What Companies Should Know about the SEC’s New Clawback Rule

On October 26, the SEC published its long-awaited clawback rule. It implements Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank).

The clawback rule was initially proposed in 2015 and a final version has been expected for years. Clocking in at 230 pages, the rule (along with the commentary) is dense and thorough. But it’s also purposeful and delivers relatively few surprises. In general, the SEC chose to adopt the most expansive alternatives available, suggesting the effect of the rule will be extremely consequential.

Enforcement of any clawback provision will be inherently messy because:

  • The number of executives affected is broad
  • These executives may have already received and spent the compensation that is being clawed back
  • Some may no longer even be employed by the registrant, or they may live and work outside the US
  • Exactly how much to recover may be subject to complex calculations and estimates

This gives rise to an interplay of legal, valuation, and administrative hurdles the board will need to oversee.

In this article, we offer a broad overview of the new clawback rule. As a compensation valuation and financial reporting consultancy, we’ll devote particular attention to the challenges involved in quantifying the amounts to recoup. These challenges are most pronounced when incentive measures are linked to total shareholder return (TSR) or the stock price.

What does the SEC rule implement?

Dodd-Frank Section 954 added Section 10D to the Exchange Act. This obligates the SEC to adopt rules that require national exchanges and associations to prohibit the listing of any security of an issuer that’s noncompliant with Section 10D. This means exchanges like the New York Stock Exchange and Nasdaq will need to establish clawback rules that conform with the framework in Section 10D such that listed entities that don’t comply with those rules shall be de-listed. The SEC rule provides the guiding framework to those rules.

When is the go-live date?

Probably in the third or fourth quarter of 2023. Unlike other recently issued rules like pay vs. performance, the fact that listing agencies must act first adds an extra layer of uncertainty. Here’s the order of operations we anticipate:

  • Clawback rules are published in the Federal Register, most likely before the first quarter of 2023
  • That will start a 90-day clock for listing exchanges to adopt new listing standards, most likely by Q2 2023
  • Then, the listing standards must have an effective date that isn’t more than one year after the SEC’s initial clawback rules are published in the Federal Register
  • Registrants will have 60 days after the effective date of the new listing standards to demonstrate compliance

Most companies have already implemented clawbacks voluntarily, noting that their provisions will be further amended when the final Dodd-Frank rules are implemented. Now that the final rules have been released, we anticipate more companies will be proactive instead of taking a wait-and-see approach.

What is a clawback?

A clawback provision is a feature of an incentive-based compensation contract that, under certain circumstances, allows the issuer of that contract to recover compensation previously paid.

The first widespread adoption of clawbacks occurred via Sarbanes-Oxley, which provides for an automatic clawback of compensation paid in the event of financial fraud.

As we mentioned, many publicly traded companies have voluntarily adopted clawback provisions that give the board of directors discretion to recover incentive-based compensation paid in the event of a financial statement restatement, intentional misconduct, or excessive risk-taking. These policies differ by company, typically target a smaller group of executives, and afford the board of directors considerable latitude in when and how to trigger a compensation recovery.

Many opponents of the SEC’s clawbacks rule argued that the rule is unnecessary given the mass-market adoption of clawback provisions. As we’ll discuss, while the benefit of the new clawback rules can be debated, the rules themselves are undoubtedly different from what’s typical in the marketplace.

How will these SEC-mandated clawbacks be different?

The direct impact will differ from one company to another, but here are some common themes:

  • The SEC-mandated clawbacks affect a broader employee population
  • Any type of financial statement restatement (including little-r restatements) is a trigger
  • The board lacks discretion as to whether to effectuate a clawback once a valid triggering event occurs
  • The board has some discretion on how to quantify the recovery amount in cases involving stock price targets
  • The board has no discretion in cases involving accounting metrics where the recoverable compensation is subject to pure mathematical recalculation
  • The coverage period is broader, encompassing the three years prior to the date in which a restatement is required
  • Disclosure of the clawback provisions (including in tagged data format) are broader to ensure uniformity across issuers listed on different exchanges
  • The clawbacks have a no-fault framework in that the affected employees needn’t have been responsible to be affected by the clawback

Are any companies exempt?

Practically speaking, no. All listed issuers must comply. In particular, there are no special exemptions for smaller reporting companies, emerging growth companies, foreign private issuers, controlled companies, or debt-only issuers.

What is a financial statement restatement?

Accounting Standards Codification (ASC) Topic 250, Accounting Changes and Error Corrections, governs the treatment of errors in previously issued financial statements. After identifying the existence of an error, the next step is to assess its materiality, which will dictate how the error is resolved.

