Listing Standards for Recovery of Erroneously Awarded Compensation

Federal RegisterNov 28, 2022

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229, 232, 240, 249, 270, and 274

[Release Nos. 33-11126; 34-96159; IC-34732; File No. S7-12-15]

RIN 3235-AK99

Listing Standards for Recovery of Erroneously Awarded Compensation

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

We are adopting a new rule and rule amendments to implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), which added Section 10D to the Securities Exchange Act of 1934 (“Exchange Act”). In accordance with Section 10D of the Exchange Act, the final rules direct the national securities exchanges and associations that list securities to establish listing standards that require each issuer to develop and implement a policy providing for the recovery, in the event of a required accounting restatement, of incentive-based compensation received by current or former executive officers where that compensation is based on the erroneously reported financial information. The listing standards must also require the disclosure of the policy. Additionally, the final rules require a listed issuer to file the policy as an exhibit to its annual report and to include other disclosures in the event a recovery analysis is triggered under the policy.

DATES:

The amendments are effective January 27, 2023.

FOR FURTHER INFORMATION CONTACT:

Steven G. Hearne, Senior Special Counsel, at (202) 551-3430, in the Office of Rulemaking, Division of Corporation Finance, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

We are adopting amendments to:

Commission reference

CFR citation (17 CFR)

Regulation S-K

Item 10 through 1406

§§ 229.10 through 229.1406.

Item 402

§ 229.402.

Item 404

§ 229.404.

Item 601

§ 229.601.

Rule 10 through 903

§§ 232.10 through 232.903.

Rule 405

§ 232.405.

Exchange Act

Rule 10D-1

§ 240.10D-1.

Schedule 14A

§ 240.14a-101.

Form 20-F

§ 249.220f.

Form 40-F

§ 249.240f.

Form 10-K

§ 249.310.

Exchange Act and Investment Company Act of 1940 (“Investment Company Act”)

Form N-CSR

§§ 249.331 and 274.128.

Investment Company Act

Rule 30a-2

§ 270.30a-2.

Table of Contents

15 U.S.C. 78a

et seq.

15 U.S.C. 80a-1

et seq.

I. Introduction and Background

II. Discussion of Final Amendments

A. Issuers and Securities Subject To Exchange Act Rule 10D-1

1. Proposed Amendments

2. Comments

3. Final Amendments

B. Restatements

1. Restatements Triggering Application of Recovery Policy

a. Proposed Amendments

b. Comments

c. Final Amendments

2. Date the Issuer Is Required To Prepare an Accounting Restatement

a. Proposed Amendments

b. Comments

c. Final Amendments

C. Application of Recovery Policy

1. Executive Officers Subject to Recovery Policy

a. Proposed Amendments

b. Comments

c. Final Amendments

2. Incentive-Based Compensation

a. Incentive-Based Compensation Subject to Recovery Policy

i. Proposed Amendments

ii. Comments

iii. Final Amendments

b. When Compensation Is “Received” and Time Period Covered

i. Proposed Amendments

ii. Comments

iii. Final Amendments

3. Recovery Process

a. Calculation of Erroneously Awarded Compensation

i. Proposed Amendments

ii. Comments

iii. Final Amendments

b. Board Discretion Regarding Whether To Seek Recovery

i. Proposed Amendments

ii. Comments

iii. Final Amendments

c. Board Discretion Regarding the Means of Recovery

i. Proposed Amendments

ii. Comments

iii. Final Amendments

D. Disclosure of Issuer Policy on Incentive-Based Compensation

1. Proposed Amendments

2. Comments

3. Final Amendments

E. Indemnification and Insurance

1. Proposed Amendments

2. Comments

3. Final Amendments

F. Transition and Timing

1. Proposed Amendments

2. Comments

3. Final Amendments

III. Other Matters

IV. Economic Analysis

A. Baseline

B. Analysis of Potential Economic Effects

1. Direct Effects on Issuers and Shareholders

2. Effects on U.S. Exchanges and Listings

3. Costs of Recovery

4. Effects on Financial Reporting

5. Effects on Executive Compensation

6. Effects of Disclosure and Tagging Requirements

7. Indemnification and Insurance

8. Effects May Vary for Different Types of Issuers

C. Alternatives

1. Exemptions for Certain Categories of Issuers

2. Excluding Incentive-Based Compensation Tied to Stock Price

3. Including Only “Big R” Restatements as Trigger Events

4. Other Alternatives Considered

V. Paperwork Reduction Act

A. Summary of the Collection of Information

B. Summary of the Final Amendments and Effect of the Final Amendments on Existing Collections of Information

C. Burden and Cost Estimates Related to the Final Amendments

VI. Final Regulatory Flexibility Act Analysis

A. Need for, and Objectives of, the Final Amendments

B. Significant Issues Raised by Public Comments

C. Small Entities Subject to the Final Amendments

D. Projected Reporting, Recordkeeping, and Other Compliance Requirements

Statutory Authority

I. Introduction and Background

Section 954 of the Dodd-Frank Act added 15 U.S.C. 78j-4 (“Section 10D”) to the Exchange Act. Title 15 Section 78j-4 (a) of the U.S. Code (“Section 10D(a)”) requires the Securities and Exchange Commission (the “Commission”) to adopt rules directing the national securities exchanges

(“exchanges”) and the national securities associations

(“associations”) to prohibit the listing of any security of an issuer that is not in compliance with the requirements of 15 U.S.C. 78j-4(b) (“Section 10D(b)”). Section 10D(b) of the Exchange Act requires the Commission to adopt rules directing the exchanges to establish listing standards that require each issuer to develop and implement a policy providing:

A “national securities exchange” is an exchange registered as such under 15 U.S.C. 78f (“Section 6 of the Exchange Act”). Certain exchanges are registered with the Commission through a notice filing under Section 6(g) of the Exchange Act for the purpose of trading security futures. As discussed in Section II.A.2, because the final rules exempt security futures products and standardized options from their scope, any registered national securities exchange that lists and trades only security futures

products or standardized options is not required to file a rule change in order to comply.

A “national securities association” is an association of brokers and dealers registered as such under 15 U.S.C. 78o-3 (“Section 15A of the Exchange Act”). The Financial Industry Regulatory Authority (“FINRA”) is the only association registered with the Commission under Section 15A(a) of the Exchange Act. Because FINRA does not list securities, generally we refer only to exchanges in this release. However, if any associations were to list securities, the rules would apply to them.

• For the disclosure of the issuer's policy on incentive-based compensation that is based on financial information required to be reported under the securities laws; and

• That, in the event that the issuer is required to prepare an accounting restatement due to the issuer's material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover from any of the issuer's current or former executive officers incentive-based compensation (including stock options awarded as compensation) that was received during the three-year period preceding the date the issuer is required to prepare the accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

In seeking to implement this statutory mandate, we have been guided by the language, structure, and legislative history of Section 10D. As a part of the Dodd-Frank Act legislative process, in a 2010 report, the Senate Committee on Banking, Housing and Urban Affairs stated that “Section 954 [Section 10D] requires public companies to have a policy to recover money that they erroneously paid in incentive compensation to executive officers as a result of material noncompliance with accounting rules.”

The Senate Report further clarified that application of the recovery policy mandated by Section 10D “does not require adjudication of misconduct in connection with the problematic accounting that required restatement.”

See

Report of the Senate Committee on Banking, Housing, and Urban Affairs, S.3217, Report No. 111-176 at 135-36 (Apr. 30, 2010) (“Senate Report”) at 135.

Id.

The Senate Report highlighted the Committee's belief that it is “unfair to shareholders for corporations to allow executive officers to retain compensation that they were awarded erroneously.”

The language and legislative history of the Dodd-Frank Act make clear that Section 10D is premised on the notion that an executive officer should not retain incentive-based compensation that, had the issuer's accounting been correct in the first instance, would not have been received by the executive officer, regardless of any fault of the executive officer for the accounting errors. The Senate Report also indicates that shareholders should not “have to embark on costly legal expenses to recoup their losses” and that “executives must return monies that should belong to the shareholders.”

Id.

Informed by this legislative history, we read Section 10D to express a simple proposition: executive officers of exchange-listed issuers should not be entitled to retain incentive-based compensation that was erroneously awarded on the basis of materially misreported financial information that requires an accounting restatement. The statute thus mandates that exchange-listed issuers maintain policies to recover such compensation for the benefit of the issuers' owners—their shareholders. In light of the straightforward nature of the goal Congress sought to achieve, we have approached implementation of the statute with the view that discretion to implement and execute these mandated recovery policies generally should be limited.

For similar reasons, we believe Section 10D's mandated recovery policies were intended to apply broadly. Because Congress specifically referenced “incentive-based compensation (including stock options awarded as compensation),” we infer that it intended the provision to cover any incentive-based compensation that may be impacted by financial reporting. Further, Congress did not define “executive officers” narrowly by limiting the term to include only the named executive officers or another subset of executives; rather it appears that Congress intended the scope of the statute to reach more broadly to include all of an issuer's executive officers.

While this scope may result in recovery from officers who did not play a direct role in an accounting error or who did not help to set a “tone at the top” that affects financial reporting accuracy, we understand that effect to be consistent with the statutory purpose of recovering compensation erroneously paid to executive officers regardless of whether the executive officer directly contributed to the error.

While Section 10D applies broadly to all executive officers and Congress did not specify a subset of executive officers, the Senate Report makes clear it is not intended to apply to rank-and-file employees.

See

Senate Report at 136 (“This policy is required to apply to executive officers, a very limited number of employees, and is not required to apply to other employees”).

In addition to the benefits and purposes that Congress identified when enacting Section 10D, our implementation of the statute has been informed by certain additional benefits of the recovery requirement. As discussed in Section IV.B., the recovery requirement may provide executive officers with an increased incentive to take steps to reduce the likelihood of inadvertent misreporting and will reduce the financial benefits to executive officers who choose to pursue impermissible accounting methods, which we expect will further discourage such behavior. These increased incentives may improve the overall quality and reliability of financial reporting, which further benefits investors. These additional benefits further support our view that the most appropriate means of implementing the Section 10D mandate is to require robust recovery policies that will help to ensure that executive officers at exchange-listed issuers do not retain the benefits of erroneously awarded incentive-based compensation.

On July 1, 2015, the Commission proposed a new rule, and rule and form amendments

to implement the provisions of Section 10D.

On October 14, 2021, the Commission reopened the comment period for the Proposing Release to allow interested persons further opportunity to analyze and comment upon the proposed rules in light of developments since the publication of the Proposing Release and the Commission's further consideration of the statutory mandate.

In the Reopening Release, the Commission stated that it was considering, and requested public comment on, certain revisions to the proposals included in the Proposing Release, including a broader

interpretation of the statutory term “an accounting restatement due to material noncompliance.”

The Commission re-opened the comment period again on June 8 2022, in connection with the addition to the comment file of a memorandum prepared by Commission staff providing additional analysis on compensation recovery policies and accounting restatements.

We have received numerous comment letters pursuant to our initiative to receive advance public comment in implementing the Dodd-Frank Act,

in response to the Proposing Release, and in response to the reopening releases.

Commenters broadly supported the objectives of the proposed rules, although commenters offered various recommendations and expressed various concerns regarding the proposed implementation. As discussed further below, after reviewing and considering the public comments and recommendations and guided by our understanding of the goal Congress was trying to achieve, we are adopting the proposed rules substantially as proposed, but with certain modifications to broaden the scope of covered restatements, clarify the rules, and address comments received on the proposals.

See Listing Standards for Recovery of Erroneously Awarded Compensation,

Release No. 34-75342 (Jul. 1, 2015) [80 FR 41144 (July 14, 2015)] (“Proposing Release”).

Public Law 111-203, 124 Stat. 1900 (2010).

See Reopening of Comment Period for Listing Standards for Recovery of Erroneously Awarded Compensation,

Release No. 34-93311 (Oct. 14, 2021) [86 FR 58232 (Oct. 21, 2021)] (“Reopening Release”).

See generally,

Reopening Release.

See Reopening of Comment Period for Listing Standards for Recovery of Erroneously Awarded Compensation,

Release No. 34-95057 (June 8, 2022) [87 FR 35938 (June 14, 2022)] (“Second Reopening Release”).

See also

Memorandum from the Division of Economic and Risk Analysis (June 8, 2022) (submitted to the comment file in connection with Second Reopening Release) (“2022 staff memorandum”).

Comment letters related to the executive compensation provisions of the Dodd-Frank Act provided prior to the Proposing Release are

available at http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml.

Comment letters related to the Proposing Release, the Reopening Release, and the Second Reopening Release are

available at https://www.sec.gov/comments/s7-12-15/s71215.htm.

A comment letter from two members of Congress raised concerns about the Reopening Release.

See

comment letter from Sen. Pat Toomey and Sen. Richard Shelby, dated Feb. 1, 2022 (“Toomey/Shelby”). Specifically, the letter criticized the Commission for reopening the comment period on the Proposing Release and seeking comment on a number of regulatory alternatives without updating the cost-benefit analysis and analysis required by 44 U.S.C. 3501

et seq.

(“Paperwork Reduction Act” or “PRA”) and 5 U.S.C. 601

et seq.

(“Regulatory Flexibility Act” or “RFA”) and urged the Commission to repropose the rulemaking. The letter asserted that the approach taken in the Reopening Release significantly impaired the public's ability to comment thoughtfully on the proposals and was inconsistent with 5 U.S.C. 551 through 559 (“Administrative Procedure Act”). In response to these concerns, we note that the Reopening Release included a robust discussion of the broader interpretation of the statutory term under consideration and certain potential changes and solicited comment on that interpretation and those potential changes. The 2022 staff memorandum in connection with the Second Reopening Release analyzed the benefits and costs of the potential changes. The 2022 staff memorandum also considered the impact on smaller registrants. Given the discussion included in the Proposing Release, the Reopening Release, the Second Reopening Release, and the 2022 staff memorandum, and in this adopting release, we believe the final rules satisfy the requirements of the Administrative Procedure Act and other applicable statutes and that a reproposal is unnecessary. Moreover, in response to both the Reopening and Second Reopening Releases, we received numerous comments from members of the public on the potential changes and additional disclosures, including comments on their economic effects, and we have considered those comments in adopting the final rules.

II. Discussion of Final Amendments

New Exchange Act Rule 10D-1 sets forth the listing requirements that exchanges and associations that list securities are directed to establish pursuant to Section 10D of the Exchange Act. Amendments to Regulation S-K, Form 10-K, Form 20-F, Form 40-F, and for certain investment companies, Form N-CSR and Schedule 14A, require disclosure of the listed issuer's policy on recovery of incentive-based compensation and information about actions taken pursuant to such recovery policy.

