GCG 2023-07-14
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Overview of Clawback Rule of Erroneously Awarded Executive Compensation

Overview of Clawback Rule of Erroneously Awarded Executive Compensation

Background and Significance

During the financial crisis of 2007, major U.S. financial institutions such as Lehman Brothers, Merrill Lynch, Bear Stearns, AIG, etc., filed for bankruptcy, throwing both the U.S. and the entire global economy into a liquidity crisis. Various programs, such as the Troubled Assets Relief Program (TARP), were created to respond to this crisis but were criticized for their systematical risks and questionable effectiveness. Against this backdrop, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in 2010 to overhaul the financial regulatory system and reinforce regulations on important financial institutions. 

The Dodd-Frank Act required the Securities and Exchange Commission (the “SEC”) to establish a new rule related to the recovery of erroneously awarded incentive compensation of executive officers. Accordingly, the SEC proposed its first clawback rule in 2015 before adopting the final rule of Listing Standards for Recovery of Erroneously Awarded Compensation (SEC Rule 10D-1, hereinafter referred to as the “clawback rule”) in October 2022. 

Under the clawback rule, the SEC required U.S. stock exchanges to establish new listing standards by February 26, 2023. The listing standards proposed by the New York Stock Exchange (the “NYSE”) and NASDAQ were approved by the SEC and are to take effect starting October 2, 2023. All listed companies shall have to adopt corporate clawback policies as directed by the listing standards by December 1, 2023, which is 60 days from October 2, 2023.

The key objective of the clawback rule is to prevent corporate executives from initially overstating the company’s financial performance in order to increase the stock price prior to announcing the financial statements then purposely revising the performance after the fact. Unlike the existing Sarbanes-Oxley Act (2002), where clawbacks were only applicable to CEOs and CFOs, this new clawback rule is notably different in that even executive officers without direct involvement in preparing or disclosing financial statements are also subject to the clawback. The following section will elaborate on the key takeaways of the new rule.

Key Takeaways

Under the new clawback rule, U.S. stock exchanges must include listing standards that require listed companies to adopt clawback policies for erroneously awarded incentive-based executive pay. Moreover, when listed companies issue a financial restatement, they must cancel or recover the excess portion of erroneously awarded incentive compensation based on miscalculated financial accounting and disclose their clawback policy and the application of such policy, regardless of whether the executive officer was involved in or culpable for the financial miscalculations. Companies that fail to act in compliance with the adoption, implementation, and disclosure of the clawback policy will be delisted or prohibited from primary listing on U.S. stock exchanges.

This rule applies to all listed entities in the NYSE and NASDAQ. It affects all corporate executive officers, including CEOs, financial and accounting executives, deputy representatives of principal business divisions, policy management officers, and all current and former executive officers. Clawback can apply to compensation dating up to three fiscal years immediately preceding the date of the determination of the financial restatement, and the amount subject to recoupment shall be the excess portion of compensation calculated by subtracting the compensation of the corrected financials from the previously received compensation. Profits from stock options and stock sales are also subject to clawback if they were awarded as compensation.


DR & AJU’s Comments

Korean companies that are listed in the NYSE, including Posco Holdings, KT, SKT, LG Display, KB Financial Group, Woori Financial Group, Shinhan Financial Group, Korea Electric Power Corporation, and the MMORPG game company Gravity, must promptly prepare and implement corporate clawback policies by December 1, 2023. Companies that fail to comply may be delisted or banned from U.S. stock exchanges. Therefore, domestic companies preparing to be listed in exchanges in the U.S. must especially be alert of the coming changes. 

The SEC’s clawback rule requires companies to strictly manage their financials, as a company’s financial statement can be crucial information to current and future investors. Likewise, companies will increasingly be expected to establish internal controls in corporate governance to create an equitable and orderly financial system.

Similarly, Korea is actively reviewing and seeking to improve issues in the existing financial system. Korea’s Financial Services Commission (the “FSC”) and Financial Supervisory Service (the “FSS”) have recently launched a joint task force to improve the corporate governance of banks in relation to compensation policies and are also currently operating a working group. Specifically, in a meeting with the CEOs of major financial holding companies, the FSC announced plans to implement the following measures: (i) the adoption of incentive plans for the long-term performance of executive officers; (ii) the reinforcement of shareholder control for executive remuneration plans; (iii) the expansion of disclosures for individual executive remuneration payment; and (iv) the establishment of legal grounds to recover incentive-based pay in the event that the company suffers a loss. 

DR & AJU's Washington, D.C. Liaison Office and D&A Advisory, Inc. deliver accurate and crucial information to help companies operating overseas to effectively respond to changes in local laws and regulations and ensure compliance with applicable laws by providing comprehensive advisory on implementing internal control strategies. 

DR & AJU will continue to closely monitor developments in global public relations and international affairs to respond expeditiously with close cooperation with businesses when necessary.

Introduction to GCG

DR & AJU’s Global Compliance Group (the “GCG”) is founded with the purpose to prevent and minimize corporate risks for companies in Korea. GCG's goal is to create a favorable business environment by providing strategic solutions to prevent, manage, and minimize various risks a corporate entity may face doing business domestically or globally. 
DR & AJU GCG provides various risk management services from pre-transaction investigation, strategic research, and field investigation to review of a potential dispute, monitoring, and representing in litigations and post-litigation follow-up work. Furthermore, GCG aims to be a strategic partner to our clients in their creative management by predicting and preparing political and regulatory risks due to changes in global dynamics or political landscape that our clients may face in or out of Korea.
DR & AJU GCG team comprises experienced lawyers of various backgrounds, including the prosecution, police, politicians, administration officials, military generals and intelligence officers, national security authorities, North Korea experts, investigators, computer forensics experts, and financial and media experts.