Materiality assessments yield one of two restatement conclusions, commonly referred to as Big-R or little-r restatements. Materiality hinges on a measure promulgated by the Supreme Court, in which they state a fact is material if there is

a substantial likelihood that the…fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.[1]

This yardstick is not dissimilar to that offered in FASB Concepts Statement 2, paragraph 132. The SEC and FASB have resisted efforts to apply a numerical formula.

If an error is deemed material to previously issued financial statements, shareholders should be notified that prior financial statements cannot be relied upon via an Item 4.02 Form 8-K disclosure and the affected financial statements should be reissued as soon as practicable. This is a Big-R restatement.

In a little-r restatement, the error isn’t material to prior-period financial statements, so they don’t need to be reissued. However, correcting the error in the current-period financials or leaving the error uncorrected would have a material impact in the current period. As such, the error should be corrected and prior-period values revised, but only by revising prior-period results in the comparative financial results presented in the current-period financial statements.

In financial reporting parlance, a Big-R restatement is a reissuance, a little-r restatement is a revision, and then there’s a third category called out-of-period adjustments. These are immaterial errors that are resolved through the current-period results and therefore don’t involve any change to a previously reported financial value (so they’re not restatements).

Why does the SEC’s clawback rule encompass both types of restatements?

This is the most controversial dimension of the SEC’s recent release. The initial proposed rules in 2015 only contemplated Big-R restatements.

Audit Analytics publishes a nice report every year on restatement prevalence. The current SEC framework regarding Big-R versus little-r restatements went into effect August 2004. As you might suspect, the trend in Big-R restatements has been declining and the trend in little-r restatements has been climbing. In other words, the SEC’s decision to include little-r restatements as clawback triggers is extremely consequential.[2]

What period of time does the clawback cover?

The statutory language states that recoverable compensation should be that which was erroneously awarded “during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement.”

Consistent with expectations, the final rule defines the trigger point in which the issuer is required to prepare a restatement. It’s the earlier of when the board (or an authorized management committee) concludes, or should have concluded, the prior financial statements contain an error and when a court or other authorized regulator directs the issuer to restate its prior financials.

Who is covered?

The cohort of executive officers impacted is broad, being modeled after the definition of officer in 17 CFR 240.16a-1(f). The goal is to include not only the named executive officers, principal financial officer, and principal accounting officer, but also officers operating in policy-making functions and in charge of business units, divisions, and functions.

A small concession in the final rule was to exclude executive officers who weren’t executive officers during the recovery period.

What is the scope of compensation covered?

Substantial controversy clouded the intended meaning of “incentive-based compensation.” The obvious coverage is a performance stock unit whose payout is linked to an accounting measure that’s subject to restatement, such as earnings per share. However, the SEC explains that non-GAAP measures, stock price, and TSR-based measures are also included.

The SEC acknowledges the principal challenges with non-financial statement metrics like stock price when it writes, “Due to the presence of confounding factors, it may be difficult to establish the relationship between an accounting restatement and the stock price.” However, the SEC notes that Rule 10D-1 allows the use of reasonable estimates and the benefits outweigh the costs of using a broad definition. The SEC goes on to require that the issuer develop documentation of their approach and provide it to the applicable listing exchange.

The amounts recovered are to be pre-tax. The board has virtually no discretion as to whether to pursue recovery. The only qualified exceptions are when the direct third-party costs associated with recovery exceed the amount recovered and if recovery would violate the home country law of the executive subject to recovery.

How would a clawback actually work?

Effectuating a clawback requires a “but for” analysis in which a study is performed to determine what compensation would have been delivered but for the accounting restatement. This is straightforward when the incentive measure is something like net income and net income is restated. In such cases, the recoverable amount of compensation can be formulaically determined using the updated financial results.

As noted, this process is much more complex when the incentive measure is TSR or stock price. The most common method, and that referenced in the rule, is to use an event study framework. These are commonly used in litigation contexts and are well established in academic research. An event study aims to isolate the incremental effect of an information disclosure that is net of all the other events occurring in the market. Quite simplistically, suppose a company restates its financials on the same day the Federal Reserve raises interest rates. An event study will attempt to disentangle the effect of the interest rate hike from the announcement of a restatement.

This is done by establishing a comparison measure of the market return that matches the registrant’s size and risk. We discuss the workings of an event study in this paper. On page 145 of the new clawback rule, the SEC discusses some of the components that should generally be considered in an event study, including:

  • How to measure an appropriate market return for comparison purposes
  • The date and time when the market first became aware of the restatement
  • The period of time to cover in the event study

Importantly, the SEC flags the measurement risk that management controls the dissemination of other news and could confound the news of a restatement by coupling it with offsetting disclosures. This SEC is very worried about management’s opportunistic use of information. The scenario posited in the rule is that if management has negative news to disclose (a restatement) they could couple this with positive news (e.g., a new product release) to show that there was no net effect from the restatement.