New Exchange Act Rule 10D-1 and the rule amendments adopted in this release supplement existing provisions

by directing the exchanges to establish listing standards that require issuers to:

See

15 U.S.C. 7243 (providing that the chief executive officer (“CEO”) and chief financial officer (“CFO”) of an issuer must reimburse the issuer for bonus or other incentive-based or equity-based compensation resulting from an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct) and 17 CFR 229.402(b) (requiring disclosure of company policies and decisions regarding the adjustment or recovery of awards or payments to named executive officers in the issuer's Compensation Discussion and Analysis (“CD&A”)). The CD&A disclosure requirement is principles-based in that it identifies the disclosure concept and provides several non-exclusive examples. Under 17 CFR 229.402(b)(1), companies must explain all material elements of their named executive officers' compensation by addressing mandatory principles-based topics in CD&A. 17 CFR 229.402(b)(2) sets forth nonexclusive examples of the kind of information that should be addressed in CD&A, if material.

Exchanges may adopt listing standards with requirements that are more extensive than those of Rule 10D-1. Listed issuers may, of course, adopt policies more extensive than those called for by the listing standards, so long as those policies at a minimum satisfy the listing standards.

• Develop and implement written policies for recovery of incentive-based compensation based on financial information required to be reported under the securities laws, applicable to the issuers' executive officers, during the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement; and

• Disclose those compensation recovery policies in accordance with Commission rules, including providing the information in tagged data format.

To assure that issuers listed on different exchanges are subject to the same disclosure requirements regarding erroneously awarded compensation recovery policies, amendments to the Commission's disclosure rules require all issuers listed on any exchange to file their written compensation recovery policy as an exhibit to their annual reports,

to indicate by check boxes on their annual reports whether the financial statements of the registrant included in the filing reflect a correction of an error to previously issued financial statements and whether any such corrections are restatements that required a recovery analysis,

and to disclose any actions an issuer has taken pursuant to such recovery policy.

See

17 CFR 229.601(b)(97), 17 CFR 240.14a-101, 17 CFR 249.220f, 17 CFR 249.240f, and 17 CFR 274.128 Item 19(a)(2).

See

17 CFR 249.220f, 17 CFR 249.240f, and 17 CFR 249.310.

But see

Section II.D.3. regarding check box disclosure on 17 CFR 274.128.

See

17 CFR 229.402(w) (“Item 402(w) of Regulation S-K”), 17 CFR 240.14a-101(b)(20), 17 CFR 249.220f Item 6.F., 17 CFR 249.240f Item 19, and 17 CFR 274.128 Item 18.

A. Issuers and Securities Subject To Exchange Act Rule 10D-1

Section 10D of the Exchange Act provides that the Commission shall, by rule, direct the exchanges to prohibit the listing of any security of an issuer that does not comply with the requirements of Section 10D. Section 10D does not distinguish among issuers or types of securities and does not specifically instruct the Commission to exempt any particular types of issuers or securities or direct the Commission to permit the exchanges to provide such exemptions.

In this regard, Section 10D differs from other Dodd Frank Act governance-related provisions, such as Section 951 Shareholder Vote on Executive Compensation Disclosure (amending the Exchange Act to add Section 14A) and Section 952 Compensation Committee Independence (amending the Exchange Act to add Section 10C), which include specific direction for either the Commission or the exchanges to consider exemptions for classes of issuers, to provide exemptions, or to take into account whether the requirements disproportionately burden small issuers.

1. Proposed Amendments

The Commission proposed to require exchanges to apply the disclosure and recovery policy requirements to all listed issuers, with only limited exceptions. As Section 10D refers to “any security” of an issuer, the Commission proposed that the listing

standards and other requirements apply without regard to the type of securities issued, including to issuers of listed debt or preferred securities that do not have listed equity.

The Commission did however propose to exempt security futures products and standardized options because the Commission recognized that information about the compensation practices at the clearing agencies that issue these securities is less relevant to investors,

and to exempt the securities of certain registered investment companies from the proposed listing standards because the Commission recognized that the compensation structures of issuers of these securities render application of the rules unnecessary.

As proposed, an exchange would not be permitted to list an issuer that it has delisted or that has been delisted from another exchange for failing to comply with its recovery policy until the issuer comes into compliance with that policy.

See

proposed Rule 10D-1(b)(1)(vi).

“Equity security” as defined in 15 U.S.C. 78c(a)(11) includes any security future on any stock or similar security. A “security future” as defined in 15 U.S.C. 78c(a)(55) means “a contract of sale for future delivery of a single security or of a narrow-based security index.” “Security futures product” as defined in 15 U.S.C. 78c(a)(56) and 7 U.S.C. 1a(32) include a security future or any put, call, straddle, option or privilege on any security future. Security futures products may be traded on exchanges registered under 15 U.S.C. 78f and associations registered under 15 U.S.C. 78o-3 without such securities being subject to the registration requirements of the Securities Act and the Exchange Act so long as they are cleared by a clearing agency that is registered under 15 U.S.C. 78q-1 or that is exempt from registration under 15 U.S.C. 78q-1(b)(7).

See

15 U.S.C. 77c(a)(14), 15 U.S.C. 78

(a), 17 CFR 240.12h-1(e). Comparable regulatory treatment exists for standardized options, which are defined in 17 CFR 240.9b-1(a)(4) as option contracts trading on an exchange, an automated quotation system of a registered association, or a foreign securities exchange which relate to option classes the terms of which are limited to specific expiration dates and exercise prices, or such other securities as the Commission may, by order, designate.

See

17 CFR 230.238, 17 CFR 240.12a-9, 17 CFR 240.12h-1(d).

The Commission proposed to exempt the listing of any security issued by a registered management investment company if such company has not awarded incentive-based compensation to any executive officer of the registered management investment company in any of the last three fiscal years or, in the case of a company that has been listed for less than three fiscal years, since the initial listing. The Commission additionally proposed to exempt the listing of any security issued by a unit investment trust.

The Commission did not propose to otherwise exempt categories of listed issuers, such as emerging growth companies (“EGCs”),

smaller reporting companies (“SRCs”),

foreign private issuers (“FPIs”),

and controlled companies.

The Commission further did not propose to grant the exchanges discretion to decide whether certain categories of securities should be exempted from the Section 10D listing standards.

See

15 U.S.C. 77b(a)(19) and 15 U.S.C. 78c(a)(80).

See

17 CFR 240.12b-2.

See

17 CFR 240.3b-4(c). The Commission did propose to permit a FPI to make a determination regarding impracticability to recover in limited circumstances where doing so would violate home country law.

See

Section II.C.3.b, of the Proposing Release and Section II.C.3.b. for a discussion of impracticability of recovery.

Under New York Stock Exchange Rule 303A.00 and NASDAQ Stock Market LLC Rule 5615(c) a “controlled compan[y]” is defined as a company of which more than 50% of the voting power for the election of directors is held by an individual, group or another company.

2. Comments

We received substantial comment on whether certain classes of issuers and securities should be subject to the proposal. Some commenters supported the scope of issuers covered by the proposal.

Other commenters recommended that the Commission exercise its exemptive authority to exclude certain issuers and classes of securities from the requirements.

See, e.g.,

comment letters from American Federation of Labor and Congress of Industrial Organizations (“AFL-CIO”); Americans for Financial Reform (Sept. 14, 2015) (“AFR 1”); Better Markets, Inc. (Sept. 14, 2015) (“Better Markets 1”); Council of Institutional Investors (Aug. 27, 2015) (“CII 1”); California Public Employees' Retirement System (Sept. 14, 2015) (“CalPERS 1”); CFA Institute (Sept. 14, 2015) (“CFA Institute 1”); Robert E. Rutkowski (Sept. 15, 2015) (“Rutkowski 1”); and State Board of Administration (“SBA”). Some of these commenters contended that investors deserve the same protections regardless of the category of listed issuer.

See

comment letters from AFL-CIO; CII 1; the Office of the Comptroller of the State of New York; and Public Citizen (Nov. 19, 2021) (“Public Citizen 2”).

See, e.g.,

comment letters from American Bar Association Committee on Federal Regulation of Securities of the Section of Business Law (Feb. 11, 2016) (“ABA 1”); Davis Polk & Wardwell LLP (Sept. 11, 2015) (“Davis Polk 1”); Duane Morris LLP (“Duane”); Financial Services Roundtable (“FSR”); Freshfields Bruckhaus Deringer (“Freshfields”); Japanese Bankers Association (“Japanese Bankers”); Kaye Scholer LLP (“Kaye Scholer”); SAP SE (“SAP”); Sullivan & Cromwell LLP (Sept. 22, 2015) (“S&C 1”); TELUS Corporation (“TELUS”); and UBS Group AG (“UBS”).

A number of commenters expressed concern regarding application of the rules to FPIs,

and suggested that application of the rules could impose inconsistent standards

and questioned the feasibility of implementation by FPIs.

Some of these commenters recommended that the Commission unconditionally exempt FPIs,

noting that FPIs have been exempted from many of the Commission's executive compensation regulations and are not subject to Section 16 of the Exchange Act,

and that other U.S. listing standards permit FPIs to comply with home country standards rather than the U.S. listing standard requirements.

Commenters alternatively recommended that the Commission exempt FPIs where the home country has an appropriate governance regime or law governing erroneously awarded compensation.

See, e.g.,

comment letters from ABA 1 (suggesting that the general presumption against the extraterritorial application of United States law, as well as the general principle of international comity, should apply); Davis Polk 1; Duane; FSR (noting the burden of having to comply with U.S.-based executive compensation governance in addition to home country laws); Freshfields; Japanese Bankers (suggesting that “a penalty on restatement of financial statements prepared in accordance with the home country accounting standard should be determined by judicial ruling of the home country, and should not be governed by the U.S. listing rules”); Kaye Scholer; SAP; S&C 1; TELUS; and UBS.

See, e.g.,

comment letters from the U.S. Chamber of Commerce Center for Capital Markets Competitiveness (Sept. 14, 2015) (“CCMC 1”) (suggesting that “affected [issuers] may find themselves endeavoring to comply with contradictory laws in multiple jurisdictions creating conflicts that cannot be addressed with a single solution”); Freshfields (expressing concerns regarding potential conflicts between the proposed listing standard and home country rules and noting potential conflicts with home country laws, stock exchange requirements, or corporate governance arrangements); and S&C 1 (stating that “[r]equiring a non-U.S. issuer to comply with U.S. and home country requirements would upset the regulatory framework established by the home country and potentially impose inconsistent standards”).

See also

comment letter from Duane (suggesting the rule could force issuers to choose between violating home country law or the listing standards).

See

comment letters from CCMC 1; and Kaye Scholer (suggesting that an issuer's home country has a more appropriate interest in determining whether companies domiciled there should be subject to a compensation recovery requirement).

See also

comment letters from ABA 1 (noting that such issuers generally adhere to IFRS, which sets forth criteria for determining when a restatement is required that differ from GAAP, such that applying the rule to FPIs may lead to inconsistent treatment among issuers); and Davis Polk 1.

See

comment letters from ABA 1; Davis Polk 1; Duane; FSR; Freshfields; Japanese Bankers; Kaye Scholer; SAP; S&C 1; TELUS; and UBS.

See, e.g.,

comment letter from FSR (noting that FPIs have been exempted from many of the executive compensation regulations enacted under the Dodd-Frank Act, as well as disclosure requirements under Item 402 of Regulation S-K, and further stating that because such issuers are not subject to Section 16, the proposed rules would require such issuers to design and implement new executive compensation governance structures).

See

comment letters from UBS (citing the NYSE Group, Inc. (“NYSE”) audit committee independence rule); and Duane (citing Exchange Act Section 10C).

See also

comment letter in response to the Reopening Release from Cravath, Swaine & Moore LLP (“Cravath”) (noting the burden placed on FPIs that may be subject to different corporate governance standards in their home countries).

See, e.g.,

comment letters from Freshfields; and TheCityUK (suggesting permitting compliance with home country provisions that provide for similarly rigorous disciplines meeting the same goals).

One commenter urged the Commission to exempt all registered investment companies unconditionally, rather than the proposed exemption for registered unit investment trusts (“UITs”) and for registered management

investment companies (“listed funds”) that have not awarded incentive-based compensation in the last three fiscal years.

The commenter asserted that the legislative history of the Dodd-Frank Act does not indicate that the purpose of Section 10D was to address abuses with respect to listed funds; that listed funds have been exempted from certain prior compensation-related rulemakings; and that listed fund financial statements are less complex than operating company financial statements, resulting in accounting restatements being rare for listed funds.

The commenter therefore believed that the costs to affected listed funds would outweigh the benefits. The commenter also stated that the proposal could affect more than the small number of internally managed listed funds that the Commission estimated in the proposal, because some externally managed listed funds may pay some or all of the funds' chief compliance officers' compensation.

See

comment letter from Investment Company Institute (Sept. 14, 2015). ICI submitted a comment letter on the original proposal in 2015 as well as on the Reopening Release (Nov. 22, 2021). Because the letters largely made the same points, the letters are referred to collectively as if they were a single letter (“ICI”). Another commenter supported the Commission's proposed conditional exemption for listed funds, while also urging the Commission to exempt them and certain other issuers unconditionally, but without any further analysis supporting this recommendation for listed funds.

See

comment letter from FSR.

See

comment letter from ICI.

Another commenter urged the Commission to extend the proposed conditional exemption to externally managed business development companies (“BDCs”).

The commenter asserted that the same policy considerations supporting the conditional exemption for listed funds apply to externally managed BDCs, and that provisions of the Investment Advisers Act of 1940

and the Investment Company Act effectively prohibit these BDCs from offering certain incentive compensation plans to their officers.

See

comment letter from Clifford Chance

et al.

15 U.S.C. 80b-1 through 15 U.S.C. 80b-21.

See

comment letter from Clifford Chance

et al.

We received limited comment on the Commission's proposal to exempt security futures products and standardized options. One commenter generally supported the proposed exemption and no other commenters objected to the proposal to exempt security futures products and standardized options, or otherwise addressed this aspect of the proposal.

Some commenters recommended exemptions for debt-only issuers

and controlled companies.

See

comment letter from ABA 1.

See, e.g.,

comment letters from ABA 1; Davis Polk 1 (noting protections from the indenture contract and Trust Indenture Act, the ability to negotiate for indenture covenants, and that a wholly-owned subsidiary of a reporting company are not required to provide executive compensation disclosure); FSR (suggesting that the harm that the proposal is designed to address is immaterial to such investors and that a public parent issuer would have oversight over its executive compensation and financial statements); Jesse M. Fried (“Fried”); and Society for Corporate Governance (formerly Society of Corporate Secretaries & Governance Professionals) (Sept. 18, 2015) (“SCG 1”).

