In late February, the NYSE and Nasdaq proposed new listing standards that would require listed companies to adopt and comply with a policy for the recovery of erroneously awarded incentive-based compensation received by covered executive officers (the “Clawback Policy”). The Clawback Policy must require that any incentive compensation (including both cash and equity compensation) paid to any current or former “executive officer” is subject to recoupment if (i) the incentive compensation was calculated based on financial statements that were required to be restated^[1] due to material noncompliance with financial reporting requirements, without regard to any fault or misconduct and (ii) that noncompliance resulted in overpayment of the incentive compensation within the three fiscal years preceding the date the restatement was required.

These proposed new listing standards related to clawbacks were mandated by Rule 10D-1 adopted by the SEC in October 2022 and are awaiting SEC approval (for more information on the SEC’s final rules, see our prior alert here). On April 24, 2023, the SEC extended its deadline to take action on the proposed new listing standards and now has until June 11, 2023 to either to approve, disapprove or institute proceedings to determine whether to approve or disapprove the proposed rules.

In accordance with Rule 10D-1, the listing standards will require listed companies to:

• Adopt a compliant Clawback Policy by the 60^th day after the listing standards are approved by the SEC (the “Effective Date”);
• Comply with the Clawback Policy for all incentive-based compensation “received” after the Effective Date; and
• Disclose in its SEC filings any actions taken or not taken with respect to a triggering restatement under its Clawback Policy on and after the Effective Date and file a copy of the Clawback Policy with its Form 10-K.

Scope of Clawback Policy

The Clawback Policy will require covered “executive officers” to reimburse the listed company for any overpayment of incentive compensation received during the covered period, which is calculated as the excess paid over the amount that would have been paid based on restated financial information. Importantly, the Clawback Policy will apply regardless of the executive officer’s misconduct or fault. In addition, recovery of incentive compensation will only be required if the compensation is received by the executive officer after his or her appointment as an executive officer and if he or she served as an executive officer at any time during the recovery period.

The purpose of this article is to identify the “executive officers” of listed companies who will be subject to a Clawback Policy.

Who is a Covered “Executive Officer”?

The SEC has based the definition of “executive officer” in Rule 10D-1 on the definition of “officer” in Section 16a-1(f) under the Securities Exchange Act of 1934 (the “Exchange Act”), which are the officers required to file beneficial ownership reports on Forms 3, 4 and 5 with the SEC under Section 16 of the Exchange Act (“Section 16”).^[2] The Rule 10D-1 definition includes an issuer’s:

• president;
• principal financial officer;
• principal accounting officer (or if there is no such accounting officer, the controller);
• any vice president 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.

Little, if any, analysis is required to identify as covered executive officers the individuals with titles listed above. In identifying Section 16 reporting officers, listed companies have been challenged with the factual determination of who performs a “policy-making function.” In addition, officers of a listed company’s parent and/or subsidiaries may also be executive officers if they perform policy-making functions for the company.

Each listed company should examine its particular facts and circumstances to determine who within the organization should be deemed a covered “executive officer” under Rule 10D-1 (and thus Section 16). The SEC Staff believes that this decision should be determined by the company’s Board of Directors with input from management and legal counsel. While the SEC Staff will not advise companies on this matter, it will generally neither object to nor concur with decisions made by a Board of Directors in good faith and on a reasonable basis.

In our experience, some financial institutions may have broadened the category of executive officer, particularly as it relates to Section 16 reporting officers, beyond what is required. This expansive application could have resulted from a number of factors, particularly corporate organizational structures that classify persons whose responsibilities include the policy-making functions noted in the definitions at the same level as other officers who may not have those same responsibilities. The fact that certain officers have the same or similar corporate titles and/or appear at the same position in an organizational chart does not mean that they have identical status with the SEC. An overly-broad designation of SEC reporting officers may create unnecessary and burdensome Section 16 reporting obligations and liability concerns for the individuals and now may unnecessarily make those individuals subject to the company’s soon-to-be-adopted Clawback Policy.^[3]

Listed companies should annually reexamine their designation of executive officers under the SEC’s rules to confirm that it remains up-to-date and appropriately reflects the officers’ roles and responsibilities, especially if new officers may have been hired or a reorganization has been effected. In addition, boards of directors of listed companies should annually adopt resolutions designating those executive officers in the organization who are considered Section 16 reporting officers, and thus also covered executive officers under Rule 10D-1, for the avoidance of doubt as to which officers are subject to the Clawback Policy.

[1] The Clawback Policy must apply to both “Big R” restatements, which restate historical financial statements to correct errors that were material to those previously issued financial statements, and “little r” restatements, which restate prior period information in the current period comparative financial statements.

[2] Rule 3b-7 under the Exchange Act also contains a similar definition of “executive officers,” but does not expressly include the principal accounting officer or the principal financial officer. In most cases, a listed company’s Section 16 officers will be the same as the listed company’s executive officers as identified in its Form 10-K and other SEC filings pursuant to Item 401(b) of Regulation S-K, with the possible addition of the principal accounting officer or controller.

[3] Note that too narrow an application of these definitions will also raise concerns and could expose the company and the effected officers to SEC enforcement actions under Section 16 and also result in potential noncompliance with the listing standards.