We acknowledge the risk but expect it to be solvable using forensic analysis of company announcements around the time of the restatement. Our review of academic literature suggests the market very rapidly embeds new information into security prices, which suggests strategically disclosed positive news would need to be disclosed very close to the date of the negative restatement announcement. This will complicate any analysis being performed.

The SEC’s stated concern in the rule segues into a discussion of the cost and complexity of performing event studies. The rule affords registrants discretion to use a reasonable method, but acknowledges that the risk of litigation may drive the adoption of more costly and complex methods. We have expertise in performing these types of analyses, and acknowledge there’s a spectrum of cost and complexity. But companies can mitigate these risks by being extra judicious as to the full spectrum of information they disclose.

What disclosures does the rule require?

The final rules require broad disclosure of the clawback policy, including filing the policy as an exhibit to the 10-K, XBRL tagging of the policy and any specific data in the policy, and including a check box disclosure on the front of the 10-K as to whether the financials involve an error correction that triggers a required clawback of compensation.

Furthermore, if the clawback is in response to a restatement, the SEC requires companies disclose the date of the restatement, the aggregate amount of compensation recovered, and the estimates and methodology used to determine the amount of compensation to recover on a TSR or stock price award. Other details may also be required if the company hasn’t determined the amount or says that recovery isn’t possible.

Must we always enforce our clawback policy?

The SEC rule affords limited exceptions for when a company can elect to not enforce its clawback policy. This is problematic insofar as some of the individuals affected by a clawback may be former employees or have already spent the money being recovered.

One creative solution is to adopt post-vest holding period provisions that require employees to hold vested shares for a period of time before they can liquidate them. Of course, the problem with this strategy is that it imposes a seemingly unfavorable restriction on a relatively large cohort of employees simply to reduce the difficulty of enforcing a clawback that has a low probability of happening.

What about insurance and indemnification prohibitions?

The clawback rule prohibits companies from entering into indemnification or insurance arrangements with covered executives that functionally insulate them from compensation recovery. The language is principles-based and intended to reject any type of arrangement that dulls the impact of the rule.

What are the accounting implications of a clawback?

If a clawback enforcement occurs, adjustments are made to both the 10-K and proxy.

In the proxy, the summary compensation table is adjusted to reflect the excess reporting of compensation to the activation of the clawback. Footnote disclosure is also required.

In the 10-K and financial reporting in general, a clawback provision is considered improbable until it actually is used. Once used, previously recognized compensation cost is reversed (in the period of enforcement) to reflect the effect of the recovery action.

While some broad and voluntary clawback rules have created ASC 718 accounting grant date problems, Dodd-Frank clawbacks won’t, because there’s nothing subjective or discretionary about their use.


The SEC’s new clawback rule will be extremely consequential. The decision to include little-r restatements will result in hundreds of companies needing to effectuate compensation recovery action on a broad cohort of individuals. Many of those individuals will no longer be employees (i.e., they will have left the company between the covered period and the time of discovery). Few will have had a direct impact on the erroneous financials. If stock price metrics existed, the clawback amount will require complex modeling and be subject to dispute.

Our advice to companies is to:

  • Socialize the new rules with the board of directors and the affected cohort of employees. Explain to them that this is a universal rule, not a discretionary decision of the board.
  • Develop a standard operating process for effectuating the clawback in the unfortunate event a restatement occurs. The process doesn’t need to be rigid or overly detailed, especially now that the final rules from the listing agencies haven’t been drafted, but there should be a process on the shelf.
  • If you have stock price metrics, show your board and affected employees how the clawback amount is quantified. Consider the pros and cons of committing to a framework ex ante and whether to rewrite grant agreements to obtain consent to whichever method the company adopts (if and when necessary).
  • Consider how the new clawback policies should interact with existing ones. You can adopt two separate and non-intersecting policies (the bifurcated model) or one integrated policy. Most companies’ current policies allow clawback for a broader array of triggers but give the board discretion on whether and how to take action. In other words, today’s policies will need to coexist in a coherent manner with the Dodd-Frank policies unless your board chooses to do away with the current ones altogether.
  • Consider whether a post-vest holding period would aid in enforcement. This seems drastic considering clawbacks are a low-probability event, but the SEC rules place a very high bar on boards to successfully recover erroneously paid compensation.
  • Monitor your listing exchange as they draft the official policies the SEC’s rule requires of them. Remember, they cannot reduce the scope to be smaller than that dictated by the SEC, but they can expand the scope. Be sure to obtain the final language and verify there are no surprises relative to the framework introduced by the SEC.

We’re happy to discuss these issues with you.

[1] TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Basic, Inc. v. Levinson, 485 U.S. 224 (1988).

[2] The debate is around the statutory language in Section 10D and whether “an accounting restatement due to the material noncompliance of the issuer” means a literal swapping out of old financial statements or a revision (in the current period) to prior period values.