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Compensation clawback policies - what the board needs to know
In October 2022, the Securities and Exchange Commission adopted Rule 10D-1, requiring listed companies to adopt and file “clawback” policies. Following accounting restatements, companies must recover erroneously awarded incentive-based compensation. In June 2023, the New York Stock Exchange and Nasdaq Stock Market adopted these listing standards, effective October 2, 2023; policies apply to incentive compensation that executives receive on or after that date. Each company on either exchange must adopt a clawback policy no later than December 1, 2023.
What are the requirements of the clawback policy?
Who and how much
A company’s clawback policy must require it to recover, reasonably promptly, erroneously-awarded incentive based compensation to a Section 16 officer during the performance period for incentive based compensation related to the three fiscal years preceding the date on which the company is required to prepare an accounting restatement. The company needs to recover the amount over what would have been paid had the stated results been accurate, calculated on a gross basis without regard to any taxes paid.
Types of restatements
Restatements due to a company’s material noncompliance with any financial reporting requirement can be classified as one of two types of restatements:
- “Big R” – restatement Corrects an error in a previously-issued financial statement that is material to the previously-issued financial statements.
- “little r” – restatement Corrects an error that is not material to previously-issued financial statements, but would result in a material misstatement if (a) the error was left uncorrected in the current report or (b) the error correction was recorded in the current period.
Recovery requirements
Recovery is on a no-fault basis, disregarding whether any misconduct occurred and whether an executive officer was responsible for the error. Finally, companies are prohibited from indemnifying current or former executive officers against the loss of erroneously paid compensation.
Key steps for preparing your compensation programs
Review current executive compensation programs and policies to understand when clawbacks may already exist in the plans.
Work with legal counsel to prepare a clawback policy compliant with the new listing exchange requirements by the December 1, 2023 deadline.
Consider implementing a companion clawback policy that encourages proper conduct, allowing the board and management to hold an employee accountable for a violation of the company’s code of conduct.
Questions board members can ask
Are procedures and controls in place to identify when a clawback is necessary any time there is a “big R” or “little r” restatement and make the required disclosures?
What elements of our compensation program — for example, performance shares that vest based on three-year EPS growth — would be subject to clawback?
Have we documented incentive-based compensation decisions in such a way that we would be able to calculate the amount of a clawback in the event of a required restatement?
Should we consider changing any elements of our compensation program, and if so, how will we explain the changes to executives and shareholders?
Should we adopt a companion clawback policy that covers instances of misconduct and/or reputational harm?
Should our clawback and/or companion policy be limited to executives as defined in the rule, or extend to additional individuals?
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Managing Director, Governance Insights Center, Boston, PwC US
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