See also

comment letter in response to the Reopening Release from Davis Polk (Nov. 22, 2021) (“Davis Polk 3”) (further noting that debt-only issuers are exempt from many rules related to executive compensation). In contrast, one commenter specifically opposed such an exemption.

See

comment letter from Better Markets 1.

See

comment letters from Duane; and Fried (both suggesting that debt-only and controlled companies may have greater control over executive officers and can employ incentives, such as extra pay or threat of termination, that would dwarf the incentive effect of a potential compensation recovery).

Some commenters expressed support for requiring recovery by SRCs and EGCs as proposed,

while others recommended that the Commission exempt SRCs and EGCs, citing the costs and burdens associated with imposing compensation recovery policies containing the detail and scope contemplated by the proposal.

As an alternative to exemption, these commenters recommended deferring compliance for these issuers.

In response to the Reopening Release, a number of commenters additionally noted the burdens on smaller issuers and recommended accommodations.

See, e.g.,

comment letters from Better Markets 1; CalPERS 1 (noting small issuers may offer substantial incentive compensation packages); Public Citizen (Sept. 14, 2015) (“Public Citizen 1”) (suggesting such issuers lack the wider and potentially more vigilant shareholder base of larger companies); and SBA (recommending that strong governance practices should be applied at early growth stages).

See also

comment letter from CFA Institute 1 (suggesting it would not be appropriate or necessary to scale the proposed disclosure requirements for smaller or EGCs).

See, e.g.,

comment letters from ABA 1 (further suggesting that such issuers should not be required to disclose their reasons for not pursuing recovery or the aggregate amount of excess compensation remaining outstanding at fiscal year-end); Compensia; Mercer; and National Association of Corporate Directors (“NACD”).

See also

Annual Report for Fiscal Year 2021: Office of the Advocate for Small Business Capital Formation (“2021 OASB Annual Report”), available at

https://www.sec.gov/files/2021-OASB-Annual-Report.pdf,

at 68 (recommending generally that in engaging in rulemaking that impacts small businesses, the Commission tailor the disclosure and reporting framework to the complexity and size of operations of companies, either by scaling obligations or delaying compliance for the smallest of the public companies, particularly as it pertains to potential new or expanded disclosure requirements).

See, e.g.,

comment letters from ABA 1; Compensia; Mercer; and NACD.

See, e.g.,

comment letters in response to the Reopening Release from Committee on Federal Regulation of Securities of the Section of Business Law of the American Bar Association (Jan. 24, 2022) (“ABA 2”); CCMC (Nov. 22, 2021) (“CCMC 2”); and Hunton Andrews Kurth (“Hunton”).

3. Final Amendments

After considering the comments, we are adopting rules to require exchanges to apply the disclosure and compensation recovery policy requirements to all listed issuers,

with only limited exceptions, substantially as proposed.

Under the final rules, an issuer would be subject to delisting if it does not adopt and comply with its compensation recovery policy.

In a clarification to the proposal, 17 CFR 240.10D-1(a) as adopted provides that the requirements of Section 10D apply to each exchange and association to the extent such exchange or association lists securities. Accordingly, the requirements will not apply to exchanges that only trade securities pursuant to unlisted trading privileges but do not list securities.

We are exempting the listing of certain security futures products, standardized options, securities issued by unit investment trusts, and the securities issued by certain registered investment companies from the mandated listing standards, as proposed.

In a modification from the proposal, the rule refers to a national securities association that lists securities generally, rather than the more specific reference to an association that “lists securities in an automated inter-dealer quotation system.” In addition, we are simplifying the rule by not adopting proposed Rule 10D-1(b)(1)(vi), which would have specifically provided that an issuer that had been delisted for failing to comply with its recovery policy may not list its securities on an exchange, and an exchange would not be permitted to list a delisted issuer until the issuer comes into compliance with its recovery policy, because such a delisted issuer that remained out of compliance with the recovery policy would already not be permitted to list its securities on an exchange by function of 17 CFR 240.10D-1(a)(1), which requires exchanges to “prohibit the initial or continued listing of any security of an issuer that is not in compliance with the requirements of any portion of this section.”

See

17 CFR 240.10D-1(a)(3).

Under the rule and rule amendments, it would also be subject to delisting if it does not disclose its compensation recovery policy in accordance with Commission rules.

See

Section II.D.3.

Such exchanges may not list securities until their listing standards comply with the requirements of Rule 10D-1. Exchanges that do not list securities should consider updating any applicable listing standards to comply with the requirements of Rule 10D-1 or including an appropriate limitation acknowledging that they may only trade securities pursuant to unlisted trading privileges.

See

17 CFR 240.10D-1(c)(1) through (4).

As the Commission stated in the Proposing Release, Section 10D does not distinguish among issuers or types of

securities, and does not instruct the Commission to exempt any particular types of issuers or securities or direct the Commission to permit the exchanges to provide for such exemptions. In evaluating whether to exempt specific categories of issuers and securities, in addition to the views of commenters, we have considered whether providing exemptions from the requirements of Section 10D would be consistent with our understanding of the purpose of this statutory provision. We have also considered the incidence of restatements by different categories of issuers and whether, in light of such incidence, exempting these classes of issuers would be necessary or appropriate in the public interest and consistent with the protection of investors. Although we recognize commenters' concerns regarding application of the rule to FPIs, SRCs, and EGCs, as discussed more fully below, we have determined not to exempt these categories of issuers from the final rules.

With respect to application of the final amendments to FPIs, we note that Section 10D does not exempt FPIs. While the Commission could exercise its discretion to exempt such issuers by rule, we decline to do so. We acknowledge some of the practical concerns regarding implementation of the recovery policy raised by commenters, as discussed above; however, these concerns are not unique to FPIs and, in any event, do not in our view justify exempting such issuers from the obligation to recover incentive-based compensation that was erroneously awarded. We believe that shareholders of FPIs listed in the United States should benefit from recovery of erroneously awarded compensation in the same manner as shareholders of domestic issuers. Moreover, the recovery requirements will help to encourage reliable financial reporting by listed issuers, which is as important for investors in FPIs as for other issuers. Studies have shown that foreign companies present a similar risk of restatement as other companies

and that U.S. issuers who are non-accelerated filers

accounted for approximately 53% of restatements.

To the extent that recovery under Rule 10D-1 would be wholly inconsistent with a foreign regulatory regime, we have included an impracticability accommodation, as discussed in Section II.C.3.b., which may alleviate some of the implementation challenges faced by FPIs.

See

2020 Financial Restatements: A Twenty-Year Review, Audit Analytics (2021) (“A Twenty-Year Review”) (analyzing data related to accounting restatements, including specific analysis for accelerated foreign filers, non-accelerated foreign filers, accelerated U.S. filers, and non-accelerated U.S. filers), and Financial Restatement Trends in the United States: 2003-2012, Professor Susan Scholz, University of Kansas, Study Commissioned by the Center for Audit Quality (comparing U.S. and foreign private issuers). Foreign companies in this study included both FPIs and foreign companies filing on Form 10-K.

17 CFR 240.12b-2.

See

A Twenty-Year Review.

We also do not view the application of the final amendments to FPIs listed on U.S. national exchanges as an extraterritorial application of U.S. law. The statutory language generally identifies the types of conduct that trigger the relevant requirement and, by extension, the focus of the statute for the purpose of an extraterritoriality analysis.

Having identified the activity regulated by the statutory provision, we can determine whether a person is engaged in conduct that the statutory provision regulates and whether this conduct occurs within the United States. The statutory focus of Section 10D is on “the listing of any security of an issuer” on a national securities exchange. The recovery policies mandated by Section 10D apply only to those foreign issuers who have chosen to access the U.S. capital markets by listing on a U.S. national exchange. We thus do not view the final rules as an extraterritorial application of U.S. legal requirements.

See Morrison

National Australia Bank, Ltd.,

130 S. Ct. 2869, 2884 (2010) (identifying the focus of statutory language to determine what conduct was relevant in determining whether the statute was being applied to domestic conduct).

With respect to the application of the rule to SRCs and EGCs, we note that, unlike in other provisions of the Dodd-Frank Act, Congress did not direct the Commission to consider differential treatment for certain classes of issuers, such as SRCs and EGCs.

Similar to our reasons for not exercising our discretion to exempt FPIs, we decline to exempt SRCs and EGCs from the final amendments. In our view, recovery of incentive-based compensation that was not earned and should not have been paid is as appropriate for smaller listed issuers as it is for larger issuers. We believe shareholders of smaller issuers should benefit from recovery of erroneously awarded compensation in the same manner as shareholders of larger issuers. Similarly, recovery encourages the preparation of reliable financial information, which may be even more important for smaller issuers and EGCs than for others because of their susceptibility to an increased likelihood of reporting an accounting error and to material weakness in internal control over financial reporting, as studies have found.

In contrast, Section 952 of the Dodd-Frank Act directs the Commission to take “into consideration the size of an issuer and any other relevant factors” when providing exemption authority.

See, e.g.,

Jacquelyn Gillette, Sudarshan Jayaraman, and Jerold Zimmerman

Accounting Restatements: Malfeasance and/or Optimal Incompetence?

(working paper Mar. 2017),

available at https://pages.business.illinois.edu/accountancy/wp-content/uploads/sites/12/2017/02/YSS-2017-Gillette.pdf

(finding that “larger and more profitable firms invest more in accounting resources”, and that “accounting resources are negatively associated with the likelihood of a restatement”);

See also

Jeong-Bon Kim, Jay Junghun Lee, and Jong Chool Park,

Internal Control Weakness and the Asymmetrical Behavior of Selling, General, and Administrative Costs,

(37) J. Acct. Auditing & Fin 259-292 (2022) (finding that firms with internal control weaknesses are significantly smaller in terms of sales revenue, selling, general and administrative costs, and total assets).

See also

discussion above and Section IV.A. discussing the number of restatements for smaller issuers as compared to other issuers.

We recognize, as some commenters asserted, that shareholders of controlled companies and certain private companies with listed debt may have a greater degree of control over executive officers than at other companies. We further recognize that debt holders of debt-only issuers receive certain protections from the Trust Indenture Act and indenture covenants governing such debt. Recovery of erroneously awarded compensation will encourage executive officers to reduce errors requiring restatements, which could benefit potential future investors and enhance the efficiency of the market as a whole. Further, while controlling shareholders generally face fewer difficulties in directing and incentivizing executive officers, the final amendments will help minimize any gaps that remain, such as those that could exist for an issuer's minority shareholders. Although a controlling majority shareholder may owe state law duties to minority shareholders, we do not believe that investors' confidence in the accuracy of financial reporting should depend on their assessment of the likelihood of successful litigation under state law to vindicate minority shareholder rights.

We are not granting the exchanges discretion to exempt certain categories of securities from the listing standards. In reaching these conclusions, in addition to the plain language of the statute and the fundamental inequity of permitting executive officers to retain compensation they did not earn, we

considered the relative burdens of compliance on different categories of issuers and types of securities. As discussed more fully in Section IV, while we recognize that the listing standards could, in certain respects, impose burdens on particular categories of issuers, there is also reason to believe that these issuers, their shareholders, and the markets in general, may derive benefits from the listing standards. The compensation recovery requirements may reduce the financial benefits to executive officers when an issuer is required to prepare an accounting restatement, and thus may increase incentives for reporting accurate financial results.

Additionally, the recovery requirements may encourage issuers and their executive officers to devote more resources to the production of high-quality financial reporting. Shareholders of listed issuers will, in turn, benefit from improved financial reporting, and issuers may derive benefits in the form of reduced costs of capital. As with other categories of listed issuers, we believe that these benefits justify the costs imposed by the final amendments for specific categories of issuers, such as EGCs, SRCs, FPIs, controlled companies, and debt-only issuers.

As discussed more fully in Section IV, academic research finds that companies with strong compensation recovery provisions experience improved financial reporting, lower CEO turnover, and lower CEO compensation.

See

Michael H.R. Erkens, Ying Gan, and B. Burcin Yurtoglu,

Not all clawbacks are the same: Consequences of strong versus weak clawback provisions,

66 J. Acct & Econ., 291 (2018).

See also

Lillian H. Chan

et al., The Effects of Firm-Initiated Clawback Provisions on Earnings Quality and Auditor Behavior

54 J. Acct. & Econ. 180 (2012) (finding that after the adoption of clawback provisions, incidence of accounting restatements declines, firms' earnings response coefficients increase, and auditors are less likely to report material internal control weaknesses, charge lower audit fees, and issue audit reports with a shorter lag); Ed DeHaan, Frank Hodge, and Terry Shevlin,

Does Voluntary Adoption of a Clawback Provision Improve Financial Reporting Quality?,

30 Contemp. Acct. Rsch. 1027 (2013) (finding improvements in financial reporting quality following clawback adoption, including decreases in meet-or-beat behavior and unexplained audit fees, a decrease in restatements, a significant increase in earnings response coefficients and a significant decrease in analyst forecast dispersion).

We are adopting, as proposed, the exemptions for the listing of security futures products cleared by a registered clearing agency or a clearing agency that is exempt from the registration requirements of the Exchange Act and for standardized options issued by a registered clearing agency because the role of a clearing agency as the issuer of these securities is fundamentally different from that of other listed issuers.

Whereas in most cases the purchaser of a security is making an investment decision regarding the issuer of a security, the purchaser of security futures products and standardized options does not, except in the most formal sense, make an investment decision regarding the clearing agency, even though the clearing agency is the issuer of those securities. As a result, information about the clearing agency's business, its officers and directors and their compensation, and its financial statements is less relevant to investors in these securities than information about the issuer of the underlying security. Moreover, the investment risk in security futures products and standardized options is largely determined by the market performance of the underlying security rather than the performance of the clearing agency, which is a self-regulatory organization subject to regulatory oversight.

Accordingly, pursuant to our authority under Section 36 of the Exchange Act, we find that it is necessary or appropriate in the public interest, and consistent with the protection of investors, to exempt the listing of a security futures product and a standardized option from the requirements of Rule 10D-1 under the Exchange Act.

See Fair Administration and Governance of Self-Regulatory Organizations; Disclosure and Regulatory Reporting by Self-Regulatory Organizations; Recordkeeping Requirements for Self-Regulatory Organizations; Ownership and Voting Limitations for Members of Self-Regulatory Organizations; Ownership Reporting Requirements for Members of Self-Regulatory Organizations; Listing and Trading of Affiliated Securities by a Self-Regulatory Organization,

Release No. 34-50699 (Nov. 18, 2004) [69 FR 71126], at n. 260 (“Standardized options and security futures products are issued and guaranteed by a clearing agency”).

The Commission has previously recognized these fundamental differences and provided exemptions for security futures products and standardized options when it adopted the audit committee listing requirements in 17 CFR 240.10A-3 and the compensation committee listing requirements in 17 CFR 240.10C-1.

