Public companies have until Dec. 1 to update or add new clawback provisions to their executive pay policies in order to comply with regulations the U.S. Securities and Exchange Commission (SEC) finalized last year.
Clawback provisions are an increasingly common feature of executive compensation packages, according to Anne Tyler Hall, an attorney with Hall Benefits Law in Atlanta. Their purpose is to enable companies to recover incentive pay if an executive’s decisions turn out to be ethically and legally questionable, thus imposing financial and reputational liabilities on the company.
In 2002, the federal Sarbanes-Oxley Act required public companies to have a clawback rule that applies only when misconduct by CEOs or CFOs results in a financial restatement to federal authorities.
In 2022, the SEC adopted much broader clawback rules under the federal Dodd-Frank Act of 2010. Stock exchanges must require listed companies to implement a clawback policy for erroneously awarded incentives received by current or former executives.
“If you don’t do it by Dec. 1, you risk having your listed securities delisted from the exchanges, so it’s a pretty punitive result,” Morrison said.
Under the new regulations, a clawback is mandatory if the company has to submit an accounting restatement correcting an error in previously issued financial statements that is material to those statements or that would result in a material misstatement if the error were corrected or left uncorrected in the current period. Erroneous payments must be recovered even if there was no misconduct or failure of oversight on the part of an individual executive.
“It doesn’t require that the executives even knew about the issue,” Tyler Hall said. “They could have no prior knowledge of the error or misstatement and still be subject to the clawback.”
In this context, incentive pay is defined as any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.
The SEC rule applies to public companies, not private employers. However, “larger private companies are putting [clawback provisions] in place, even though they’re not required to do it. They tend to follow what public companies do when it comes to corporate governance,” Morrison said. “They have discretion to claw it back or not.”
“As a matter of sound corporate governance, it’s good to have a clawback policy. It’s something shareholders and investors expect to see,” Tyler Hall said.
That’s because clawbacks “provide for some concept that, if you are a bad actor, we’re going to hold you accountable for it” rather than have shareholders foot the bill for a mistake, Morrison said.
The SEC rule applies to a broader range of executives than the Sarbanes-Oxley rule does. “It covers all the executive officers who have a policymaking function,” Morrison said. “Most companies seem to be doing the minimum number of covered executives.”
“They are adding teeth to the clawbacks. That’s a positive development,” Tyler Hall said.
Recovering the Money
Companies usually need to sue an individual to get the money back. Even then, “good luck,” Morrison said. “It’s hard to get someone to pay you back once they have the cash.”
“Often, they’ve already spent the money,” said Tyler Hall. Depending on the amount, “the company doesn’t have a tolerance or the interest in a long, protracted litigation.”
Even without a lawsuit, companies can still cancel any outstanding payments, such as a stock option that hasn’t vested yet, Morrison said.
Another option is to stipulate that severance payments and golden parachute payments won’t be paid until six or 12 months after the executive leaves. That gives the company time to figure out if any of the executive’s actions did harm to the company, Tyler Hall said. “These issues are often uncovered shortly after an executive’s exit,” she said.
Recent Examples of Clawbacks
In 2021, the car rental agency Hertz filed a lawsuit alleging that gross negligence and misconduct of two senior executive officers caused the need for a financial restatement that identified accounting errors. The company sought to recover $56 million through a clawback policy because of a breach of the company’s standards of business conduct.
However, a federal district court ruled in June that the clawback policy and standards of business conduct were not binding, standalone contracts that the company could enforce through a breach-of-contract lawsuit.
Meanwhile, in 2020, Goldman Sachs announced that it would use clawbacks to recover $174 million from current and former executives following a $2.9 billion settlement of claims that Goldman Sachs executives paid bribes to officials in the United Arab Emirates and Malaysia to obtain lucrative business for the bank, according to the U.S. Department of Justice.