How The SEC's New Clawback Rules Could Operate In Practice: A Hypothetical

• Published date: 18 January 2024
• Subject Matter: Corporate/Commercial Law, Securities
• Law Firm: Barnes & Thornburg
• Author: Jay H. Knight and Brittany McCants

On December 1, 2023, the clawback policy listing standards established by NASDAQ and NYSE went into effect. Specifically, these listing standards require issuers to implement policies that require the issuer to recover erroneously awarded compensation received by current and former executive officers during the three-year period preceding the date the issuer is required to prepare an accounting restatement. Implementation and continued compliance with the policies established by these listing standards present complexities in assessing whether the policy has been triggered and, once triggered, who has to remit what forms of 'incentive-based compensation' and how much of such compensation needs to be recovered.

We have prepared the hypothetical below and a Q&A to help illustrate how a compliant clawback policy might operate, as a hypothetical sometimes helps to focus the lens on the complex issues that arise.

Hypothetical: John Smith is the chief executive officer (CEO) of Company X, whose equity securities are listed on NASDAQ, and he's held this role since Jan. 1, 2010. In February 2021, the Board of Company X approved a compensation package for the CEO that included a performance-based equity incentive award for the Jan. 1, 2021, through Dec. 31, 2023 performance period. The target performance-based equity incentive award was based on 150 percent of base salary, which equaled 11,000 shares for the CEO. The payout opportunity equaled 0 percent (minimum), 100 percent (target), and 200 percent (maximum), with the growth in earnings per share (EPS) compared to the growth in peer companies' EPS during the same period. Each named executive officer (NEO), including the CEO, was entitled to earn the performance shares at the end of the performance period depending on attainment level satisfied in respect of such EPS performance targets.

The Compensation Committee met in February 2024 to review the extent to which the CEO earned the 2021 equity incentive award. During the 2021-2023 performance period, the Compensation Committee analyzed the GAAP EPS growth over the performance period and using previously established payout matrix determined that the CEO was entitled to a payout of 200 percent of the target award. As a result, the CEO was awarded 22,000 shares in February 2024.

The 10-K was filed in late February 2024. In April 2024, the accounting team, working with its external auditor, discovered an accounting issue. After an investigation into the issue, the...