See Listing Standards for Compensation Committees,

Release No. 33-9330 (June 20, 2012) [77 FR 38422 (June 27, 2012)].

See

17 CFR 240.10D-1(c)(1) and (2).

Similarly, we are adopting the proposal to exempt the listing of any security issued by a listed fund on the condition that the fund has not awarded incentive-based compensation to any current or former executive officer of the fund in any of the last three fiscal years or, in the case of a fund that has been listed for less than three fiscal years, since the initial listing.

We make this conditional exemption pursuant to our authority under Section 36 of the Exchange Act, because we find that it is necessary or appropriate in the public interest, and consistent with the protection of investors. The conditional exemption would permit listed funds that do not pay incentive-based compensation to avoid the burden of developing recovery policies they may never use.

Listed funds that have paid incentive-based compensation in that time period, however, would be subject to the rule and rule amendments and be required to implement a compensation recovery policy like other listed issuers.

See

17 CFR 240.10D-1(c)(4). Listed funds, unlike most other issuers, are generally externally managed and often have few, if any, employees that are compensated by the fund (

i.e.,

the issuer). Instead, listed funds typically rely on employees of the investment adviser to manage fund assets and carry out other related business activities. Such employees are typically compensated by the investment adviser of the registered management investment company as opposed to the fund. In order to apply the new rules to listed funds, we are amending Form N-CSR as proposed to redesignate Item 18 as Item 19 and to add a new paragraph (a)(2) to this Item (with current paragraph (a)(2) redesignated as (a)(3)) to require any listed fund that would be subject to the requirements of Rule 10D-1 to include as an exhibit to its annual report on Form N-CSR its policy on recovery of incentive-based compensation. We are also adding new Item 18 to Form N-CSR as well as amending Item 22 of Schedule 14A of the Exchange Act to require listed funds that would be subject to Rule 10D-1 to provide information that would generally mirror the disclosure requirements of Item 402(w) of Regulation S-K.

In addition, because the exemption applies to the listing of securities of registered investment companies, it would not apply to business development companies, which are a category of closed-end management investment company that is not registered under the Investment Company Act.

One commenter observed that the rule would cover any incentive-based compensation paid to listed fund chief compliance officers (“CCOs”) if they are within the rule's definition of an “executive officer.”

See

comment letter from ICI. We agree that if a listed fund pays an executive officer incentive-based compensation within the time period specified in the final rule, then the fund would be required to implement a compensation-recovery policy. Although the commenter urged the Commission to interpret the executive officer definition to exclude a listed fund's CCO, we do not see a basis for this interpretation and the commenter did not provide one.

We are not exempting listed funds unconditionally, as two commenters suggested. The final rules are designed to reflect the structure and compensation practice of listed funds by requiring funds to implement compensation recovery policies only when they in fact award incentive-based compensation covered by Section 10D. While listed funds' financial statements may in general be less complex than those of operating companies, restatements can and do still occur. To the extent that executive officers of listed funds receive incentive-based compensation on the basis of a financial reporting measure that is restated, we

believe that the policy concerns underlying the rule apply equally to listed funds, regardless of whether they were specifically mentioned in the Dodd-Frank Act's legislative history or the treatment of registered investment companies for purposes of other compensation-related disclosure requirements.

We also are not exempting externally managed BDCs, as one commenter suggested. Although BDCs whose advisers receive certain forms of compensation are subject to certain limitations on their ability to offer equity compensation such as options, or to establish a profit-sharing plan, the definition of incentive-based compensation in Section 10D applies to a broader range of incentive-based compensation arrangements. In addition, BDCs are generally subject to other disclosure requirements in Regulation S-K, and the final rules treat all BDCs, whether managed externally or internally, in a consistent manner.

A commenter suggested that the Commission had previously exempted externally managed BDCs from pay ratio disclosure requirements adopted in 2015.

See

comment letter of Clifford Chance

et al.

The rule did not provide an exemption for externally managed BDCs. Instead, the Commission observed that as a practical matter no externally managed BDCs would be subject to it.

See Pay Ratio Disclosure,

Release No. 33-9877 (Aug. 5, 2015) [80 FR 50103 (Aug. 18, 2015)] at n.90 (“Business development companies will be treated in the same manner as issuers other than registered investment companies and therefore will be subject to the pay ratio disclosure requirement”).

As proposed, we are exempting the listing of any security issued by a UIT because, unlike listed funds, UITs are pooled investment entities without a board of directors, corporate officers, or an investment adviser to render investment advice during the life of the UIT, and they do not file a certified shareholder report. In addition, because the investment portfolio of a UIT is generally fixed, UITs are not actively managed. Accordingly, pursuant to our authority under Section 36 of the Exchange Act, we find that it is necessary or appropriate in the public interest, and consistent with the protection of investors, to exempt the listing of any security issued by a UIT from the requirements of Rule 10D-1 under the Exchange Act.

See

17 CFR 240.10D-1(c)(3) and (4).

B. Restatements

1. Restatements Triggering Application of Recovery Policy

Sections 10D(a) and 10D(b)(2) require the Commission to adopt rules directing exchanges and associations to establish listing standards that require issuers to develop and implement policies that require recovery “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.” The Senate Report indicated that Section 10D was intended to result in “public companies [adopting policies] to recover money that they erroneously paid in incentive compensation to executives as a result of material noncompliance with accounting rules. This is money that the executive would not have received if the accounting was done properly . . . .”

See

Senate Report at 135.

a. Proposed Amendments

The Commission proposed to require that issuers adopt and comply with a written policy providing that in the event the issuer is required to prepare a restatement

to correct an error

that is material

to previously issued financial statements,

the obligation to prepare the restatement would trigger application of the compensation recovery policy. In connection with this proposed trigger, the Commission proposed to define an “accounting restatement”

and specifically noted that issuers should consider whether a series of immaterial error corrections, whether or not they resulted in filing amendments to previously filed financial statements, could be considered a material error when viewed in the aggregate.

Under U.S. Generally Accepted Accounting Principles (“GAAP”), a restatement is “the process of revising previously issued financial statements to reflect the correction of an error in those financial statements.”

See

Financial Accounting Standards Board Accounting Standards Codification Topic 250,

Accounting Changes and Error Corrections

(“ASC Topic 250”). Under International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS”), a retrospective restatement is “correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred.”

See

International Accounting Standard 8,

Accounting Policies, Changes in Accounting Estimates and Errors

(“IAS 8”), paragraph 5.

Under GAAP, an error in previously issued financial statements is “[a]n error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles (GAAP), or oversight or misuse of facts that existed at the time the financial statements were prepared. A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.”

See

ASC Topic 250. Under IFRS, prior period errors are “omissions from, and misstatements in, the entity's financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that: (a) was available when financial statements for those periods were authorised for issue; and (b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.”

See

IAS 8, paragraph 5.

The Commission did not propose any additional clarification about when an error would be considered material for purposes of the listing standards required by proposed Rule 10D-1 because materiality is a determination that must be analyzed in the context of particular facts and circumstances and has received extensive and comprehensive judicial and regulatory attention.

See, e.g., TSC Industries, Inc.

Northway,

426 U.S. 438 (1976);

Basic

Levinson,

485 U.S. 224 (1988).

When we refer to financial statements, we mean the statement of financial position (balance sheet), statement of comprehensive income, statement of cash flows, statement of stockholders' equity, related schedules, and accompanying footnotes, as required by Commission regulations. When we refer to financial statements for registered investment companies and business development companies, we mean the statement of assets and liabilities (balance sheet) or statement of net assets, statement of operations, statement of changes in net assets, statement of cash flows, schedules required by 17 CFR 210. 6-10, financial highlights, and accompanying footnotes, as required by Commission regulations.

The Commission proposed to define the term as “the result of the process of revising previously issued financial statements to reflect the correction of one or more errors that are material to those financial statements.”

See

Section II.B.1 of the Proposing Release.

After the Commission issued the Proposing Release, some commentators expressed concerns that some issuers may not be making appropriate materiality determinations for errors identified

and may be seeking to avoid recovery under their compensation recovery policies.

In the Reopening Release, the Commission stated that it was considering whether to interpret the phrase “an accounting restatement due to material noncompliance” to include all required restatements made to correct an error in previously issued financial statements and sought public feedback on such an interpretation. In particular, the Commission requested comment on whether to provide that recovery is required with respect to both (1) restatements that correct errors that are material to previously issued financial statements (commonly referred to as “Big R” restatements), and (2) restatements that correct errors that are not material to previously issued financial statements, but would result in a material misstatement if (a) the errors were left uncorrected in the current

report or (b) the error correction was recognized in the current period (commonly referred to as “little r” restatements).

A “little r” restatement differs from a “Big R” restatement primarily in the reason for the error correction (as noted above), the form and timing of reporting, and the disclosure required. For example, a “Big R” restatement requires the issuer to file an Item 4.02 Form 8-K and to amend its filings promptly to restate the previously issued financial statements.

In contrast, a “little r” restatement generally does not trigger an Item 4.02 Form 8-K, and an issuer may make any corrections “the next time the registrant files the prior year financial statements.”

In connection with the Second Reopening Release, the Commission provided further opportunity to analyze and comment upon a memorandum prepared by Commission staff containing additional analysis and data on compensation recovery policies and accounting restatements.

See

Choudhary

et al., supra

note 61.

See, e.g.,

Jean Eaglesham,

Shh! Companies Are Fixing Accounting Errors Quietly,

Wall St. J. (Dec. 5, 2019),

available at https://www.wsj.com/articles/shh-companies-are-fixing-accounting-errors-quietly-11575541981.

See also

Rachel Thompson,

Reporting Misstatements as Revisions: An Evaluation of Managers' Use of Materiality Discretion

(working paper Sept. 17, 2021)

available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3450828

(

retrieved from SSRN Elsevier database

See

Staff Accounting Bulletin No. 108,

Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements

(Sept. 13, 2006). Studies cited and data included in this release on “little r” restatement frequency may define “little r” restatements differently than the definition used herein and are generally based on the total number of revisions to previously issued financial statements where the issuer did not file an Item 4.02 Form 8-K.

An Item 4.02 Form 8-K is required to be filed when an issuer concludes that any of its previously issued financial statements should no longer be relied upon because of an error in such financial statements. It is due within four business days after the conclusion.

See

supra

note 80.

In the 2022 staff memorandum, the staff refers to “little r” restatements as restatements that correct errors that would only result in a material misstatement if the errors were left uncorrected in the current report or the error correction was recognized in the current period. This reference has the same meaning as the description of “little r” restatements in this release.

b. Comments

We received a range of comments on the proposals regarding restatements triggering application of the compensation recovery policy. In response to the Proposing Release, some commenters expressed support for the proposed use of the concept of a “material error” as the standard for the recovery trigger.

Some commenters suggested that the materiality standard was vague, or thought examples would be helpful.

Other commenters recommended that the Commission expressly provide that a restatement to correct immaterial errors would not trigger a compensation recovery,

or sought additional guidance for aggregating immaterial error corrections.

Some commenters recommended that recovery should not be limited to restatements for errors that were material to the previously issued financial restatements,

or recommended revisions to the proposed definition of “accounting restatement.”

Other commenters suggested that recovery should be triggered when

any

revision to previously issued financial statements occurred.

Other commenters, noting a decline in the number of formal accounting restatements, recommended that the Commission expand the scope of the rulemaking beyond implementation of Section 10D to require compensation recovery policies to address instances of misconduct by executive officers that do not result in a financial restatement.

See

comment letters from Business Roundtable (Sept. 14, 2015) (“BRT 1”); Better Markets 1; Center On Executive Compensation (Sept. 14, 2015) (“CEC 1”); CFA Institute 1; Ernst & Young LLP (“EY”) (Sept. 15, 2015); NACD; PricewaterhouseCoopers LLP (“PWC”); SCG 1; and SBA.

See

comment letters from CalPERS 1; Exxon/Mobil Corporation (“Exxon”) (suggesting that recovery should only be triggered by a restatement that “significantly altered the total mix of information available”); International Bancshares Corporation (“IBC”) (suggesting that recovery should only be triggered by a restatement if there is a substantial likelihood a reasonable investor would consider the restatement as important in deciding how to vote); Japanese Bankers; National Association of Manufacturers (“NAM”) (suggesting ambiguity could result in great variation among issuers in which restatements should trigger recovery); and SBA.

See

comment letters from CCMC 1; Chevron Corporation (“Chevron”); EY; and SCG 1.

See also

comment letter from PWC (suggesting that inclusion of the word “material” clarifies that the listing standard would not apply to restatements that reflect the correction of immaterial errors).

See

comment letters from ABA 1; Chevron; Corporate Governance Coalition for Investor Value (“Coalition”); Davis Polk 1; FSR; and IBC.

See

comment letters from AFL-CIO (Sept. 14, 2015) (expressing concern regarding “revision restatements” that would allow an issuer to avoid the application of the proposed compensation recovery provisions); As You Sow (Sept. 15, 2015) (“As You Sow 1”); CII 1; CalPERS 1; and SBA.

But see

comment letter from ABA 1 (noting “that the analysis of an error's materiality takes into account the error's impact on executive compensation”).

See

comment letters from Chevron and SCG 1 (recommending that the definition include a specific reference to GAAP) and from ABA 1 (recommending that the definition refer to the applicable accounting standards).

See also

comment letter from PWC (noting that the proposed definition permits the listing standard to be applied regardless of the accounting framework a listed issuer follows).

See, e.g.,

comment letters from As You Sow 1; CII 1; and CalPERS 1.

See

comment letters from AFL-CIO; AFR 1; Plamen Kovachev (“Kovachev”) (recommending the rule include ethical misconduct triggers to more closely align the rule with executives' fiduciary duties); Rutkowski 1; and UAW Retiree Medical Benefits Trust,

et al.

(“UAW,

et al.”

In response to the Reopening Release, we received a similar range of comments relating to the recovery trigger and the meaning of “an accounting restatement due to material noncompliance.”

A number of commenters supported the standard set forth in the Proposing Release that would apply recovery policies only when a restatement is required to correct errors that are material to previously issued financial statements and triggers disclosure under Item 4.02(a) of Form 8-K.

These commenters further contended that an “accounting restatement due to material noncompliance” should not include “little r” restatements.

Other commenters supported interpreting what it means to be required to prepare an accounting restatement due to material noncompliance in the manner described in the Reopening Release.

Some of these commenters noted research suggesting that issuers may be deeming revisions to be immaterial even though the revisions meet at least one of the indicators of materiality described in Staff Accounting Bulletin No. 99.

Some of these commenters additionally suggested that the increasing prevalence of revisions may stem from management seeking to avoid restatements that would trigger an Item 4.02 Form 8-K filing or the application of a compensation recovery policy provision.

Some commenters further recommended expanding the recovery policy triggers.

