded incentive-based compensation’ during the three-year look-back period – which will require UK companies that have not had to identify their executive officers for US law purposes previously to do so (which may or may not overlap with the existing PDMR population). The rules apply regardless of any actual misconduct.
  • Claw back must be on a pre-tax basis, meaning executives would be required to return amounts greater than the after-tax amounts actually received.
  • Individual disclosure for named executives is required where there is a restatement but amounts are not clawed back because it is ‘impracticable’ to do so.

In more detail

The US Securities and Exchange Commission (SEC) has adopted rules on mandatory recovery of executive pay that apply to non-US companies listed on Nasdaq or the New York Stock Exchange (NYSE) as well as US companies. The new rules also apply to companies with any security listed on a US exchange so companies, whether US or non-US, that have listed only debt or preferred securities on a US exchange are caught.

The rules instruct the NYSE and Nasdaq to adopt listing standards that require their listed companies to develop and implement a policy requiring recovery of excess incentive-based executive compensation paid because of a material error resulting in a restatement of their financial statements. Failure to comply with the new standards could result in delisting. The standards must also require each listed company to disclose any actions it takes under its recovery policy and to file the policy as an exhibit to its annual report (20-F or 10-K as applicable).

Key features:

  • Limited discretion is left to the company over whether to seek recovery – there need be no fault by the executive and recovery is required unless impracticable either in economic terms or because it would violate home country law (for non-US companies). The exceptions are narrow. The company must make reasonable efforts to seek recovery, document those efforts and only conclude recovery is economically impracticable where the cost would exceed the amount to be recovered. Non-US companies are required to submit an opinion of home country counsel acceptable to its US exchange that recovery would violate home country law. Home country means the home country of the company rather than of the executive which may cause difficulties where executives are based outside the home country and in a jurisdiction where such recovery may be illegal. Even in the UK, this is likely to cause some complications as claw back can generally only be enforced where an executive has agreed in writing to the claw back power.
  • Scope of covered restatements is broader in the new rules than in the original proposal and now covers all restatements, including so-called “little r” restatements or revision restatements (restatements that correct errors that are not material to previously issued financial statements, but would lead to a material misstatement if either the errors were left uncorrected in the current report, or the error correction was recognized in the current period). The original proposal covered only so-called “Big R” or re-issuance restatements which correct an error in prior period financial statements that is material to those financial statements.
  • Broad group of covered executives – current or former ‘executive officers’ are subject to the rules and the term is broadly defined to include the CEO, CFO, chief accounting officer or controller, any vice-president responsible for a principal business function (such as sales, administration or finance) and any other officer or person who performs important policy-making functions for the company. Executive officers of a parent company or subsidiary can be deemed executive officers of the listed company if they perform such policy-making functions for that company.
  • Three-year look-back period – broadly, the recovery policy applies to any incentive-based pay received during the three completed fiscal years preceding the decision to restate previously issued financial statements to correct a material error. This captures any such pay governed by arrangements that were put in place prior to the effectiveness of the listing standards. However, companies are only required to apply the claw back policy to incentive -based compensation received after the effective date of the applicable listing standard.
  • Disclosure in the annual report – generally, the required disclosure of actions the company takes under the policy is to be made on an aggregated basis except where recovery is impracticable when any named executive concerned (current and former), the amount forgone and the reason must be disclosed, or where erroneously paid incentive pay remains outstanding for 180 days or more when any named executive (current and former) and the amount owed must be disclosed.
  • Share price and total shareholder return are included in the financial measures that can be used to determine whether the incentive-based compensation is paid so companies will need to estimate the effect of the restatement on these measures in calculating amounts to be recovered. They will also need to disclose in the annual report the estimates used and their methodology.
  • Tax already paid on excess compensation is not taken into account when calculating the amount to be recovered. This will have a particularly penal impact on executives who are subject to a tax regime where claiming tax back on clawed back remuneration is difficult.
  • No indemnification – the rules prohibit companies from indemnifying executives against the loss of clawed-back amounts and from paying premiums on an insurance policy that would protect against such loss.
  • Timetable – The exchanges have up to 26 February 2023 to file their proposed listing standards with the SEC for approval and the listing standards must be effective no later than 27 November 2023.  Listed companies will then have 60 days from effectiveness of the listing standards to comply with the new standards. This means full compliance will be required by end of 2023 or early 2024 at the latest.

Implications for non-US companies:

  • The rules represent a hardening of the approach in the UK because the claw back will be mandatory rather than simply a power of the Remuneration Committee (which is more typical);
  • Review any existing claw back policy, and consider amending it, to ensure that the company will be able to meet the new listing standards within the 60-day compliance period once it goes into effect;
  • Review the existing approved directors’ remuneration policy and incentive plan rules to consider whether any changes need to be made, noting that the requirements will also apply to awards granted prior to the date of the updated listing standards. This could be particularly pressing if the policy is up for renewal in the 2023 AGM season or new incentive plans are being put up for shareholder approval;
  • Check historic and future grant documentation, or employment contracts, to see whether executives agree to claw back terms (as this is an important aspect of making sure that claw back is enforceable in the UK);
  • Consider identifying executive officers for purposes of the recovery policy and how best to implement the policy in the company’s particular context; this will be particularly important where executives are working outside the US and the UK because of the way in which the illegality rules work.

We would be happy to discuss with you the implications of the new rules as well as plans for compliance. Please reach out to your usual Freshfields contact.

Here is a link to the 230-page SEC Release adopting the new rules.

If you would like a more detailed summary of the new rules, please see our full alert. 


corporate governance, financing and capital markets, employment, ecm, dcm