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Dodd-Frank clawback requirements: Documenting incentive pay decisions

Part 2 in a series

By Stephen Douglas and Steve Seelig | May 5, 2023

Companies should conduct a detailed inventory of each element of officer pay and carefully document incentive pay decisions.
Executive Compensation

In this second article in our three-part series on adopting Securities and Exchange Commission (SEC)-mandated, Dodd-Frank-compliant clawback policies, we focus on determining which elements of executive compensation could be subject to recovery upon a financial restatement.

Companies should consider conducting a detailed inventory of all plan documents and other written communications that reference pay decisions. Once that is complete, each company can determine what changes are necessary and how the compensation committee, advisors and corporate secretary can prepare for when clawbacks are required.

‘Financial reporting measures’ defined

The SEC defines “financial reporting measures” as ones that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements along with any measures derived wholly or in part from such measures. This includes ‘‘non-GAAP financial measures’’ as well as other measures, metrics and ratios that are not non-GAAP measures, such as same store sales.

Financial reporting measures can be included in a filing with the SEC but also be presented separate from financial statements, such as in the performance graph or Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

In the adopting release for the final regulations, the SEC provides examples of financial reporting measures, including, but not limited to:

  • Revenues; net income; operating income; profitability of one or more reportable segments; 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); EBITDA — 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; revenue per user, or average revenue per user; cost per employee; or any of such financial reporting measures relative to a peer group; and tax basis income.

Elements of pay considered ‘financial reporting measures’

To determine which elements of pay within a compensation program can be considered based on financial reporting measures, companies should review all documents that apply to compensation, including:

  • Employment agreements
  • Equity plan documents
  • Grant agreements
  • Bonus plans
  • Bonus target communications
  • Long-term incentive plan target communications
  • Proxy statements, including tables and Compensation Discussion and Analysis (CD&A)
  • Compensation committee minutes
  • Management presentations
  • Compensation consultant reports
  • Salary adjustment communications
  • Performance reviews
  • Deferred compensation plans
  • Supplemental executive retirement plan (SERP) documents
  • 401(k) plan documents

Once all documents are thoroughly reviewed, companies can determine what changes are needed for future years.


Under the final regulations, salary paid during any year for which a company must issue a restatement is not considered “incentive-based compensation.” However, the adopting release states that an executive officer’s “salary increase earned wholly or in part based on the attainment of a financial reporting measure performance goal” would be subject to clawback. To avoid ambiguities, companies should clearly document the reason or reasons for a salary adjustment. If it turns out the adjustment was based on a financial metric, the entire increase may be subject to clawback for multiple years after it was adopted.

Non-equity incentive-based compensation of the summary compensation table (SCT) (annual bonuses)

Some bonus plans — such as single annual plans or bonus pool plans — allow the compensation committee to exercise negative discretion, giving it the ability to reduce or eliminate an executive’s incentive-based compensation based on performance goals.

In any bonus plan, again, the reasons for any adjustments must be clearly documented to show if any portion of a bonus paid is based on non-financial factors. For bonus pool plans, recent guidance on pay versus performance suggests that the entire bonus based on a restated financial metric, even if adjusted by committee discretion, is subject to clawback.

Bonus column of the SCT (special bonuses)

Often, when special bonuses are given, the reasonings behind them are documented in the CD&A and compensation committee minutes. It is important to note that bonuses paid, even to a single executive, can still be tied to financial performance. As per our theme, make sure the reasoning is fully documented.

Stock awards and option awards columns of the SCT (time-based equity)

The adopting release states that specific examples of ‘‘incentive-based compensation’’ include (but are not limited to): restricted stock, restricted stock units, performance share units, stock options, and stock appreciation rights that are granted or become vested based wholly or in part on satisfying a financial reporting measure performance goal.

Examples of compensation that is not ‘‘incentive-based compensation’’ for this purpose include (but are not limited to): equity awards for which the grant is not contingent upon achieving any financial reporting measure performance goal and vesting is contingent solely upon completion of a specified employment period and/or attaining one or more nonfinancial reporting measures.

If performance-based options are issued, the metrics used to trigger vesting will need to be documented.

Stock awards and option awards columns of the SCT (performance shares and retention grants)

In many circumstances, not all the financial measures that apply to a performance share grant are disclosed in the Grants of Plan-Based Awards table, so grant agreements and other communications should be carefully reviewed. Similar issues regarding the use of discretion, as discussed in the non-equity incentive awards section above, may apply here, although it is more likely that most of the performance measures and adjustments made remain incentive-based compensation because discretionary adjustments often are accompanied by undesirable accounting charges.

The adopting release provides that “if an executive officer erroneously receives incentive-based compensation based on stock price or TSR [total shareholder return] that was inaccurate as a result of an accounting misstatement, that compensation is based on such erroneous data” and could be subject to clawback.

Making sure the precise details of how the TSR-based programs work will be crucial to determining precisely how a financial restatement impacts payouts previously calculated under those plans. Lack of details here could cause the company to claw back more pay, just in case, to be sure shareholders will not question its judgment.

Retention grants also need to be closely scrutinized to determine the extent they are time-/service-based (and thus not subject to clawback), with their details recorded.

Pension/Nonqualified deferred compensation column of the SCT, 401(k) and SERPs

Clawbacks are not required if recovery would likely cause a retirement plan — for example, a 401(k) plan — to lose its tax-qualified status under the Internal Revenue Code. However, at least for 401(k) plans, if incentive compensation is deferred into the plan, it may be appropriate for the company to seek recoupment of those amounts from other sources. A detailed review requires determining if the source of deferrals includes bonuses subject to the clawback rules.

The SEC also clarified that the clawback rule can apply broadly to other compensation plans, including long-term disability, life insurance, nonqualified deferred compensation plans or any other compensation that is based on the incentive-based compensation. Companies should consult with experts to determine if any incentive compensation is used to fund or pay these benefits.

Going forward

Companies should begin the tedious and lengthy process of reviewing current pay documents and procedures and meeting with all stakeholders, so they understand the importance of better documentation and their role within company clawback processes. We believe waiting until a restatement triggers a clawback may provide unpleasant surprises that could have been avoided with sufficient planning, per the road map we have outlined.

The third article in this series will focus on determining the source of money to pay back to the company in the event of a restatement that requires a clawback.


Senior Director, Retirement and Executive Compensation

Senior Director, Executive Compensation

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