One commenter on the Reopening Release suggested “it would be easier and more streamlined for issuers to rely on existing guidance, literature, and definitions concerning accounting errors rather than define the terms `accounting restatement' and `material noncompliance.' ”

See

comment letter in response to the Reopening Release from ABA 2.

See, e.g.,

comment letters in response to the Reopening Release from Davis Polk 3 (stating that “immaterial errors should not trigger clawback policies” and cautioning against creating a new materiality standard for disclosure of financial restatements solely for Rule 10D-1 purposes); Hunton; McGuireWoods, LLP and Brownstein Hyatt Farber Schreck LLP (“McGuireWoods”) (recommending that the Commission define “material error” as occurring when the issuer is required, by applicable accounting standards, to issue restated financial statements to correct one or more errors that are “material” to previously issued financial statements); S&C (contending that immaterial error corrections to the current period—commonly referred to as out-of-period adjustments—should not be included because they are not restatements or “due to material noncompliance”) (Nov. 16, 2021) (“S&C 2”); and SCG (Nov. 29, 2021) (“SCG 3”).

See, e.g.,

comment letters in response to the Reopening Release from Davis Polk 3 (contending that Proposing Release facilitates the purpose of the recovery rule in being triggered on the basis of “meaningful errors” and that “little r” restatements do not meet this standard and would create costs due to the uncertainty of the standard); Hunton (suggesting that “little r” restatements are immaterial to investors and should not serve as a recovery policy trigger); McGuireWoods (suggesting that Section 10D intended that not all restatements should trigger recovery and, in particular, that immaterial restatements should be excluded from recovery); and SCG 3. As discussed below, we disagree with how a number of these commenters characterize “little r” restatements.

See, e.g.,

comment letters in response to the Reopening Release from Better Markets (Nov. 22, 2021) (“Better Markets 2”) (recommending including a definition in the final rule, such as one defining an accounting restatement as either a revision restatement or a re-issuance restatement, to avoid unintended, inconsistent interpretations, and other enforcement challenges that could result from reliance on guidance); CFA Institute (Nov. 22, 2021) (“CFA Institute 2”) (suggesting a broad interpretation may serve to mitigate the perception of misaligned motivations); Council of Institutional

Investors (Nov. 18, 2021) (“CII 3”) (suggesting that Section 10D was not intended to narrowly limit the required recovery policy to exclude “little r” restatements); International Corporate Governance Network (“ICGN”); Occupy the SEC (“Occupy”); Ohio Public Employees Retirement System (Nov. 22, 2021) (“OPERS 2”) (recommending that the Commission clarify “that its definition of `accounting restatement' includes all required restatements made to correct an error in previously issued financial statements, regardless of whether they are formal restatements or revisions”); and Public Citizen 2.

See also

comment letters in response to the Second Reopening Release from Americans for Financial Reform (July 6, 2022) (“AFR 2”) (noting studies finding that “little r” restatements have been issued in lieu of “Big R” restatements to avoid compensation recovery provisions); and Council of Institutional Investors (June 24, 2022).

See, e.g.,

comment letters in response to the Reopening Release from CFA Institute 2 (further suggesting that lack of transparency in the issuer's materiality assessment and the reason for the method of correction may be contributing factors); and OPERS 2.

See, e.g.,

comment letters in response to the Reopening Release from Better Markets 2; and OPERS 2.

See, e.g.,

comment letters in response to the Reopening Release from New York City Retirement Systems (“NYCRS”) (recommending recouping compensation from executives responsible for detrimental conduct causing significant financial or reputational harm); and New York State Common Retirement Fund (“NYSCRF”) (recommending recouping compensation awarded to executives during periods of fraudulent activity, inadequate oversight, misbehavior, including discrimination and harassment of any kind, or gross negligence, which impacted or is reasonably expected to impact financial results or cause reputational harm).

A few commenters supported a requirement for an issuer to disclose its evaluation that errors are immaterial,

while some other commenters opposed requiring this disclosure.

100

Another stated that “involvement of the independent auditors in evaluating management's materiality analysis and concurring (through the audit opinion) with management's conclusion, with oversight from the company's audit committee, provides sufficient protection of investor interests that material errors do not go uncorrected by a company trying to avoid the clawback of incentive compensation.”

101

See, e.g.,

comment letters from Better Markets 1; CalPERS 1; and CFA Institute 1.

See also

comment letter from CFA Institute 1 (noting that because of the inherent estimates, judgements, and complexity involved, issuers should disclose their evaluations, the process and assumptions used to determine whether the error(s) in question were material or immaterial, and why they decided the matter in this way and suggesting that thorough disclosure provides investors enough information to understand the material facts and the reasoning behind such determination, and thereby helps them to make appropriate decisions about the board's actions); and ICGN.

100

See, e.g.,

comment letters from BRT 1 (suggesting it is a tenet of the Federal securities laws that disclosure of immaterial information is not required); EY; NACD; and SCG 1.

101

See

comment letter from EY.

c. Final Amendments

After considering comments received on the Proposing Release and reopening releases, in a change from the proposal, we are adopting rules to require listed issuers to adopt and comply with a written compensation recovery policy that will be triggered in the event the issuer is required to prepare an accounting restatement that corrects 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.

102

While the proposed rules focused on restatements for errors that are material to the previously issued financial statements, after further consideration and input from commenters, the final rules reflect a broader construction of the phrase “an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws” based upon the fact that both types of restatements are caused by

material

misstatements that either already exist or would exist in the current period.

102

See

17 CFR 240.10D-1(b)(1) (“Rule 10D-1(b)(1)”).

In our view, the statutory language of Section 10D—“an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws”—can appropriately be read to encompass both “Big R” and “little r” restatements. First, as a threshold matter, we disagree with those commenters who stated that “little r” restatements are not accounting restatements. We note that both are considered “accounting restatements” under U.S. GAAP and IFRS

103

because both result in revisions of previously issued financial statements for a correction of an error in those financial statements. In contrast, as noted by one commenter, sometimes the correction of an error is recorded instead in the current period financial statements—commonly referred to as an out-of-period adjustment—when the error is immaterial to the previously issued financial statements, and the correction of the error is also immaterial to the current period.

104

We agree with that commenter that an out-of-period adjustment should not trigger a compensation recovery analysis under the final rules, because it is not an “accounting restatement.”

105

103

See supra

note 72.

104

See

comment letter from S&C 2.

105

See supra

note 93. In response to commenters who requested clarification about the statement in the Proposing Release that “issuers should consider whether a series of immaterial error corrections, whether or not they resulted in filing amendments to previously filed financial statements, could be considered a material error when viewed in the aggregate,” we do not think this is necessary.

See supra

note 87. Staff guidance on materiality is already available which specifically addresses the aggregation of misstatements that individually do not cause the financial statements taken as a whole to be materially misstated.

See infra

note 108. Furthermore, the scope of the final amendments includes “little r” restatements, which are sometimes required due to the cumulative effects of an error over multiple reporting periods.

See

more detailed discussion below.

Second, both types of restatements address material noncompliance of the issuer with financial reporting requirements. In the case of a “Big R” restatement, the material noncompliance results from an error that was material to previously issued financial statements. In the case of a “little r” restatement, the material noncompliance results from an error that is material to the current period financial statements if left uncorrected or if the correction were recorded only in the current period.

106

Due to the materiality of the impact the error would have on the current period, the previously issued financial statements must be revised to correct it even

though the error may not have been material to those financial statements. We note that the plain language of Section 10D does not limit the concept of “an accounting restatement due to material noncompliance” to effects on previously issued financial statements, and thus the final rules require compensation recovery analysis for both “Big R” and “little r” restatements.

106

We note that certain errors may compound over time. While the initial error amount may not have been material to previously issued financial statements, it may become material due to its cumulative effect over multiple reporting periods. A material adjustment to the current period that relates to an error from previously issued financial statements would cause the current period financial statements to be materially misstated. An example of such error is an improper expense accrual (such as an overstated liability) that has built up over five years at $20 per year. Upon identification of the error in year five, the issuer evaluated the misstatement as being immaterial to the financial statements in years one through four. To correct the overstated liability in year five a $100 credit to the statement of comprehensive income would be necessary; however, $80 of it would relate to the previously issued financial statements for years one through four. During the preparation of its annual financial statements for year five, the issuer determines that, although a $20 annual misstatement of expense would not be material, the adjustment to correct the $80 cumulative error from previously issued financial statements would be material to comprehensive income for year five. Accordingly, the issuer must correct the financial statements for years one through four.

We also disagree with those commenters who asserted that including “little r” restatements would make it difficult to comply with the rule. Issuers are already required to perform a materiality analysis on each error that is identified in order to determine how to account for and report the correction of that error. Thus, issuers will have already performed the analysis necessary to identify these additional accounting restatements. Furthermore, the final rules reduce uncertainty regarding their scope by expressly identifying the types of restatements that are required to be included within an issuer's recovery policy.

In addition to being clear and consistent with applicable accounting literature, guidance, and the plain language of Section 10D, this construction of the statutory language addresses concerns that issuers could manipulate materiality and restatement determinations to avoid application of the compensation recovery policy.

107

In this regard, we note that Commission staff has provided guidance to assist issuers in making materiality determinations. The staff guidance emphasizes that an issuer's materiality evaluation of an identified unadjusted error should consider the effects of the identified unadjusted error on the applicable financial statements and related footnotes, and evaluate quantitative and qualitative factors.

108

Registrants, auditors, and audit committees should already be aware of the need to assess carefully whether an error is material by applying a well-reasoned, holistic, objective approach from a reasonable investor's perspective based on the total mix of information. Further, whether the misstatement has the effect of increasing management's compensation, for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation, is a qualitative factor that should be considered when making a materiality determination.

107

We note evidence supporting the materiality manipulation concern.

See, e.g.,

Brian Hogan and Gregory A. Jonas,

The association between executive pay structure and the transparency of restatement disclosures,

Acct. Horizons (Sept. 2016) (finding that CFO pay structure is correlated with the transparency of restatement disclosure (“Big R” vs. “little r”)).

See also

Thompson,

supra

note 69 (finding that issuers with compensation recovery provisions are more likely to report misstatements as “little r” restatements instead of “Big R” restatements).

108

See

Staff Accounting Bulletin No. 99,

Materiality

(Aug. 12, 1999) and Staff Accounting Bulletin No. 108,

Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements

(Sept. 13, 2006). (This guidance and any other staff statement cited in this release is not a rule, regulation, or statement of the Commission and the Commission has neither approved nor disapproved its content. This guidance, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.) We note that Commission staff have observed that some materiality analyses appear to be biased toward supporting an outcome that an error is not material to previously issued financial statements.

See id.

Relatedly, it has been reported that, while the total number of accounting restatements by issuers declined each year from 2013 to 2020, the percentage of “little r” restatements increased to approximately 76% of restatements in 2020.

See

Audit Analytics,

2020 Financial Restatements: A Twenty-Year Review

(November 2021).

Requiring recovery analysis for both “Big R” and “little r” accounting restatements does not eliminate the risk that an issuer could avoid a recovery obligation by manipulating its materiality analysis of an error.

109

While this is an inherent risk, we note the involvement of an independent auditor in evaluating management's materiality analyses, with the oversight of the audit committee, protects investor interests by helping ensure that material errors do not go uncorrected by an issuer seeking to avoid the recovery of erroneously awarded compensation. Furthermore, we note the potential serious consequences, including but not limited to Commission enforcement action and private litigation, of mischaracterizing material accounting errors as immaterial.

109

This could occur if an issuer were to inappropriately conclude that an identified error was not material to its previously issued financial statements or the current period.

For similar reasons, we are not adopting a requirement for an issuer to disclose the materiality analysis of an error when the error is determined to be immaterial, as recommended by some commenters. Inclusion of “little r” restatements in the scope of restatements triggering recovery, the involvement of independent auditors and oversight of audit committees, and the serious potential consequences of deliberate mischaracterizations of accounting errors, should mitigate the risk that some errors will be incorrectly determined to be immaterial. Further, many assessments of materiality are complex and highly sensitive to particular facts and circumstances. Requiring issuers to disclose sufficient information to make these assessments meaningful to investors would likely entail lengthy disclosures that may be of limited use for investors. Instead, we are adopting a disclosure requirement, discussed in Section II.D., for issuers to clearly identify on the cover page of their annual reports when the financial statement periods presented contain restatements, which should provide additional transparency regarding such restatements.

In a change from the proposal, Rule 10D-1 will not provide separate definitions of “accounting restatement” or “material noncompliance” as proposed. Existing accounting standards and guidance already set out the meaning of those terms.

110

This rule is not intended to affect that guidance. While we acknowledge that a number of commenters supported the proposed definitions of “accounting restatement” and “material noncompliance,” in light of the modifications discussed above, we agree with the commenter that suggested that it will be easier for issuers to look to existing guidance, literature, and definitions when assessing accounting errors

111

and that such an approach will help ensure that those standards are consistently applied both across different issuers and over time.

110

Rule 10D-1 clarifies the meaning of an “accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws.”

111

See

comment letter in response to the Reopening Release from ABA 2.

As indicated in the Proposing Release, we understand that under current accounting standards the following types of changes to an issuer's financial statements do not represent error corrections, and therefore would likewise not trigger application of the issuer's compensation recovery policy under the listing standards:

• Retrospective application of a change in accounting principle;

112

A change in accounting principle is “[a] change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles that apply or when the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle.”

See

ASC Topic 250. IAS 8 has similar guidance. A change from an accounting principle that is not generally accepted to one that is generally accepted, however, would be a correction of an error.

• Retrospective revision to reportable segment information due to a change in the structure of an issuer's internal organization;

113

If an issuer changes the structure of its internal organization in a manner that causes the composition of its reportable segments to change, the corresponding information for earlier periods,

including interim periods, should be revised unless it is impracticable to do so.

See

ASC Topic 280-10-50-34. IFRS 8 has similar guidance.

• Retrospective reclassification due to a discontinued operation;

114

See

ASC Topic 205-20. IFRS 5 has similar guidance.

• Retrospective application of a change in reporting entity, such as from a reorganization of entities under common control;

115

See

ASC Topic 250-10-45-21. IFRS does not have specific guidance addressing this reporting matter.

• Retrospective adjustment to provisional amounts in connection with a prior business combination (IFRS filers only);

116

and

116

See

IFRS 3, paragraph 45.

• Retrospective revision for stock splits, reverse stock splits, stock dividends or other changes in capital structure.

2. Date the Issuer Is Required To Prepare an Accounting Restatement

Section 10D(b)(2) requires recovery of erroneously awarded compensation “during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement.” Section 10D does not specify when an issuer is “required to prepare an accounting restatement” for purposes of this provision.

a. Proposed Amendments

The Commission proposed that the date on which an issuer is required to prepare an accounting restatement is the earlier to occur of:

• 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's previously issued financial statements contain a material error; or

• The date a court, regulator or other legally authorized body directs the issuer to restate its previously issued financial statements to correct a material error.

