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Article | Executive Pay Memo North America

Tips for drafting a clawback policy to protect against future risks

By Steve Seelig , Josephine Gartrell, J.D. and Shannon Williams | August 21, 2023

Clawback policies can take many forms. Make sure yours will hold up to scrutiny while allowing room for the tough decisions.
Executive Compensation

Fortunately, as compensation consultants, we are not tasked with legal counsel’s job of drafting our clients’ Dodd-Frank clawback policies. Of course, we have views on how policies might better align both with the Securities and Exchange Commission (SEC) regulations (including the preamble) and all the practical considerations about how to administer a cumbersome process.

One thing we have learned over time is that draft policies are like snowflakes: No two are the same. Some are minimal, “just the facts, please” drafts; others provide profound detail on precisely how each step of the process will work, including precise requirements as to the time by which an officer must respond to a clawback demand; while others leave great discretion to the board as administrator. However, most policies we’ve seen are extremely thorough and hang together well.

This article offers ideas about how company policies could be crafted to help minimize questions about their function and application when a restatement takes place. Our goal is to help companies strike a balance between being expansive enough for the board or Compensation Committee to have authority and discretion to make tough decisions yet specific enough to avoid definitional ambiguity that may lead to future disputes.

The following are our observations. (Note: Where we reference the “board” in the following, we mean the full board of directors or the committee of the board designated as policy administrator, likely the Compensation Committee.)


    Include an expansive provision regarding the “means of recovery” to satisfy the clawback.

It was something of a surprise when the SEC appeared to endorse comment letters stating that companies should not be limited to only seeking repayment from compensation previously paid. In the preamble, the SEC states: “[W]e continue to believe that the adopted rules should provide boards discretion, subject to certain reasonable restrictions, regarding the means of recovery…” (87 FR 73103-4). The SEC endorsed the notion that assets available for the clawback are “fungible” and needn’t be limited only to compensation previously paid. It went on to favorably cite comments that “recommended permitting issuers various means of recovery, such as through canceling unrelated unvested compensation awards, offsets against nonqualified deferred compensation and unpaid incentive compensation, future compensation obligations, or dividends on company stock owed to an executive officer.”

At these early stages, we’ve seen draft policies that solely focus on how to recover after-tax incentive compensation amounts already in the possession of executive officers that, by definition, will mean clawback enforcement will be a cumbersome process. Where that is the only recovery avenue, we are concerned that companies will have difficulty recovering funds “reasonably promptly,” per the listing exchange requirements. In discussing this issue, the preamble permits having a broad palette of recovery measures available: “Furthermore, the rules do not prevent an issuer from securing recovery through means that are appropriate based on the particular facts and circumstances of each executive officer that owes a recoverable amount.”

We recommend implementing policies that permit the board to exercise broad discretion to access an enumerated list of previously earned and in-flight sources, potentially including deferred compensation, so that the company is assured of clawing back every dollar in value of erroneously issued incentive compensation. We prefer this laundry-list approach with a kicker mentioning “any other recovery action” that is determined to be appropriate, or similar language.

If those provisions are not included, officers would be within their rights to contest later attempts to hold back pay from those other sources, thereby depriving the company of the broadest range of potential sources of recovery.


    Don’t perceive impracticality provisions as a free pass.

A company that embraces the above-mentioned fungible approach to the means of recovery would have less need to utilize what the SEC calls the “Impracticality” exceptions authorized by the listing exchange rules. Impracticality provisions are of two types: 1) those where recovery is prohibited by home country law or the ERISA section of the tax code, and 2) those where the cost of recovery exceeds the amount to be clawed back.

We understand there will be situations involving former officers where the only source of funds would be previously paid (and taxed) compensation. In such situations, the impracticality exception would be in play.

For the vast majority of clawbacks enforced against current executive officers, an expansive provision will be beneficial, assuming it does not conflict with existing compensation contracts. Unlike with terminated executive officers where funds are not in company possession, we are concerned that shareholders would raise questions where a policy did not permit the company to exhaust all sources of recoupment for erroneously paid compensation. Remember, if any one of the impracticality provisions is invoked, there must be a detailed accounting of costs incurred and/or a legal analysis of why laws would prevent enforcement. We suspect many companies would prefer to avoid making the case for impracticality if they had alternative funding sources.

For example, let’s say an officer elected to defer the portion of her annual bonus, up to the tax code-imposed limits, into a 401(k) plan for the year of a restatement. While ERISA may intervene to prevent recoupment of the deferred bonus, the board would then need to determine if it would seek recoupment from other sources when acting in shareholder interests. It is not clear if failing to pursue other means would support a shareholder claim against the company or the board, but we raise this as a possibility.

Empowering the board to make these recovery decisions makes sense to us. This leads to the next question: How can a company help to make sure executive officers and the board can agree on the best approach?


    Create a process whereby the board and executive officers can discuss the recoupment approach.

