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A Fresh Take

Insights on M&A, litigation, and corporate governance in the US.

| 9 minutes read

The State of Clawbacks and the SEC’s Renewed Interest

Recently the Securities and Exchange Commission (the SEC) re-opened the comment period on its proposed clawback regulation first mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd Frank Act) nearly a decade ago. In the years since the SEC’s initial proposal of clawback rules to implement its mandate under Dodd-Frank in 2015, many public companies voluntarily adopted clawback policies intended to satisfy the minimum requirements under the proposed rules, while others adopted policies more expansive than the proposed rules in response to scrutiny from investors and legislators following a wave of corporate scandals involving misconduct and supervisory failures.  Now, as the specter of final rules once again becomes a meaningful possibility, we re-examine the initial proposed rules and the current state of play for corporate clawback policies in effect today.

I. Background

Until the enactment of the Dodd-Frank Act in 2010, Section 304 of the Sarbanes-Oxley Act of 2002 (SOX) was the only legislation governing recoupment of executive compensation.  Under Section 304 of SOX, the SEC is authorized to require a company’s chief executive officer and chief financial officer to repay the company for any incentive compensation received over the preceding one-year period in the event the company is required to restate its financial reports due to misconduct. [1] 

In the aftermath of the 2008 financial crisis, the SEC increased enforcement under Section 304 of SOX, and Congress enacted Section 954 of Dodd-Frank in 2010, which added a new Section 10D to the Securities Exchange Act of 1934 (the Exchange Act).  Section 10D directs the SEC to implement rules requiring national securities exchanges (including NASDAQ and NYSE) to adopt listing standards mandating each listed company to adopt and implement a clawback policy providing for the recoupment of incentive compensation erroneously paid to current or former executive officers in the preceding three years due to misstatement of its financial reports, regardless of any actual misconduct. Companies failing to comply could be delisted from the applicable exchange. 

After a five-year wait, the SEC issued proposed rules in July 2015 designed to implement its mandate under Section 10D (the Proposed Rules) [2].  The Proposed Rules depart from the narrower scope of Section 304 of SOX in certain key respects, including: shifting the onus of recoupment onto the company, expanding application to all executive officers, lengthening the lookback period during which compensation may be recovered, and eliminating the fault requirement.  Together, clawback rules under SOX and Dodd-Frank signaled a desire for improved accountability following the 2008 economic downturn and underscored the importance of a strong corporate culture of integrity, robust internal controls, and ongoing review and enhancement of compliance and ethics programs and processes. These are principles that continue into 2021 as the “tone at the top” comes under increased scrutiny by investors seeking reform in environmental, social, and governance matters.    

II. Key Provisions of the 2015 Proposed Rules and the SEC’s Most Recent Request for Comment 

The Proposed Rules in July 2015 introduced new complexities as companies prepared to establish compliance and were at the time followed by a 60-day comment period. Recently the SEC re-opened a comment period.  It is unclear whether the final rules, if issued, will be responsive to comments received during the solicitation period or provide additional guidance on the issues noted below.     

  • Application: With limited exceptions, the Proposed Rules would apply to all listed companies, including foreign private issuers, emerging growth companies, and smaller reporting companies that have previously benefited from exemptions to say-on-pay requirements and certain disclosure rules.

  • Covered Persons: Incentive compensation received by any individual would be recoverable if he or she served as an executive officer at any time during the performance period for that award, requiring companies to carefully keep record of awards granted to executive officers before internal promotions or appointments. For this purpose, executive officers would include all “officers” as defined under Section 16 of the Exchange Act.

  • Triggering Event: Under the Proposed Rules, the clawback would be triggered in the event the company is required to prepare a restatement to correct a material error in previously issued financial statements, regardless of misconduct or fault. This type of restatement would typically coincide with the issuance of a Form 8-K under Item 4.02 (Non-reliance on Previously Issued Financial Statements)). The SEC, however, appeared to eschew a bright line rule by noting in its adopting release that companies should consider whether a series of corrections that did not themselves result in restatements, could be considered material in the aggregate. In effect, this would mean that boards would need to engage in an ongoing materiality analysis of revisions and out of period adjustments.

    • This is a key area that the SEC more recently requested comment on. The SEC has asked whether “an accounting restatement due to material noncompliance” should include restatements that correct errors that are not material to previously issued financial statements - essentially expanding the potential for clawbacks to what are commonly referred to as “little r” or revision restatements where a company corrects the current year’s financial statements by adjusting the prior period information because an error is immaterial to prior financial statements, but if not corrected in the current period, would materially misstate the current period financial statements. Given the complexity of accounting judgments made in connection with the preparation of financial statements, we believe it is excessive to force clawbacks given immaterial accounting errors that may have been made with no fault whatsoever. These types of errors may be inevitable from time to time and the triggering of an executive compensation clawback in these circumstances may have negative effects on companies’ cultures.
  • Covered Compensation: Any cash or equity incentive compensation, calculated on a pre-tax basis, that is granted, earned or vested based on the achievement of a financial reporting measure (e.g., net income), stock price, or total shareholder return (TSR) would be subject to the clawback to the extent in excess of what would have paid to the executive absent the financial restatement. Perhaps among the more controversial provisions of the Proposed Rules, the inclusion of inherently dynamic metrics such as stock price and TSR raised questions as to how companies would estimate what the stock price or TSR would have been at a given point in time in the absence of a misstatement.