A note to the proposed rule indicated that the first proposed date generally is expected to coincide with the occurrence of the event described in Item 4.02(a) of Exchange Act Form 8-K, although neither proposed date would be predicated on if or when a Form 8-K was filed. In the Reopening Release, the Commission solicited further comment as to whether to remove the “reasonably should have concluded” language in light of concerns that the language adds uncertainty to the determination.

b. Comments

We received a range of comments on the proposed specification of the date the issuer is required to prepare an accounting restatement (referred to in this release as the “trigger date”). Some commenters supported including “reasonably should have concluded” as an objective standard that provides certainty and prevents manipulation or the potential for evasion,

117

while others expressed concern that use of “reasonably should have concluded” could introduce elements of uncertainty and subjectivity into the determination.

118

Some commenters recommended a bright-line standard involving a single date, such as the date of the Item 4.02(a) Form 8-K filing.

119

Other commenters recommended including as a trigger the filing of an Item 4.02(b) Form 8-K disclosing that independent accountants have advised the issuer that the financial statements can no longer be relied upon.

120

Some commenters, however, did not believe that receipt of such a notification from the auditor should be conclusive.

121

117

See

comment letters from Better Markets 1; and Compensia. Some commenters specifically supported using the earlier to occur of the alternative dates, as proposed.

See, e.g.,

letters from CalPERS 1; CII 1; and CFA Institute 1.

118

See, e.g.,

comment letters from ABA 1; BRT 1; CEC 1; Exxon; and SCG 1. Some of these commenters further suggested that the language could invite disputes or lead to litigation.

See, e.g.,

comment letters from Exxon; and SCG 1.

119

See, e.g.,

comment letters from Davis Polk 1; Mercer; and NACD.

See also

comment letters from Exxon (recommending the actual issuance of a restatement); and Public Citizen 1 (recommending the date the erroneous financial statement is filed).

120

See

comment letters from CFA Institute 1; and EY.

121

See

comment letters from ABA 1; and SCG 1.

Some commenters expressed the view that existing legal requirements provide sufficient deterrents against intentionally delaying issuance of a restatement.

122

Other commenters expressed concerns about the potential for delay,

123

and one suggested the proposed “reasonably should have concluded” language would discourage issuers from improperly delaying filing a restatement to avoid recovery.

124

122

See, e.g.,

comment letters from ABA 1 (noting that other existing laws, including the certification requirements and anti-fraud provisions of the Exchange Act as well as applicable corporate law, provide the appropriate incentives to make timely financial reporting determinations in connection with Commission filings); and Exxon (noting Commission and private litigation liabilities likely to accrue while a material error in an issuer's financial reporting remains uncorrected, the personal certification requirements applicable to the principal executive and financial officers, and the risk that an issuer's independent auditors will refuse to give an opinion on financial statements containing an uncorrected material error).

123

See

comment letters from Public Citizen 1; and CFA Institute 1 (noting that considerable time can pass between the time an error is detected and the time a court or regulator requires the issuer to take action).

124

See

comment letter from CII 1.

In response to the Reopening Release, a number of commenters expressed support for the inclusion of “reasonably should have concluded” language in the proposed rule because in their view it would create a more objective standard and appropriately limit board discretion.

125

In contrast, other commenters supported using the date the issuer's board of directors (or 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 that the issuer's previously issued financial statements contain a material error. Some of these commenters expressed concern about uncertainty or ambiguity associated with the “reasonably should have concluded” determination.

126

125

See, e.g.,

comment letters in response to the Reopening Release from Better Markets 2 (suggesting the “reasonably should have concluded” language imposes an enforceable obligation on the issuer and reduces the likelihood of litigation by inducing issuers to act prudently to avoid the risk); CFA Institute 2 (suggesting the language would mitigate concerns about internal investigations taking longer than necessary, unreasonable delays in reaching a conclusion, or misalignment of executives' incentives impacting the timeliness or accuracy of the financial reporting); and ICGN.

See also

comment letters in response to the Reopening Release from Eileen Morrell; Public Citizen 2; Occupy; and OPERS 2 (supporting the use of the “reasonably should have concluded” language); and comment letter in response to the Second Reopening Release from AFR 2 (suggesting that the “reasonably should have concluded” language discourages issuers from delaying actions necessary to fix erroneous financial statements).

126

See, e.g.,

comment letters in response to the Reopening Release from ABA 2 (suggesting the “reasonably should have concluded” language would add subjectivity by using a triggering event that differs from Form 8-K and would be open to second-guessing and litigation); CEC (Nov. 17, 2021) (“CEC 2”) (suggesting the language creates excessive uncertainty and excessive legal risk based on the board's view of when the look back period should commence versus the view of an impacted shareholder or an executive who disputes that timing); Davis Polk 3; and McGuireWoods (suggesting the standard would be ambiguous and overly broad and noting that Item 4.02 of Form 8-K relies on when the board concludes a restatement is required).

See also

comment letter in response to the Reopening Release from SCG 1 (noting that knowingly, recklessly, or negligently misreporting false or misleading financial information already subjects the issuer to liability).

Some commenters on the proposal additionally sought guidance as to the types of facts that would support a finding that the issuer reasonably should have concluded that its previously issued financial statements contain a material error.

127

Some

commenters also sought clarification regarding when a regulator or other legally authorized body directs an issuer to restate its previously issued financial statements to correct a material error.

128

127

See

comment letters from CEC 1; Compensia; and SCG 1 (seeking clarification that a restatement

by an issuer's peer group member does not trigger recovery when an issuer's incentive-based compensation is based on performance relative to the peer group).

128

See

comment letter from EY (suggesting that it may be unclear whether a request for a restatement from a regulator would be a trigger, given the lack of finality of the determination).

See also

comment letters from CEC 1 (recommending that the date not be established until a court order is final and non-appealable); and SCG 1 (recommending that the date of the initial court or agency restatement order should be designated as the starting point of the three-year look-back period, but only after the order is final and non-appealable).

c. Final Amendments

After considering the comments, we are adopting the rules substantially

129

as proposed to provide that under the listing standards the date on which an issuer is required to prepare an accounting restatement is the earlier to occur of:

129

In a nonsubstantive change from the proposal, we have incorporated the standard for the date the issuer is required to prepare an accounting restatement into 17 CFR 240.10D-1(a)(1)(ii) rather than separately defining the term “date on which an issuer is required to prepare an accounting restatement” in paragraph (c) as proposed.

• 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 due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws as described in Rule 10D-1(b)(1); or

• The date a court, regulator or other legally authorized body directs the issuer to prepare an accounting restatement.

130

See

17 CFR 240.10D-1(b)(1)(ii) (“Rule 10D-1(b)(1)(ii)”).

We believe the final rule provides reasonable certainty for issuers, shareholders, and exchanges while minimizing incentives for issuers to delay their restatement conclusions. While we acknowledge some commenters' assertion that a bright-line or single-date standard might be easier to apply, we continue to have concerns that such an approach would not address the potential for delay of a restatement determination in order to manipulate the recovery date.

As noted in the Proposing Release,

131

using the date the erroneous financial statements were filed as the triggering date would be inconsistent with the three-year look-back period because if the date of filing of the erroneous financial statements were used, recovery would not apply to any incentive-based compensation received after that date, even when the amount was affected by the erroneous financial statements. As a result, we disagree with the suggestion that the look-back period should be triggered by the date the issuer files the accounting restatement. The issuer will necessarily determine that it is “required to prepare” a restatement on or before the day it files the restatement. We have not adopted this suggestion because it would allow an issuer to delay the recovery period, and potentially reduce the amount of compensation subject to recovery, by delaying the filing of a restatement it had already determined it was required to prepare.

131

See

Proposing Release at Section II.B.2 (“For example, if 2014 net income was materially misstated, and a 2014-2016 long-term incentive plan had a performance measure of three-year cumulative net income, a look-back period that covered only the three years before the erroneous filing would not capture the compensation earned under that plan.”).

Rather, we agree with the commenters that indicated that the timing standard we are adopting is sufficiently certain and appropriately limits board discretion. The standard promotes compliance with the rule by making evasion of the application of a recovery policy more difficult.

132

The “reasonably should have concluded” concept reduces the incentive for an issuer to delay the investigation of a known error and the decision that a restatement is necessary, because the delayed decision date would not determine the beginning of the recovery period. We recognize that, as some commenters indicated, establishing the trigger date as the date that the issuer's board concludes, or reasonably should have concluded, that the issuer is required to prepare an accounting restatement creates some risk that the board's conclusions will be subject to litigation. We believe this risk is acceptable in light of the benefit of deterring issuers from manipulating the timing of their conclusions to avoid or delay a recovery obligation. In order to trigger application of the recovery policy, an issuer merely needs to have concluded that it is required to prepare an accounting restatement, which may occur before the precise amount of the error has been determined.

133

We further note that applying a reasonableness standard to the determination of the three-year look-back supports an exchange's ability to enforce the recovery provision by providing the exchange a standard by which to review an issuer's conclusion.

132

Rule 10D-1(b)(1)(ii) is being established specifically for purposes of determining the relevant recovery period under Rule 10D-1. The “reasonably should have concluded” language applies only with respect to the determination of the three-year look-back timing for purposes of compensation recovery. It does not apply with respect to a conclusion under applicable accounting rules and standards as to whether there is an error that requires a restatement.

133

We disagree with commenters that asserted that the reasonableness standard increases uncertainty or ambiguity. While we acknowledge that the standard is not a fixed date in time, it is intended to allow an exchange to assess, based on the facts available to the issuer, the point at which a reasonable person would have concluded that an accounting restatement is required. Contrary to a subjective determination, this standard provides for an objective assessment based on the facts available as to the determination of the timing of the lookback.

To the extent that an issuer is required to file an Item 4.02(a) Form 8-K, the conclusion that it is required to prepare an accounting restatement is expected to coincide with the occurrence of the event disclosed in the Form 8-K.

134

In addition, in applying a reasonableness standard to the determination of a three-year look-back period, while not dispositive, one factor that an issuer would have to consider carefully would be any notice that it may receive from its independent auditor that previously issued financial statements contain a material error.

135

134

In a modification from the proposal, we are no longer including a note indicating that the date generally is expected to coincide with the occurrence of the event described in Item 4.02(a) of Exchange Act Form 8-K because we are expanding the circumstances that would trigger the analysis to include “little r” restatements which generally do not require reporting on a Form 8-K.

135

We are not, however, adopting the suggestion of some commenters that the filing of an Item 4.02(b) Form 8-K disclosing that independent accountants have advised the issuer that the financial statements can no longer be relied upon be included as a trigger.

See supra

note 120. As noted by another commenter, such a date may not be conclusive.

See

comment letter from ABA 1. However, if a listed issuer files an Item 4.02(b) Form 8-K because it is advised by, or receives notice from, its independent accountant that disclosure should be made or action should be taken to prevent future reliance on a previously issued audit report or completed interim review related to previously issued financial statements that contain a material error, the triggering event for the recovery policy occurs, at the latest, when the listed issuer determines to restate its financial statements, even if it subsequently neglects to file an Item 4.02(a) Form 8-K to report that decision.

While we anticipate that most issuers will make their determination regarding the three-year look-back trigger based on the standard in 17 CFR 240.10D-1(b)(1)(ii)(A), some issuers may not conclude they are required to prepare an accounting restatement and instead may choose to contest whether an accounting restatement is required. While we expect these occurrences to be rare, 17 CFR 240.10D-1(b)(1)(ii)(B) (“Rule 10D-

1(b)(1)(ii)(B)”) clarifies that in these circumstances, the trigger date will be

no later than

the date a court, regulator, or other legally authorized body directs the issuer to prepare an accounting restatement. In the event that such date is different than the date an issuer reasonably should have concluded that an accounting restatement is required, Rule 10D-1(b)(1)(ii) mandates that the trigger date be the earlier date. In response to questions raised by a commenter, we are clarifying that for purposes of Rule 10D-1(b)(1)(ii)(B), the date of the initial court order or agency action would be the trigger date for the three-year look-back period, but that the determination and application of the recovery policy would occur only after the order is final and non-appealable.

Incorporating the triggering events into the rule rather than leaving the determination solely to the issuer will better realize the objectives of Section 10D while providing clarity about when a recovery policy, and specifically the determination of the three-year look-back period, is triggered for purposes of the listing standards. In this regard, we note that the rule also states that an issuer's obligation to recover erroneously awarded compensation is not dependent on if or when the restated financial statements are filed with the Commission.

136

See

17 CFR 240.10D-1(b)(1)(i)(B) (“Rule 10D-1(b)(1)(i)(B)”).

C. Application of Recovery Policy

1. Executive Officers Subject to Recovery Policy

Section 10D identifies the class of persons and the time frame during which that class of persons is subject to recovery of erroneously awarded incentive-based compensation. Specifically, Section 10D(b)(2) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with policies that provide for recovery of erroneously awarded compensation from “any current or former executive officer of the issuer who received incentive-based compensation” during the three-year look back period.

137

Section 10D does not define “executive officer” for purposes of the recovery policy. The Senate Committee on Banking, Housing, and Urban Affairs noted that “[t]his policy is required to apply to executive officers, a very limited number of employees, and is not required to apply to other employees.” Senate Report at 136.

a. Proposed Amendments

The Commission proposed to include in the listing standards a definition of “executive officer” modeled on the definition of “officer” in 17 CFR 240.16a-1(f) (“Rule 16a-1(f)”). For purposes of Section 10D, the proposed definition of “executive officer” included 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. The proposed definition expressly included the principal financial officer and the principal accounting officer (or if there is no such accounting officer, the controller), reflecting the view that their responsibility for financial information justifies their inclusion in the definition of “executive officer” for this purpose. As proposed, executive officers of the issuer's parents or subsidiaries would be deemed executive officers of the issuer if they perform such policy making functions for the issuer.

138

The proposed definition also contained specific provisions with respect to limited partnerships and trusts, and a note providing that “policy-making function” is not intended to include policy making functions that are not significant and that persons identified as “executive officers” pursuant to 17 CFR 229.401(b) are presumed to be executive officers for purposes of the proposed rule.

The Commission additionally proposed that the rules require recovery of excess incentive-based compensation received by an individual who served as an executive officer of the listed issuer at any time during the performance period. This would include incentive-based compensation derived from an award authorized before the individual becomes an executive officer, and inducement awards granted in new hire situations, as long as the individual served as an executive officer of the listed issuer at any time during the award's performance period.

