As 2023 comes to a close and companies begin preparing their Form 10-K, one question keeps emerging: to check or not to check Form 10-K’s new restatement and compensation recovery (“clawback”) checkboxes?
Clawback Rules Refresher
In October 2022, the SEC issued final rules implementing Section 954 of the Dodd-Frank Act. The new rules directed national securities exchanges to establish standards requiring listed companies to develop, implement and disclose policies to recover incentive-based compensation awarded to executive officers based on financial statements that are later restated. (See our October 28, 2022 client alert). Listed companies were required to adopt compliant clawback policies by December 1, 2023, which must be filed as exhibit 97 to upcoming Form 10-K filings.
The Checkboxes are Mandatory this Year
The SEC first introduced the checkboxes on Form 10-K in early 2023, but companies were not expected to comply with the checkboxes until they were required to have in place a clawback policy. See Exchange Act Forms C&DI 104.19. For calendar-year companies, the Form 10-K for fiscal year 2023 that gets filed in 2024 will be the first time that compliance with the SEC’s new clawback checkboxes is required. The first checkbox (“Box 1”) addresses whether the company had to correct errors from previous financial statements. The second checkbox (“Box 2”) covers whether a corrected error prompted a clawback analysis:
How the New Checkboxes Interact
If a company checks Box 1 to reflect the correction of an error to previously issued financial statements, then that company will only check Box 2 if a compensation recovery or clawback analysis was required as a result of that error. Checking Box 1 is a prerequisite to checking Box 2. The reverse is not true. While a company will never check Box 2 unless it has also checked Box 1, Box 1 can be checked without a concurrent check in Box 2.
To Check or Not to Check
Companies should check Box 1 if “the financial statements … included in the filing reflect the correction of an error to previously issued financial statements.” Whether to check Box 1 requires a two-part analysis: (i) does the filing reflect the correction of an error, as defined in US accounting rules, specifically Accounting Standards Codification (ASC) Topic 250, Accounting Changes and Error Corrections; and (ii) were “previously issued” financial statements corrected If the answer to question (i) is “no,” then the analysis stops.
Assuming Box 1 is checked, companies then analyze whether the error correction also requires checking Box 2. Box 2 should be checked if the error correction involves a type of restatement that requires a company to determine whether it must recover incentive-based compensation. Under the applicable Nasdaq and NYSE listing standards, a clawback analysis is triggered for “an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws, including any required accounting restatement to correct 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.” (emphasis added)
The below table explains and summarizes the checkbox requirements in the context of distinct types of financial restatements and revisions.
Change to Financial Statements
Check Box #1
Check Box #2
“Big R” restatements – restatements that correct material errors to previously issued financial statements
“little r” revisions or restatements – restatements that correct immaterial errors 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
Voluntary restatements – restatements that correct immaterial errors to previously issued financial statements and would not be material if (a) the errors were left uncorrected in the current report or (b) the error correction was recognized in the current period
Out-of-period adjustments – an adjustment recorded in the current period financial statements to correct an error when the error is immaterial to the previously issued financial statements, and the correction of the error is also immaterial to the current period
Retrospective changes that do not constitute error corrections:
- Retrospective application of a change in accounting principle (e.g., disaggregation of income statements (DISE) under US Generally Accepted Accounting Principles (GAAP))
- Retrospective revision to reportable segment information due to a change in the structure of an issuer’s internal organization
- Retrospective reclassification due to a discontinued operation
- Retrospective application of a change in reporting entity, such as from a reorganization of entities under common control
- Retrospective adjustment to provisional amounts in connection with a prior business combination (IFRS filers only)
- Retrospective revision for stock splits, reverse stock splits, stock dividends or other changes in capital structure
Other Reporting Considerations
Companies should also keep in mind the other clawback-related disclosures that follow if Box 2 is checked. Specifically, the SEC’s amendments to S-K Item 402 added new Item 402(w), which mandates certain disclosures about a company’s clawback-related actions when the company was required to prepare an accounting restatement that triggered an obligation to recover erroneously awarded compensation under its clawback policy. Where a company recovers compensation amounts under its clawback policy, certain adjustments may also be required to the company’s Summary Compensation Table.