We’ve seen at least a few clawback policies that establish what amounts to an adversarial relationship between the board and executive officers whose compensation is to be recouped. Some include a process by which demand letters would be issued, others have a binding arbitration clause for dispute resolution, and still others articulate that any legal actions necessary would be enforced under a particular state law. While we understand these provisions are drafted with the intention to protect company interests, our view is these provisions may do more harm than good given that the board must enforce the clawback “reasonably promptly” as a listing exchange requirement.

We appreciate that boards will be required to perform some very difficult calculations to determine the value of the clawback and will even be required to use reasonable estimates to do so. Because there may be close shareholder scrutiny about those calculations — details must be disclosed in the proxy — our view is that boards will likely err on the side of taking a conservative approach. This may mean the board and the executive officer may disagree with the calculation approach. Yet, the rules are clear that the board must act based on shareholder interests, not those of executive officers. On this point, we encourage companies and counsel to require executive officers to acknowledge they are subject to the policy and that they will defer to board discretion; explore with counsel the different mechanisms to employ.

To help reduce the temperature, we recommend that policies create a forum for executive officers and the board to discuss the recoupment action being proposed. These typically include provisions that would have the board give the executive officer(s) notice of the action to be taken that also then permit the executive officer(s) to discuss that determination with the board. This process would be less adversarial, thereby permitting a discussion of how the calculations were done as well as the most preferable means of recovery.

For example, the executive officer may not have the funds available or wish to sell existing stock holdings to pay back the amount due — each of which could create unpleasant economic or tax hardships. Rather, the executive officer may prefer to forego future compensation, subject to both parties understanding the tax and legal ramifications of doing so. (There are too many scenarios to discuss here; stay tuned for a forthcoming article.) That said, those issues need not be resolved today and should not inhibit drafting a policy that permits these discussions.


    Permit the board to hire third parties to help with the calculations.

Since many paths can be taken in performing the clawback calculations and determining the means of recovery, we encourage the clawback policy to permit the board to hire independent counsel and compensation experts to assist in doing the numbers. We absolutely expect there to be many iterations of calculations, and, to the extent possible, we believe the deliberations between the board, its counsel and those doing the calculations should be protected by attorney-client privilege, assuming it is available. We understand that the Compensation Committee charter already permits the hiring of experts and counsel to meet its independence requirements, arguably making the inclusion of a similar provision redundant.

We agree with having a stand-alone provision included in the clawback policy, which implements a new listing exchange requirement and whose administration was not contemplated when those independence rules were first instituted. It also reminds any shareholder who would seek to litigate the accuracy of the calculations that the board hired its experts specifically to perform these calculations and that they may be different experts than the current Compensation Committee advisor.


    Be judicious in expanding on the listing exchange requirements.

This is more of a generic comment: We don’t think everything referenced by the SEC in its preamble should be part of the policy. Of course, every policy must include the salient elements of the listing exchange requirements, but we see a wide variety of approaches within those parameters. Some policies are very sparse in content, with the detailed definitions often liberally cross-referenced to the listing exchange requirements. Others approach the policy as a total redraft of the requirements and reprint virtually all of the definitions directly from the requirements. Our preferences are a matter of taste that we will keep to ourselves.

One thing we don’t like seeing are attempts to amplify the listing exchange requirements with definitions that borrow from the preamble or other areas of reference. For example, we would prefer that the policy not include a mention of all the things that are or are not restatements, in that the decision whether to restate is being made elsewhere and is not exclusive to the policy itself. Sure, the full board will have a role in making that determination, but not the Compensation Committee.

We also don’t like policies that tailor their definition of what is and is not incentive compensation to their existing plans, mostly because it might miss certain elements of compensation that are incentive compensation (e.g., the salary increase based on prior year revenue). Rather, simply restate the listing exchange definition of incentive compensation and call it a day.

The watchword here is to not try and narrow the scope of your policy any more than you need to.


Other documents will need amendment.

The above section provided a lot to digest, but there is still more work to do with documents outside of the clawback policy itself. These items should be on your to-do list to consider before year-end; we’ve listed them here without explication on all the issues to consider:

  • Amend nonqualified deferred compensation plans to permit future deferrals to be forfeited to cover clawback amounts — if permissible under Internal Revenue Code section 409A.
  • Think about whether incentive compensation can or should be included in defined benefit retirement plan formulas (both qualified and nonqualified) and whether bonuses should be available for deferral into a section 401(k) plan.
  • Determine how board and committee charters should be amended to identify which committee administers the clawback and which committee must communicate when a restatement is required.
  • As noted above, determine how executive officers will acknowledge their compensation is subject to the clawback policy.
  • Reconcile existing compensation agreements and plan documents with the terms of the clawback policy so there are no inconsistencies.

Companies must consider numerous issues when making these documentary changes, but they have more time to accomplish these amendments: Closer to year-end would be fine.


Senior Director, Executive Compensation

Senior Director, Executive Compensation and Board Advisory (San Francisco)
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Senior Associate, Executive Compensation & Board Advisory (New York)
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