Four Tips for Drafting a Clawback Policy to Protect Against Future Risks
Workspan Daily
September 22, 2023
Key Takeaways

  • Include an expansive provision. Organizations should include expansive provision regarding the “means of recovery” to satisfy the clawback. 
  • Be aware of “impracticality” provisions. If any one of the impracticality provisions is invoked, there must be a detailed accounting of costs incurred and/or a legal analysis of why laws would prevent enforcement. 
  • Recoupment approach discussions. Create a forum for executive officers and the board to discuss the recoupment action being proposed; typically, include provisions that would have the board notice the executive officer(s) of the action to be taken and permit the executive officer(s) to discuss that determination with the board. 
  • Be judicious with listing exchange requirements. Don’t broaden the scope of your policy any more than you need to. 

Draft policies are like snowflakes: No two are the same. Some are minimal, “just the facts, please;” others provide profound detail on precisely how each step of the process will work; while others leave great discretion to the board administrator. However, most policies are extremely thorough and hang together well. 

Below are four tips for organizations in considering how to protect against future risks when drafting a clawback policy.  

Note: References to the “board” refer to the full board of directors or the committee of the board designated as policy administrator, likely the compensation committee. 

1. Include an Expansive Provision  

Organizations should include expansive provision regarding the “means of recovery” to satisfy the clawback. The SEC endorsed the notion that assets available for the clawback are “fungible” and companies should not be limited to seeking repayment from previous compensation paid.  

Additionally, it went on to favorably cite comments that “recommended permitting issuers various means of recovery, such as through canceling unrelated unvested compensation awards, offsets against nonqualified deferred compensation and unpaid incentive compensation, future compensation obligations, or dividends on company stock owed to an executive officer... “[T]he rules do not prevent an issuer from securing recovery through means that are appropriate based on the particular facts and circumstances of each executive officer that owes a recoverable amount.” 

Despite the broad means of recovery, draft policies still focus on recovery of after-tax incentive compensation amounts already in the possession of executive officers. By definition, that sole recoupment method means clawback enforcement will be a cumbersome process. In this situation, companies may have difficulty recovering funds “reasonably promptly,” per the listing exchange requirements.  

We recommend implementing policies that permit the board broad discretion and access to an enumerated list of previously earned and in-flight sources so that the company is assured of clawing back every dollar in value of erroneously issued incentive compensation.  

This laundry-list approach is preferred with an appropriate kicker mentioning “any other recovery action,” or similar language. If those provisions are not included, officers may be within their rights to contest later attempts to hold back pay from those other sources, thereby depriving the company of the broadest range of potential sources of recovery.  

2. Impracticality Provisions Are Not a Free Pass 

Companies would have less need to utilize what the SEC calls the “impracticality” exceptions authorized by the listing exchange rules if they embrace the aforementioned fungible approach to the means of recovery. 

However, the impracticality exception may apply in situations where former officers’ only source of funds would have been previously paid (and taxed) compensation.  

For most clawbacks enforced against current executive officers, an expansive provision will be beneficial, assuming it does not conflict with existing compensation contracts. Unlike with terminated executive officers where funds are not in company possession, we are concerned that shareholders would raise questions if a policy did not permit the company to exhaust all sources of recoupment for erroneously paid compensation.  

Remember, if any one of the impracticality provisions is invoked, there must be a detailed accounting of costs incurred and/or a legal analysis of why laws would prevent enforcement. We suspect many companies would prefer to avoid making the case for impracticality if they had alternative funding sources.  

3. Create a Process for Recoupment Approach Discussion  

We have seen clawback policies that could establish an adversarial relationship between the board and executive officers whose compensation is to be recouped. While it’s understandable these provisions are drafted with the intention to protect company interests, our view is these provisions may be detrimental given that the board must enforce the clawback “reasonably promptly” as a listing exchange requirement.  

To lower the temperature, we recommend that policies create a forum for executive officers and the board to discuss the recoupment action being proposed; typically, include provisions that would have the board notice the executive officer(s) of the action to be taken and permit the executive officer(s) to discuss that determination with the board.  

A less adversarial process permits a discussion of how the calculations were done as well as the most preferable means of recovery.  

4. Be Judicious in Expanding on Listing Exchange Requirements. 

Not everything referenced by the SEC in its preamble should be part of the policy. Of course, every policy must include the salient elements of the listing exchange requirements, but we see a wide variety of approaches within those parameters.  

Some policies are very sparse in content, with the detailed definitions often liberally cross-referenced to the listing exchange requirements. Others approach the policy as a total redraft of the requirements and reprint virtually all of the definitions directly from the requirements.  

The watchword here is to not try and broaden the scope of your policy any more than you need to. 

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