Businessman calculating effect of financial restatement on compensation

SEC Adopts Final Dodd-Frank Clawback Rules

November 02, 2022

The SEC has adopted final rules requiring companies to implement policies to recover compensation awarded to executive officers that later turns out to be erroneous as a result of a material financial restatement. Here’s what you need to know.

On October 26 of this year, as required under the Dodd-Frank Act, the SEC adopted final rules on the recoupment of incentive-based compensation erroneously paid to executive officers. The rules direct US securities exchanges (e.g., the NYSE and Nasdaq) to adopt standards requiring listed companies to implement policies under which incentive-based compensation paid to executive officers will be clawed back if based on financial measures that have been materially restated.

Background of the Proposed Rules on Compensation Recovery

The Dodd-Frank Act was enacted in 2010 and the SEC proposed rules to implement this requirement in 2015, but the rules were never finalized. This is probably in part because the proposal was fairly controversial and also because when the prior presidential administration took office in 2017, the SEC’s priorities shifted.

Now, with a Democratic administration in place again, there has been yet another shift in the SEC’s priorities and many of the remaining outstanding Dodd-Frank rulemaking projects are now being completed (the pay vs. performance disclosure requirement is another example). The SEC reopened the comment period on the proposed clawback rules in October of 2021 but the final rules were adopted with only minimal changes.

The intent behind this requirement seems logical. Say that a company makes a payment to an officer based on the company having achieved a specified financial result. Then, after making the payment, the company discovers an error that causes it to restate its financials and, under the restated financials, the officer would not have earned the previously paid compensation. This section of Dodd-Frank is intended to ensure that the officer has to return the compensation that wasn’t earned. In theory, this seems reasonable. If the officer didn’t earn the compensation, should they be able to keep it?

But, in practice, recovering compensation in this circumstance is challenging, for a host of reasons. The requirements here are also much broader than the current clawback rules that are in effect under the Sarbanes-Oxley Act (which require misconduct and apply only to the CEO and CFO).

This blog provides a summary of what is required under the final rules.

Which Companies Are Subject to the New Clawback Rules?

For reasons that I don’t fully understand, the SEC apparently can’t just make a rule that all public companies have to implement a clawback policy. So instead, Dodd-Frank directs the SEC to mandate that US securities exchanges include a clawback policy requirement in their listing standards. The result is that this will apply to all listed companies.

Commenters suggested excluding emerging growth companies, smaller reporting companies, and foreign private issuers but the SEC chose not to do so; thus, newly public companies will need to have a clawback policy in place. According to a report from Audit Analytics, restatements increased by 289% in 2021, largely driven by SPACs. Imagine if all those restatements had triggered clawbacks of executive compensation.

Which Officers Are Subject to the Rules?

Clawback policies will be required to apply to all current executive officers (generally the same officers who are subject to Section 16) and former executive officers.

What Compensation Is Subject to Recoupment?

Only incentive compensation that is granted, earned, or vested contingent upon financial measures will be required to be subject to recovery. The final rules, however, interpret this to include both GAAP and non-GAAP measures, and total shareholder return or stock price targets.

Some commenters argued that stock price targets and TSR should not be considered financial measures but failing to include them would have given companies a loophole to avoid complying with the requirement. The SEC notes in the adopting release that:

Stock price and TSR are frequently used incentive-based performance metrics for executive compensation, such that excluding them could lead issuers to alter their executive compensation arrangements in ways that would avoid application of the mandatory recovery policy, undermining the objectives of the rule, as well as impacting efficient incentive alignment.

When Is Recovery of Compensation Required?

Companies will have to implement policies to recover incentive-based compensation when required to issue a restatement as a result of material noncompliance with financial reporting standards, regardless of whether intent, fraud, or misconduct is involved.

There is a lot of discussion in the final rules about “big R” and “little r” restatements. In a big R restatement, the company must issue a Form 8-K and amend its public filings to correct the error. In a little r restatement, there’s no 8-K and the correction is made simply by correcting the prior period results included in the current financial statements. The important thing to know is that, if material, both types of restatements can trigger the recovery requirement. This is a broader interpretation of which restatements can trigger recovery than the SEC initially proposed.

It's also worth emphasizing that recovery is required regardless of intent or the involvement of fraud or misconduct. Thus, companies could be required to claw back compensation even if the restatement is the result of an honest mistake or misunderstanding, or where the executive officer had no control over the reported financials.

How Much Compensation Must Be Recovered?