139

As proposed, recovery would not apply to an individual who is an executive officer at the time recovery is required if that individual had not been an executive officer at any time during the performance period for the incentive-based compensation subject to recovery.

b. Comments

Commenters provided varying recommendations on the appropriate definition of “executive officer.” Some commenters expressly supported the proposed definition,

140

and one recommended expanding the definition.

141

Other commenters suggested that the proposed definition was too broad.

142

Some of these commenters contended that Section 10D does not require the breadth of the proposed definition,

143

and some further recommended various other limits on covered executive officers.

144

In contrast, some commenters noted that a narrower definition would exclude individuals with a significant executive role at an issuer and could be contrary to the interests of investors.

145

140

See, e.g.,

comment letters from AFL-CIO; AFR 1; As You Sow 1; Better Markets 1; CEC 1; CFA Institute 1; CII 1; OPERS (Sept. 14, 2015) (“OPERS 1”) (supporting the focus on policy-making functions); Public Citizen 1; Rutkowski 1; and UAW,

et al.

141

See

comment letter from Better Markets 1 (recommending including the principal legal officer, the chief compliance officer, and the chief information officer).

But see

comment letter from CEC 1 (suggesting that expanding the pool of executives beyond Section 16 officers would go beyond Congress' intended purpose).

142

See, e.g.,

comment letters from ABA 1; American Vanguard Corporation (“American Vanguard”); CCMC 1; Chevron; Coalition; Compensia; Duane; FedEx Corporation (Sept. 14, 2015) (“FedEx 1”); Fried; Hay Group, Inc. (“Hay Group”); IBC; Japanese Bankers; Kovachev; NAM; Pay Governance LLC (“Pay Governance”); S&C 1; SCG 1; Steven Hall & Partners (“SH&P”); and WorldatWork (“WAW”).

See also

comment letters in response to the Reopening Release recommending limiting the term to executives who had a meaningful role or responsibility over the issuer's financial reporting from ABA 2; CCMC 2; McGuireWoods; and SCG (Nov. 3, 2021) (“SCG 2”).

143

See, e.g.,

comment letters from CCMC 1; Chevron; Compensia; NAM; and SCG 1.

144

Some commenters recommended limiting the definition to the issuer's named executive officers as defined in 17 CFR 229.402(a)(3).

See, e.g.,

comment letter from Duane; FedEx 1; Fried; Hay Group; and NACD. Other commenters recommended limiting the definition to only the principal executive officer, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), and, in addition, any officer in charge of a principal business unit, division, or function or who performs a policy-making function and whom the board of directors or compensation committee determines to have had an important role in contributing to the events leading to a financial restatement.

See, e.g.,

comment letters from ABA 1; Chevron; and SCG 1. Still other commenters recommended various forms of scienter requirements.

See, e.g.,

comment letters from American Vanguard; CCMC 1; Coalition; Compensia; and SH&P.

145

See, e.g.,

comment letters from AFL-CIO; AFR 1; and Rutkowski 1.

We received limited comment specific to our proposal to base the definition on the Rule 16a-1(f) definition of “officer,” instead of the 17 CFR 240.3b-7 (“Rule 3b-7”) definition of “executive officer.”

146

A few commenters suggested that including all Section 16 officers, without providing the compensation committee discretion in enforcing recovery, may affect issuers' practices in identifying their executive officers.

147

146

See

comment letters from Keith Paul Bishop (“Bishop”) (recommending use of the Rule 3b-7 definition) and CalPERS 1 (supporting use of the Rule 3b-7 definition as an alternative to the proposal).

147

See

comment letters from ABA 1 (suggesting that some issuers may have an incentive to

reevaluate the identification of their “corporate insiders” to see whether they should reduce the number of individuals subject to those rules—particularly where the individual has little or no responsibility for accounting and finance matters); and Pearl Meyer (suggesting the definition may lead some issuers to redefine duties of executive officers in order to limit those subject to recovery).

See also

Compensia.

Several commenters recommended limiting recovery only to incentive-based compensation earned during the portion of the look-back period when the individual was an executive officer of the issuer.

148

Some questioned whether recovery for periods when the individual was serving in non-executive capacities would be consistent with the statute.

149

Others questioned the fairness of applying recovery to periods when an officer was not serving in an executive capacity.

150

Some commenters further expressed concern that this aspect of the proposal would discourage employees from serving as executive officers, with a detrimental impact on corporate governance and the issuer's ability to provide for smooth transitions.

151

In contrast, one commenter expressly supported the proposal.

152

148

See, e.g.,

comment letters from ABA 1; CCMC 1; CEC 1; Chevron; Compensia; Davis Polk 1; Duane; Ensco, PLC (“Ensco”); Exxon; FSR; FedEx 1; IBC; Mercer; NACD; and S&C 1.

See also

comment letters in response to the Reopening Release from Davis Polk 3; and McGuireWoods. One commenter additionally suggested granting the board discretion to recover only for the portion of the look-back period when the person was an executive officer.

See

comment letter from Ensco.

149

See

comment letters from Exxon; and FSR.

150

See

comment letters from FSR; and SH&P.

151

See

comment letters from Davis Polk 1; IBC; and S&C 1.

152

See

comment letter from CalPERS 1.

c. Final Amendments

After considering the comments, we are adopting the rules defining executive officers subject to recovery substantially as proposed, with modifications in response to commenters.

153

Section 10D uses the term “executive officer” to identify the persons who are to be subject to the rules without reference to a specific scope or defined term. As described above, while Congress did not intend to cover rank-and-file employees, it also did not limit the scope of recovery to those officers who may be “at fault” for accounting errors that led to a restatement, nor to those who are directly responsible for the preparation of the financial statements.

153

See

17 CFR 240.10D-1(b)(1)(i) (“Rule 10D-1(b)(1)(i)”) and the definition of “executive officer” in 17 CFR 240.10D-1(d) (“Rule 10D-1(d)”).

In developing the definition of “executive officer” for purposes of Rule 10D-1, we considered the statutory purpose of the rule. First, Section 10D seeks to recover erroneously awarded incentive-based compensation, reducing a potential form of unjust enrichment, in which executive officers would gain from accounting errors at the expense of shareholders. The statute thus protects shareholders from bearing the economic burden of erroneously awarded compensation derived from material noncompliance with financial reporting requirements. The statute also helps to maintain investor confidence in markets and improve liquidity by incentivizing executive officers to provide more accurate financial reporting. While some commenters recommended that we use our discretion to apply Section 10D to a limited set of executive officers, such as named executive officers, executive officers who had a role in preparing the financial statements, or executive officers who had a role in the accounting error leading to the restatement, we are not persuaded that such limitations would be consistent with Congress' goals. Further, Congress' use of the unqualified term “executive officer” in Section 10D, compared to its application of qualifiers to that term elsewhere in the Dodd-Frank Act, suggests that it did not intend to limit the group of executive officers subject to recovery.”

154

We note, for example, that Section 952 of the Dodd-Frank Act uses the term “named executive officer” and Section 953 directly refers to 17 CFR 229.402, which makes extensive use of the term “named executive officer”.

We also acknowledge commenters who recommended that we base the definition on Rule 3b-7.

155

The term “executive officer” as defined in 17 CFR 240.3b-7 and the term we are adopting are similar. However, we determined to establish a definition of “executive officer” in Rule 10D-1 in order to expressly include officers with an important role in financial reporting. This includes an issuer's president, principal financial officer, and principal accounting officer (or if there is no such accounting officer, the controller), which we note is consistent with the term “officer” as defined in Rule 16a-1(f). Although the compensation recovery provisions of Section 10D apply without regard to an executive officer's responsibility for preparing the issuer's financial statements, we believe that it is essential that officers with an important role in financial reporting be subject to the recovery policy, which is expected to further incentivize high-quality financial reporting.

155

See supra

note 146.

At the same time, because Congress broadly intended Section 10D to ensure that erroneously awarded compensation be returned to the issuer, we do not agree with commenters who suggested that the scope of the rule should be limited to only officers with a direct role in financial reporting. Further, including officers with policy-making functions or important roles in the preparation of financial statements in the definition of “executive officer” for purposes of Rule 10D-1 will ensure that the recovery policy requirements have the additional benefits of providing executive officers with an increased incentive to reduce the likelihood of inadvertent misreporting and of reducing the financial benefits to executive officers from failures to accurately account for the issuer's results. Because officers with policy making functions or important roles in the preparation of financial statements play an important managerial role and help set the tone at the top, ensuring that the required recovery policy will apply to any such officers may enhance these benefits. Further, requiring the issuer to establish a direct connection between an executive officer and a material error would add significant time, uncertainty, and litigation risk to recovery determinations, which in turn would increase costs to the issuer and its shareholders.

Further, the definition of “executive officer” we are adopting, like the Rule 16a-1(f) definition of “officer,” provides that executive officers of the issuer's parents or subsidiaries may be deemed executive officers of the issuer if they perform policy making functions for the issuer. Identification of an executive officer for purposes of this section would include, at a minimum, executive officers identified pursuant to 17 CFR 229.401(b).

156

With respect to commenters who indicated that issuers may have an incentive to mischaracterize an officer determination, we remind issuers that such a determination must be an objective determination without regard to whether that officer is subject to a recovery policy.

156

See

Rule 10D-1(d), modeled on the Note to Rule 16a-1(f).

We also concluded that applying additional scienter or responsibility requirements as suggested by some commenters would run counter to the intent of the statute. Section 10D does not require the issuer to establish scienter before it may recover erroneously awarded incentive-based compensation, nor does the statute limit recovery to executive officers who were directly involved with the accounting error. This suggests that Congress intended that the recovery policy be

implemented without regard to the fault of the executive officers for the accounting errors. In this regard, we believe Section 10D was established not to punish wrongdoing, but to require executive officers to return monies that rightfully belong to the issuer and its shareholders.

The statute specifically requires recovery from any current or former executive officers of the issuer who received incentive-based compensation in excess of what would have been paid to the executive officer under the accounting restatement. Section 10D(b)(2) expressly states that the recovery policy must apply to “any current or former executive officer of the issuer.” We believe recovery from former executive officers is appropriate because otherwise, such individuals would be in a position to improperly benefit from material errors that occurred during their tenure as executive officers at the issuer.

157

The final amendments do not distinguish between former executive officers that leave a company, retire, or transition to an employee role (including after serving as an executive officer in an interim capacity) during the recovery period. We disagree with commenters who suggest that an individual who serves as an executive officer and then transitions to an employee role should not be subject to recovery of incentive based compensation received while serving as an employee. Section 10D-1 specifically applies to “former executive officers” and does not distinguish among types of former executive officers. Moreover, any former executive officer who is now an employee who receives incentive-based compensation that would be affected by the recovery policy is receiving compensation that, had the issuer's financial statements not been in error, the individual would not have received. Similarly, while we acknowledge commenters' concerns regarding the application of the statute and the rules to interim executive officers, the recovery policy would only apply if such interim (and former interim) executive officers received erroneously awarded compensation as a result of errors in the financial statements. Like retired executives, such individuals would be in a position to benefit from erroneously awarded compensation as a result of such errors. The potential for such benefit would weaken the individual's incentives to ensure accurate financial statements while they were serving as an executive.

We agree, however, with commenters who suggested that requiring recovery from individuals for incentive-based compensation received prior to the period when they became an executive officer may not serve the goals of the statute.

158

Therefore, in a change from the proposal, the final rule will only require recovery of incentive-based compensation received by a person (i) after beginning service as an executive officer and (ii) if that person served as an executive officer at any time during the recovery period.

159

Recovery of compensation received while an individual was serving in a non-executive capacity prior to becoming an executive officer will not be required.

160

158

See supra

note 150.

159

See

17 CFR 240.10D-1(b)(1)(i)(A) and (B). The rule further provides that the recovery policy applies to incentive-based compensation received while the issuer has a class of securities listed on an exchange and during the three completed fiscal years immediately preceding the date that the issuer is required to prepare an accounting restatement.

See

17 CFR 240.10D-1(b)(1)(i)(C) and (D).

160

Id.

Note that an award of incentive-based compensation granted to an individual before the individual becomes an executive officer will be subject to the recovery policy, so long as the incentive-based compensation was received by the individual at any time during the performance period after beginning service as an executive officer.

We further note that the recovery requirement also does not apply to an individual who is an executive officer at the time recovery is required if that individual was not an executive officer at any time during the period for which the incentive-based compensation is subject to recovery. Nevertheless, nothing in the rule would limit an issuer's compensation recovery policy from requiring recovery more broadly.

2. Incentive-Based Compensation

a. Incentive-Based Compensation Subject to Recovery Policy

Section 10D(b)(2) requires exchanges and associations to adopt listing standards that require issuers to adopt and comply with recovery policies that apply to “incentive-based compensation (including stock options awarded as compensation)” that is received, based on the erroneous data, in “excess of what would have been paid to the executive officer under the accounting restatement.” Implicit in these statutory requirements is that the amount of such compensation received in the three-year look-back period would have been less if the financial statements originally had been prepared as later restated.

i. Proposed Amendments

The Commission proposed to define “incentive-based compensation” in a principles-based manner as “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure.” The proposed definition further provided that “financial reporting measures” are measures that are determined and presented in accordance with the accounting principles used in preparing the issuer's financial statements, any measures derived wholly or in part from such financial information, and stock price and total shareholder return (“TSR”). As proposed, “incentive-based compensation” would include options and other equity awards whose grant or vesting is based wholly or in part upon the attainment of any measure based upon or derived from financial reporting measures.

ii. Comments

We received a range of comments relating to the proposed definition of “incentive-based compensation.” Some commenters endorsed the proposed principles-based approach to defining “incentive-based compensation.

161

Other commenters recommended that the definition leverage existing executive compensation disclosure requirements and look to the existing definition of “incentive plan.”

162

We also received a range of comments relating to the types of awards that should be covered. Some commenters recommended that the Commission expand the definition to include subjective awards as covered incentive-based compensation,

163

while others objected to recovering compensation based on qualitative or discretionary standards.

164

Similarly, a number of commenters expressed concern about excluding, or recommended including, time- or service-based awards.

165

Other

commenters supported excluding time- or service-based awards

166

and awards based on attaining nonfinancial measures.

167

Some of these commenters requested specific confirmation that time-based equity awards are not considered incentive-based compensation for purposes of the rule.

168

Some commenters supported having the rule also apply to deferred compensation as proposed;

169

however, several other commenters expressed concern that application to deferred compensation plans and pension plans could violate the Internal Revenue Code or Employee Retirement Income Security Act (“ERISA”).

170

161

See, e.g.,

comment letters from Better Markets 1; CalPERS 1; CFA Institute 1; and OPERS 1. Commenters generally did not see the need for anti-evasion provisions.

See, e.g.,

comment letters from Better Markets 1; CalPERS 1; and NACD.

But see

comment letter from OPERS 1.

