A clawback is the recovery of money or benefits already paid out, under a contract clause or a statute, when a stated triggering condition occurs. The verb is two words, so a company claws back a bonus, and the money that comes back has been clawed back. The word carries no trigger and no time limit of its own, so what makes a payment recoverable, and how far the recovery reaches, is set by whichever clause or rule applies. On the sale of a practice, the retention adjustment that recalculates the price on the clients who stay is one commercial instance, and how to value a CPA firm covers what it does to a deal.
The Clawback an Accounting Restatement Triggers
Section 10D of the Securities Exchange Act, added by Section 954 of the Dodd-Frank Act, directs the Securities and Exchange Commission to make the national securities exchanges and national securities associations prohibit the listing of any security of an issuer that does not comply with the section (15 U.S.C. 78j-4).
The rule that carries that out is the listing standard on recovery of erroneously awarded compensation. A listed issuer must adopt and comply with a written policy providing that it will recover reasonably promptly the amount of erroneously awarded incentive-based compensation if it is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws (17 CFR 240.10D-1(b)(1)).
That trigger is wider than a headline restatement. It covers any required restatement correcting an error in previously issued financial statements that is material to those statements, and also one that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period (17 CFR 240.10D-1(b)(1)).
Reach is set by four conditions that all have to hold. The compensation must have been received after the person began service as an executive officer, by someone who served as an executive officer at any time during the performance period for that compensation, while the issuer had a class of securities listed, and during the three completed fiscal years immediately preceding the date the issuer is required to prepare the restatement (17 CFR 240.10D-1(b)(1)(i)).
The amount recovered is the excess, not the whole payment. Erroneously awarded compensation is the incentive-based compensation received that exceeds what would have been received had it been determined on the restated amounts, and it must be computed without regard to any taxes paid (17 CFR 240.10D-1(b)(1)(iii)).
Say an annual bonus pays a fixed share of reported pre-tax income, and a restatement lowers that income. On the stated inputs the recoverable amount falls out like this.
Bonus rate 5% of pre-tax income
Reported pre-tax income 10,000,000
Bonus received 500,000
Restated pre-tax income 8,000,000
Bonus on the restated amounts 400,000
Erroneously awarded compensation 100,000The last line is what the policy has to go after, and tax the executive already paid on the original bonus does not reduce it.
Two provisions limit how far an issuer can bend that policy. It is prohibited from indemnifying any executive officer or former executive officer against the loss of erroneously awarded compensation, and it may stop short of recovery only where its committee of independent directors responsible for executive compensation decisions, or a majority of the independent directors on the board where there is no such committee, determines that recovery would be impracticable on one of three stated grounds: direct expense paid to a third party to assist in enforcing the policy exceeding the amount to be recovered, a violation of home country law adopted before November 28, 2022, or a likely failure of a tax-qualified retirement plan (17 CFR 240.10D-1(b)(1)(iv) and (b)(1)(v)).
The disclosure sits in Item 402(w) of Regulation S-K, which asks for the date the registrant was required to prepare the restatement, the aggregate dollar amount of erroneously awarded compensation with an analysis of how it was calculated, the amount still outstanding at the end of the last completed fiscal year, and, for any named executive officer whose amount has been outstanding for 180 days or longer since the registrant determined what that person owed, the dollar amount due from them (17 CFR 229.402(w)).
Sarbanes-Oxley Section 304, the One It Gets Confused With
The Sarbanes-Oxley provision titled forfeiture of certain bonuses and profits is a different mechanism with a different trigger. It applies where an issuer is required to prepare an accounting restatement due to material noncompliance as a result of misconduct, and it names two people, the chief executive officer and the chief financial officer, who must reimburse the issuer (15 U.S.C. 7243).
What those two reimburse is any bonus or other incentive-based or equity-based compensation received from the issuer during the 12-month period following the first public issuance or filing with the Commission, whichever first occurs, of the financial document embodying the reporting requirement, plus any profits realized from the sale of the issuer’s securities during that same period (15 U.S.C. 7243). The Commission may exempt any person from that subsection as it deems necessary and appropriate.
Three differences separate them, and they are why the two are not interchangeable. The statute turns on misconduct and the listing rule’s trigger does not name it. The statute reaches only the two officers it names, while the rule reaches every person meeting its own definition of executive officer. And the lookback windows run from different events. The rule reaches the three completed fiscal years before the restatement is required, while the statute runs forward twelve months from the first public issuance or filing of the document.
What a Clawback Is Not
Depreciation recapture is not one. It changes the character of a gain on the disposition of depreciable property rather than recovering a payment, which depreciation recapture works through in full.
A refund is not one either. A refund returns money because the payment or the transaction behind it was wrong when it happened. A clawback undoes a payment that was correct under the arrangement at the time and became recoverable later, because a condition the parties or a rule had already stated came true.
Vesting is not one at all. Vesting settles whether a person keeps what they earned going forward, while a clawback recovers what was already paid.
Common Questions About Clawbacks
Money or benefits already handed out and then recovered because a stated condition occurred. The condition comes from the contract clause or the rule that applies, never from the word itself.
A listed company recovering an executive bonus after a restatement shows the earnings the bonus was calculated on were overstated. The issuer’s policy has to recover the excess over what the restated figures would have produced, computed without regard to any taxes paid (17 CFR 240.10D-1(b)(1)(iii)).
The codified text avoids the word. The listing standard calls the thing recovery of erroneously awarded compensation (17 CFR 240.10D-1). The Sarbanes-Oxley provision is titled forfeiture of certain bonuses and profits and uses the verb reimburse (15 U.S.C. 7243). Recovery, reimbursement and forfeiture are the words the two US authorities actually use.
In finance the word usually attaches to incentive pay, meaning a clause or a listing standard that lets a company take back compensation once the numbers it rested on turn out to be wrong. For a listed US issuer, the listing standard and the Sarbanes-Oxley provision are the two that carry legal force rather than contract force.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms on accounting and tax work rather than audit or SEC reporting engagements, and a firm can grade that work on its own files through a trial task.