The amount of compensation that must be recovered is the excess of the amount granted or paid over what the officer is entitled to, based on the restated financials.  In the context of equity awards, you would compare the number of shares or units that were granted or vested to the number that should have been granted or vested based on the restated financials. The difference between these two amounts is subject to recovery.

This is tricky to determine for awards in which vesting is contingent on TSR or stock price targets. In that case, the company will have to estimate the impact of the error on its stock price and calculate the portion of the award that would have vested based on the estimated stock price. Between this requirement and the pay vs. performance disclosures, valuation consultants should have no shortage of work.

What Is the Recovery Period?

Recovery policies should cover incentive compensation received during the three fiscal years preceding the date that the company first becomes aware that the restatement is necessary, reasonably should have been aware that the restatement would be necessary, or is directed to restate its financials by a court or regulatory agency.

An important nuance here is that compensation is considered to be “received” during the fiscal period that the financial measure is achieved, regardless of when it is actually granted or paid. In the context of stock compensation, this means the following:

  • If the grant of an award is based on satisfaction of a financial reporting measure, the award is deemed received in the fiscal period when that measure was satisfied even if not granted until a subsequent period
  • If an equity award vests only upon satisfaction of a financial reporting measure, the award is deemed received in the fiscal period when it vests. Conversely, if an award is subject to both time-based and performance-based goals, the award is considered received in the period that the performance-based goals are achieved, even if the award continues to be subject to additional time-based vesting requirements.

The adopting release also notes that “Ministerial acts or other conditions necessary to effect issuance or payment, such as calculating the amount earned or obtaining the board of directors’ approval of payment, do not affect the determination of the date received.”

Are There Any Exceptions?

Probably the most helpful exception to the compensation recovery requirement is that companies are not required to pursue recovery if the expenses they would have to pay to a third party (e.g., outside counsel) to do so would exceed the amount of recoverable compensation. The company would still need to make a reasonable attempt to recover the compensation and provide documentation of that attempt to the exchange.

Disclosures of Compensation Recovery

In addition to requiring companies to implement a clawback policy, the rules require a number of disclosures related to that policy.

10-K Checkboxes: Two checkboxes will be added to the cover of Form 10-K to indicate the following:

  • Whether the included financial statements reflect correction of an error to previously issued financial statements.
  • Whether those restatements trigger recovery analysis of incentive-based compensation received by the company’s executive officers.

10-K Exhibit: The recovery policy itself will be filed with the SEC as an exhibit to Form 10-K.

Reg S-K Item 402(w): Under new item 402(w), companies will be required to disclose whether a restatement that triggered recovery of compensation has occurred in the past year or there is an outstanding balance of unrecovered compensation as of the end of the last fiscal year. For each such restatement, the company must disclose the following:

  • The date on which the company was required to prepare a restatement and the aggregate amount of compensation recoverable as a result of the restatement.


  • The aggregate amount of erroneously awarded compensation that remains unrecovered as of the end of the last fiscal year.
  • If the recovery relates to TSR or stock price targets, the method used to estimate the impact of the restatement on the company’s stock price.
  • The names of and amounts recoverable from current and former officers for whom recoverable compensation remains outstanding for more than 180 days.
  • For each named executive officer for whom the company decides not to pursue recovery of compensation, the company would have to disclose the name of the person, the amount recoverable, and a brief description of the reason the company decided not to pursue recovery. For other officers (and former officers), this disclosure shall be made in aggregate without identifying the specific officers.

Summary Comp Table: Where amounts reported in the SCT have been recovered, the reported amounts should be reduced for the recovery and the amounts recovered should be indicated in a footnote.

When Do We Have to Comply with These Rules?

We still have a little ways to go on this. First, the final rule must be published in the Federal Register. As of today, that hasn’t happened yet.

The exchanges are required to propose the listing standards necessary to comply with the SEC’s rules within 90 days of when the rules are published in the Federal Register and the proposed standards must be effective no later than one year after this same publication date.

Once the listing standards are finalized and go into effect, the exchanges can give listed companies up to 60 days to comply. The upshot here is that if the SEC’s final rules are published in the Federal Register in November of this year, companies will likely have to comply with them by some time In January 2024. 

More Information

Lawyers at Jones Day came up with 26 things to understand about the final rules and has published an A-to-Z guide to them that I found helpful in writing this blog entry. This memo by Orrick includes a sample of what a clawback policy might look like.

  • Barbara Baksa
    By Barbara Baksa

    Executive Director