In 2022, after seven years of marinating on the SEC’s long-term agenda, the SEC adopted rules to implement Section 954 of Dodd-Frank, the clawback provision. The rules directed the national securities exchanges to establish listing standards requiring listed issuers to adopt and comply with a clawback policy and to provide disclosure about the policy and its implementation. Under the rules, the clawback policy was required to provide that, in the event the listed issuer was required to prepare an accounting restatement—including not just “reissuance,” or “Big R,” restatements, but also “revision” or “little r” restatements—the issuer must recover the incentive-based compensation that was erroneously paid to its current or former executive officers based on the misstated financial reporting measure. (See this PubCo post.) The requirements have been in effect for a bit now. But how did companies respond? Did they stick to the script? Or, after examining their own “governance philosophies,” did companies amp up the rules to actually expand the scope of their clawback policies? This piece from consultant FW Cook reporting on their study of large cap companies showed that “80% maintain an expanded clawback policy that goes beyond the SEC requirements.”
The SEC’s clawback rules
Triggers. Under the SEC’s clawback rules, policies should trigger clawbacks if the issuer is “required to prepare an accounting restatement that corrects 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.” Notably, no fault or involvement with the error is required; in essence, the rule requires recovery of compensation to which the officers were never entitled in the first place.
Persons covered. Under the SEC’s rules, clawbacks apply to the company’s “president, principal financial officer, principal accounting officer (or if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer.” Only significant policy-making functions are covered. Executive officers of the company’s parent or subs are deemed executive officers of the company if they perform policy-making functions for the company.
Compensation covered. The clawback policy covers “incentive-based compensation (including stock options awarded as compensation)” that is received, based on the erroneous data, in “excess of what would have been paid to the executive officer under the accounting restatement.” The rule defines “incentive-based compensation” to be “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.” “Financial reporting measures” are defined as “measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, and any measures derived wholly or in part from such measures,” including stock price, TSR, non-GAAP financial measures and “other measures, metrics and ratios that are not non-GAAP measures, like same store sales,” where sales are subject to an accounting restatement.
In addition, recoverable incentive-based compensation includes options and other similar equity awards, including restricted stock, RSUs, performance share units, stock options, and SARs (as well as proceeds from sale of these shares), the grant or vesting of which is based wholly or in part upon the attainment of financial reporting measures. Also included are non-equity incentive plan awards, bonuses from bonus pools and cash awards based wholly or in part on satisfying a financial reporting measure performance goal. Incentive-based compensation does not include salaries (except for salary increases based on attainment of a financial reporting measure performance goal), discretionary bonuses (not from pools the size of which is determined by meeting financial reporting measures), bonuses or non-equity awards based on achievement of subjective standards or strategic or operational goals (e.g., excellent leadership, completion of a merger or increase in market share) and equity awards that are only time-vested or vest based on achievement of nonfinancial reporting measures.
FW Cook study
The Cook study looked at clawback practices among 45 large-cap companies with market caps over $10 billion. They “found that 80% maintain an expanded clawback policy that goes beyond the SEC requirements.” However, they also found that the expanded clawback provisions were usually discretionary, in contrast to the mandatory SEC requirements.
Triggers. Many of the companies surveyed expanded the triggers that would precipitate a clawback under their policies, including triggers that were not predicated on a restatement. These included 64% that triggered clawbacks in the event of fraud or misconduct; 31% that triggered clawbacks in the event of reputational, financial or other harm to the company; 25% that employed triggers based on a violation of company policy or code of conduct; 17% that treated a violation of restrictive covenants as a clawback trigger; 6% each that used failure of risk management or failure to supervise as triggers; and 3% that used termination for cause—in each case absent any restatement.
The study also found that some companies used clawback triggers related to financial restatements but applied the policy to a broader group or wider range of compensation, including 17% where the restatement involved misconduct, 14% without misconduct and 11% where there were materially inaccurate financial statements.
Persons covered. Of the companies surveyed, the study revealed, the clawback policies of 66% applied to a broader population than required under SEC rules, including 44% that applied the policy to senior management or an otherwise broader group of executives and 22% that covered all incentive plan participants in requirements; 8% gave the comp committee discretion.
Compensation covered. The study found that 67% of the companies surveyed allowed the clawback to be applied to a wider range of compensation, such as “all cash and equity incentives (including time-based awards).”
Of the 20% of companies in the survey with clawback policies satisfying only minimum SEC requirements, Cook reports that one-third “indicated an intention to review their policies soon and are considering adoption of an expanded policy.”