    • Recently the SEC sought comment on whether additional disclosure beyond those provided for in the Proposed Rules should be mandatory, such as a requirement that,  in the case of incentives based on stock price or shareholder return, the issuer disclose not only what hypothetical stock price it estimated in its amended statements, but the methods and assumptions it used to arrive at such stock prices or total shareholder return.
  • Lookback: The clawback would reach all covered compensation earned during the three fiscal years preceding the date a court mandates restatement, or if earlier the date on which the company’s board concludes, or reasonably should have concluded, that the financial reports contained a material error. While the SEC stated that the reasonableness standard was intended to avoid manipulation of the lookback period, commentators at the time noted that the standard would also introduce inherent subjectivity as parties dispute what a reasonable board should have done in scenarios that inevitably involve a unique and nuanced set of circumstances.

    • This is also an area that the SEC requested comment on by proposing to remove the phrase “reasonably should have known” from the rule. The SEC explained that it is proposing this change based on previous comments critiquing the subjective standard as highly difficult to enforce, and one which would put boards in a position to demonstrate that they could not have reasonably been expected to know about an error. Additionally, this standard may have pushed issuers to invest valuable resources, which could be better utilized elsewhere, on searching for potential misstatements.
  • Discretion: The clawback would be mandatory without any discretion of the company’s board of directors, with limited exceptions if, following a reasonable attempt at recovery, the board determines it would be impracticable in light of undue expense, or if the clawback would violate the home country law of the company. In each case, the company would be required to demonstrate the applicability of its exemption after having already incurred potentially substantial costs attempting recovery.

  • Disclosure: The Proposed Rules included the addition of Item 402(w) to Regulation S-K, pursuant to which companies would be required to disclose certain details in the event of a clawback, including the dollar amount deemed to have been erroneously paid and outstanding clawback efforts.

III.  Trends in Voluntary Adoption

Despite the lack of certainty around when the Proposed Rules would be finalized, companies maintained their existing policies or began voluntarily adopting clawback policies as part of corporate governance initiatives responsive to increased scrutiny by investors and other stakeholders.  A ClearBridge 100 Report cited 98% of its 100 sampled S&P 500 companies disclosed some form of clawback policy by 2020.    In some instances, companies have chosen to limit the policy to a smaller number of senior executives (similar to Section 304 of SOX), instances involving misconduct or actions constituting “cause”, shortening the lookback period, or retaining discretion of the board to determine whether to pursue a clawback, while others have taken a more expansive approach.

Most notably, partly in response to the #MeToo era and in the wake of other corporate scandals and pressures from certain institutional investors, some companies have expanded clawbacks beyond the minimum requirements of the Proposed Rules to provide for recoupment in the event of violations of restrictive covenants or company policy, or in the event of behavior causing material harm to shareholders or reputational risks to the company. Both ISS and Glass Lewis have in recent years also expressed a willingness to support shareholder proposals seeking recoupment of executive incentive compensation in the event of reputational harm to the company.

The following table illustrates various alternatives which different companies have adopted in developing their clawback policies, from the most narrow (on the left) to the broadest scope (on the right):

Design Considerations

Covered Persons


Executive officers

Executives/ Select functions

All employees*

Triggering Event

Financial restatement, intentional misconduct

Financial restatement,

gross negligence/error

Any financial restatement

(no fault)

Reputational harm, violation of policies

Covered Compensation

Cash Incentives

Cash incentives and performance equity awards

All cash and equity incentives


1 year

2 years

3 years

3+ years


Full discretion

Limited discretion



*Generally limited to where a clawback is triggered by an error in the computation of incentive compensation.

IV.  Practical Considerations

As the rules and investor expectations around clawback policies continue to evolve, companies continue to be presented with a number of practical concerns around the design, implementation, and enforcement of such policies, regardless of the particular form they take.

  • Enforceability.  There continues to be a lack of certainty as to whether clawback of already paid amounts will be enforceable under state law principles. [3] To enhance the enforceability of company clawback policies against any particular individual, companies should seek to secure privity of contract by including clawback provisions directly in award agreements and making clear that the awards are in respect of future services. Companies should keep in mind that the enforceability of the clawback may be challenged in court.

  • Indemnification. In more recent high-profile cases, former executive officers have sought advancement of legal fees to defend against clawback lawsuits brought by their employers. Companies, including their Boards, should be aware of and evaluate the company’s governing documents and individual indemnification agreements and consider the applicability of, and exceptions to, advancement provisions in the event of a clawback so that any advancement of fees to executives accused of wrongdoing is intended and not surprising.

  • Thorough Investigation.  Companies conducting investigations into whether an executive has engaged in wrongdoing such that the executive will be terminated with “cause” and/or trigger recoupment under the company clawback policy should be careful to exercise care in conducting a thorough investigation and consider the engagement of outside counsel to demonstrate objective process. Because of the substantial sums often involved in clawback disputes, the efficacy of clawback policies and the board’s implementation of such policies is likely to be an issue that remains in the spotlight.

  • SEC’s Renewed Interest. Given the SEC’s renewed interest in the Proposed Rules, companies should be sure to keep their Boards as current as possible on the Proposed  Rules, including the areas on which the SEC has requested comment. 


[1] Following the 2008 financial crisis, the SEC began pursuing cases requiring clawback of incentive compensation from chief executive officers and chief financial officers who were not alleged to have engaged in any misconduct under the theory that misconduct within the company by any employee  was sufficient to trigger enforcement of SOX 304. See, e.g., SEC v. Jenkins, (D. Ariz. July 22, 2009); SEC v. Jensen (9th Cir., Aug. 31, 2016).


[3] See, e.g., California Labor Code Section 221. California courts have recognized that “wages” include bonuses and incentive plans, but not options. See, e.g., Schachter v. Citigroup Inc., 101 Cal. Rptr. 3d 2, 9 (2009). 


capital markets and securities