A clawback is the legally required return of incentive compensation such as a bonus or stock grant. Once applicable only to top company officers, clawback provisions are appearing in more employment contracts, particularly in the financial services industry. If your contract has a clawback clause, a financial advisor can help you understand the often complex rules and what to do in the event that you face one.
What Is a Clawback Provision?
A clawback provision is a section of a contract that stipulates when money must be paid back to an individual, company or another party in the event of someone not performing to a contract. It can also protect a party from losing money due to a mistake that could have been avoided.
For example, an employee might sign an employee contract guaranteeing a certain level of performance and in exchange, the company provides a signing bonus. If the individual never shows up for work then the clawback provision would protect the business from losing that money. These provisions have many different uses but are most often used in the financial sector in order to protect the money that people are working with.
Corporate Clawback Policies
In the wake of the financial crisis of 2008, clawback clauses are becoming more common in employment contracts. Typically, a company can recoup disbursed funds when there is misconduct, erroneous financial reporting, poor performance or a drop in company profits. But employees who face clawbacks aren’t always personally involved in the triggering event. Someone’s misconduct or mistake in, say, sales can lead to other people in, say, product development having to return compensation to their employer.
That said, it’s important to note that clawbacks apply only to incentive compensation like cash bonuses, stock grants and stock options. This means your regular paycheck remains yours.
Federal Clawback Laws
Clawbacks can be traced back to the 2002 Sarbanes-Oxley Act. This was the first federal law that allowed companies to recover incentive compensation from CEOs and CFOs in the event that company misconduct led to discrepancies in financial reporting.
The Emergency Economic Stabilization Act of 2008 expanded the reach of clawbacks and the reasons for them. It allowed companies to retrieve incentive compensation from an executive officer and any of the next 20 highest-paid employees. It also added inaccurate financial reporting as a clawback trigger. Companies no longer needed to prove fraud or misconduct. This statute applied only to firms that received funds through the Troubled Asset Relief Program.
The 2010 Dodd-Frank Act aimed to expand clawbacks even more. A provision within the Dodd-Frank Act proposed that the Securities and Exchange Commission delist any public company that didn’t require clawbacks from executive officers after an accounting restatement. It also put forth that money that had been wrongly paid in the three years before the restatement was eligible for clawbacks from former as well as current senior executives. This rule has not been approved.
Could You Face a Clawback?
If you’re signing on as an executive at a large financial services company, your contract may include a clawback clause. Many of the country’s biggest companies have fairly recently put these policies in place. Indeed, while less than 3% of Fortune 100 companies had clawback contracts before 2005, that percentage rose to 82% by 2010.
Ideally, the prospect of clawbacks protects companies from fraud, keeps employees accurate and boosts investor confidence. From the individual viewpoint, the possibility of clawbacks is also a good reason not to spend your bonus right away (or before you receive it). Many of these policies give companies broad discretion when deciding whether or not to take back executive compensation.
Other Kinds of Clawbacks
Clawbacks aren’t only the tool of employers, of course. Other business contracts can also mandate them under the law. Some common examples are below:
- Dividends: Investors in a project promise to return dividends to cover any cash shortfalls.
- Life insurance payments: policyholders or their beneficiaries may have to give back payments in the event of a canceled policy.
- Government contract payments: The government can recoup funds paid to contractors when work doesn’t meet contractual requirements.
- Medicaid coverage: After a Medicaid recipient dies, the government may be able to recover costs from the sale of the deceased’s home.
- Pension payments: Companies can require the return of overpayments made by mistake.
The Bottom Line
Think of clawback clauses as a company’s insurance policy. In addition to restoring funds, they deter employees from committing fraud while providing incentives to be accurate in their financial reports. What’s more, these provisions ensure that executives perform their duty of financial oversight. As these stipulations become more common, advocates of the clawback hope the trend will lead to better financial practices across the board.
Tips on Avoiding Clawback
- As an executive subject to a clawback policy, you may receive specific compensation you’d want to protect. A financial advisor can help you do just that by managing your asset strategy. If you don’t have a financial advisor, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A company can avoid clawback if all employees perform their jobs diligently and ethically. Of course, this isn’t always the case. So the best way to defend yourself from this provision is by understanding your employment contract and asking questions.
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