162

See, e.g.,

comment letters from ABA 1 (recommending including only awards already reported in an issuer's executive compensation disclosure and reported in the equity incentive plan and non-equity incentive plan awards columns of the Grants of Plan-Based Awards Table pursuant to 17 CFR 229.402(d) that are granted, earned or vested based wholly or in part upon attainment of a financial reporting measure); and Kovachev (recommending reference to the 17 CFR 229.402(a)(6)(ii) definition of “incentive plan,” excluding compensation determined by metrics such as market share or customer satisfaction).

163

See, e.g.,

comment letters from Better Markets 1 (recommending a presumption that all incentive-based compensation is based in whole or in part on financial reporting measures); and Public Citizen 1 (recommending similar levels of recovery of all incentive-based compensation).

See also

comment letter from CFA Institute 1 (recommending board discretion to recover compensation based on satisfying subjective standards to the extent the subjective standards are satisfied in whole or in part by meeting a financial reporting measure performance goal) and comment letter in response to the Reopening Release form ICGN (recommending including ESG-related metrics).

164

See, e.g.,

comment letters from FSR; Kovachev (contending that including discretionary bonuses would be beyond the scope of the statute); and NACD.

See also

comment letter from ABA 1 (noting that subjective awards do not lend themselves to formulaic re-creation).

165

See, e.g.,

comment letters from AFL-CIO (recommending that for stock options awarded as compensation the board make reasonable estimates of the effect on stock price); and Pay Governance (suggesting that excluding service-based equity awards could create an incentive to grant more such awards, thus shifting away from pay-for-performance).

166

See, e.g.,

comment letters from ABA 1; CEC 1; Chevron; Compensia; Davis Polk 1; FedEx 1; Japanese Bankers; Kovachev; and SCG 1.

167

See

comment letter from FedEx 1.

See also

Kovachev (recommending defining covered equity awards by referencing compensation reported in the Estimated Future Payouts Under Equity Incentive Plan Awards column of the Grants of Plan-Based Awards table provided pursuant to 17 CFR 229.402(c)).

168

See, e.g.,

comment letters from Chevron; Compensia; and SCG 1. These commenters were concerned that the stock price metric included in the proposed definition could be read to include an equity award for which value is determined based on stock price but vests solely upon completion of a specified employment period or passage of time.

169

See

comment letters from AFR 1; and Rutkowski 1.

170

See, e.g.,

comment letters from ABA 1; Exxon; FSR; IBC; Mercer; SCG 1; Sutherland Asbill & Brennan LLP (“Sutherland”); and WAW.

But see

comment letter from ABA 1 (noting that the forfeiture of excess incentive-based compensation deferred into a holdback plan as a recovery mechanism would be permissible and would not result in an accelerated payment under Section 409A of the Internal Revenue Code).

See

discussion relating to the exemption for tax-qualified retirement plans in Section II.B.3.b.iii.

We received a number of comments on the proposed inclusion of TSR/stock price metrics. Some commenters expressly supported inclusion of these metrics,

171

some commenters expressed qualifications or reservations but did not object to their inclusion,

172

and other commenters expressly opposed inclusion of stock price/TSR metrics.

173

Commenters opposed to inclusion of these metrics noted the costs, uncertainty, and subjectivity of calculating recoverable amounts,

174

questioned the proposed definition of “incentive-based compensation,”

175

expressed concern over the potential for litigation from shareholders or executive officers challenging the amount determined,

176

questioned the statutory authority to cover the metrics,

177

and suggested that the metrics' inclusion could discourage the use of TSR as a performance measure.

178

Another commenter recommended providing a safe harbor for determining the amount subject to recovery if stock price and TSR metrics are included.

179

171

See, e.g.,

comment letters from AFR 1; Better Markets 1 (suggesting that these metrics fall within the ambit of the statutory formulation, which broadly encompasses all compensation “based on financial information required to be reported under the securities laws” and provides for recovery of excessive compensation “based on” erroneous data and that because stock price and TSR are widely used in calculating executive compensation their exclusion would substantially undermine the attainment of the objectives underlying Section 10D); CalPERS 1; and Rutkowski 1 (suggesting that inclusion is appropriate because stock price is based on investor expectation of cash flows, which are in turn deeply informed by accounting metrics).

172

See,

e.g.,

comment letters from CFA Institute 1 (noting that establishing a link between financial errors and a change in stock price would be easier in cases of fraud that are meant to directly affect stock price); Compensia (expressing concern regarding how to calculate the amounts subject to recovery); and OPERS 1.

173

See, e.g.,

comment letters from ABA 1; BRT 1; Davis Polk 1; FSR; FedEx 1; Fried; IBC; Japanese Bankers; Mercer; Meridian Compensation Partners LLC (“Meridian”); NACD; Pearl Meyer; and SH&P.

See also

comment letters in response to the Reopening Release from Cravath, McGuireWoods; and Hunton.

174

See, e.g.,

comment letters from Davis Polk 1; FedEx 1; Fried; FSR; IBC (suggesting that analyses by third-party advisors are expensive, highly speculative, and imprecise); Mercer (citing the study of restatements by the Center for Audit Quality considered in the Proposing Release to show that restatements at over 4,000 companies caused only an average 1.5% decline in stock price and a median decline of 0.01%. The average impact of restatements as a result of a material error was slightly higher (−2.3%), but the median was also near zero%); and SH&P. Some of these commenters suggested that the subjectivity of calculating the amounts for stock price/TSR metrics would be incompatible with the no-fault standard of the proposed rule.

See, e.g.,

comment letters from Davis Polk 1; FedEx 1; and SH&P (further recommending that due to the subjectivity, recovery should be at the discretion of the board).

See also

comment letters in response to the Reopening Release from Cravath; Hunton; and McGuireWoods (suggesting that calculating the amounts would be difficult and would require additional economic analysis by issuers).

175

See, e.g.,

comment letter from ABA 1 (recommending that the present disclosure requirements under Item 402 of Regulation S-K adequately define the types of compensation that should be considered “incentive-based compensation” for purposes of Section 10D: that is non-equity incentive plan awards as reported in columns (c) through (e) of the Grants of Plan-Based Awards table pursuant to 17 CFR 229.402(d)(2)(iii) and equity incentive plan awards as reported in columns (f) through (h) of that table pursuant to 17 CFR 229.402(d)(2)(iv)).

176

See

comment letters from Davis Polk 1; and FSR.

177

See

comment letters from ABA 1; Meridian (suggesting that implicit in the determination of excess incentive-based compensation is that the reach of Section 10D is limited to incentive-based compensation that is linked to the achievement of specific financial metrics); and NACD.

See also

comment letters in response to the Reopening Release from ABA 1 (suggesting it is inconsistent with the statutory mandate to include either an issuer's stock price or its TSR in such definition as each measure reflects many factors beyond the issuer's reported financial information, the sole criterion set forth in Section 10D); and McGuireWoods (suggesting the term is limited to financial reporting measures used in preparing the issuer's financial statements that are accounting-based metrics).

178

See, e.g.,

comment letter from FSR (suggesting that avoiding the use of TSR could be problematic in light of proposed “pay-versus-performance” rules requiring issuers to disclose the relationship between company performance as reflected by TSR and the compensation paid).

179

See

comment letter in response to the Reopening Release from McGuireWoods.

iii. Final Amendments

After considering the statutory language of Section 10D, the views of commenters, and the administrability of any mandatory recovery policy that encompasses incentive-based compensation, we are adopting substantially as proposed the defined term “incentive-based compensation.”

180

Specifically, for purposes of Rule 10D-1, we are defining “incentive-based compensation” to be “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.”

181

We determined to define the term in a principles-based manner so that the rule will capture new forms of compensation that are developed and new measures of performance upon which compensation may be based. As noted above, any incentive-based compensation recovered under the final rules is compensation that an executive officer would not have been entitled to receive had the financial statements been accurately presented. A number of the alternatives recommended by commenters would omit incentive-based compensation received outside of an incentive plan. Allowing executive officers to retain such incentive-based pay when it was erroneously awarded based on material accounting errors would undermine the statutory purpose of Section 10D to recover these amounts for the benefit of issuers and their shareholders. Absent recovery of such compensation, executive officers would still be in a position to benefit from

accounting errors, undermining their incentives to ensure reliable financial reporting. Further, gaps in the forms of incentive-based pay that would be subject to recovery might encourage issuers to shift compensation towards omitted categories, further undermining the purpose of the rule.

180

See

Rule 10D-1(d). The definition applies only to recovery of incentive-based compensation under proposed Rule 10D-1, and does not apply to the recovery of incentive-based compensation pursuant to 15 U.S.C. 7243 (“Sarbanes-Oxley Act Section 304”).

181

“In part” is included in the definition to clarify that incentive-based compensation need not be based solely upon attainment of a financial reporting measure. An example of compensation that is based in part upon the attainment of a financial reporting measure would include an award in which 60% of the target amount is earned if a certain revenue level is achieved, and 40% of the target amount is earned if a certain number of new stores are opened. Similarly, an award for which the amount earned is based on attainment of a financial reporting measure but is subject to subsequent discretion by the compensation committee to either increase or decrease the amount would be based in part upon attainment of the financial reporting measure.

Consistent with the proposal, we are defining “financial reporting measures” to be measures that are determined and presented in accordance with the accounting principles used in preparing the issuer's financial statements, and any measures derived wholly or in part from such measures.

182

This includes “non-GAAP financial measures” for purposes of Exchange Act Regulation G and 17 CFR 229.10 as well other measures, metrics and ratios that are not non-GAAP measures, like same store sales.

183

Financial reporting measures may or may not be included in a filing with the Commission, and may be presented outside the financial statements, such as in Management's Discussion and Analysis of Financial Conditions and Results of Operations

184

or the performance graph.

185

182

See

Rule 10D-1(d).

183

See Conditions for Use of Non-GAAP Measures,

Release No. 33-8176 (Jan. 22, 2003) [68 FR 4820 (Jan. 20, 2003)] and

Commission Guidance on Management's Discussion and Analysis of Financial Condition and Results of Operations,

Release No. 33-10751 (Jan. 30, 2020) [85 FR 10571 (Feb. 25, 2020)].

184

17 CFR 229.303.

See also

Item 5, Form 20-F. Examples of such measures could be accounts receivable turnover, Earnings before interest, taxes, depreciation and amortization, or sales per square foot.

185

17 CFR 229.201(e).

In order to provide guidance to issuers, we reiterate the examples of financial reporting measures provided in the Proposing Release, including, but not limited to, the following accounting-based measures and measures derived from:

• Revenues;

• Net income;

• Operating income;

• Profitability of one or more reportable segments;

186

As disclosed in a financial statement footnote.

See

ASC Topic 280.

• Financial ratios (

e.g.,

accounts receivable turnover and inventory turnover rates);

• Net assets or net asset value per share (

e.g.,

for registered investment companies and business development companies that are subject to the rule);

• Earnings before interest, taxes, depreciation and amortization;

• Funds from operations and adjusted funds from operations;

• Liquidity measures (

e.g.,

working capital, operating cash flow);

• Return measures (

e.g.,

return on invested capital, return on assets);

• Earnings measures (

e.g.,

earnings per share);

• Sales per square foot or same store sales, where sales is subject to an accounting restatement;

• Revenue per user, or average revenue per user, where revenue is subject to an accounting restatement;

• Cost per employee, where cost is subject to an accounting restatement;

• Any of such financial reporting measures relative to a peer group, where the issuer's financial reporting measure is subject to an accounting restatement; and

• Tax basis income.

In addition, the definition of “financial reporting measures” also includes stock price and TSR, as proposed.

187

As the Commission noted in the Proposing Release, Section 10D(b) requires disclosure of an issuer's policy with respect to “incentive-based compensation that is based on financial information required to be reported under the securities laws” and recovery of compensation awarded “based on the erroneous data.” We note that Congress' direction to include compensation that is “based on” financial information and to recover compensation “based on” the erroneous accounting data suggests Congress' intent to provide an expansive reading of those terms. The final rule therefore encompasses incentive-based compensation tied to measures such as stock price and TSR because improper accounting affects such measures and in turn results in excess compensation.

188

187

In a nonsubstantive modification from the proposal, we have broken out the inclusion of stock price and TSR in a separate clause of the definition. By including a separate clause in the definition, instead of using the conjunctive “and,” the modification makes clear that stock price and TSR are financial reporting measures.

188

One commenter recommended using the definition of “incentive plan award” in 17 CFR 229.402(a)(6)(iii) of Regulation S-K, which includes “any other performance measure.”

See

comment letter from ABA 1. Using the existing definition of “incentive plan award” to define “incentive-based compensation” would apply the recovery to a different scope of incentive compensation. The Rule 10D-1 definition does not include “other performance measures” in light of Section 10D's reference to incentive-based compensation based on financial information required to be reported under the Federal securities laws.

Although the phrase “financial information required to be reported under the securities laws” might be interpreted as applying only to accounting-based metrics, in consideration of the statutory purpose described above, we have determined that it is appropriate to interpret the term to include performance measures including stock price and TSR that are affected by accounting-related information and that are subject to our disclosure requirements. 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. While some commenters recommended that we narrow the scope of the definition, we agree with other commenters that supported a broader reading of the definition.

189

As one commenter noted, stock price is at least in part based on investor expectation of cash flows, which is intrinsically tied to a company's financial statement disclosures.

See supra

note 171.

We disagree with the contention put forth by some commenters that Section 10D is limited to incentive-based compensation that is linked to the achievement of specific financial metrics. Section 10D requires disclosure of the policy of the issuer on “incentive-based compensation that is based on financial information required to be reported under the securities laws.” The use of the term “based on” is expansive and the statute does not explicitly delineate the types of financial information that should be considered. Section 10D(b) separately requires the issuer to recover from any current or former executive officer of the issuer who received “incentive-based compensation . . . based on the erroneous data.” As we have previously noted, if an executive officer erroneously receives incentive-based compensation based on stock price or TSR that was inaccurate as a result of an accounting misstatement, that compensation is based on such erroneous data.

190

Being mindful of the statutory language and purpose of Section 10D, we do not see a basis for allowing that executive officer to retain such compensation, given that it was erroneously awarded. Absent recovery of such compensation, certain executive officers would be in a position to benefit from accounting errors, undermining their incentives to ensure reliable financial reporting. We therefore believe that inclusion of incentive-based

compensation based on stock price and TSR is necessary and appropriate for the implementation of Section 10D. Adopting a narrower definition of “incentive-based compensation” or “financial reporting measures” would result in the failure to recover from executive officers incentive-based compensation that was erroneously awarded to them, and therefore would be less effective in achieving the goals of the statute.

190

We note that Rule 10D-1 applies only to erroneously awarded incentive-based compensation based on stock price or TSR that was inaccurate as a result of the issuer's a

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