One of the significant executive compensation reforms in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) is a requirement that all public companies establish a clawback policy for incentive compensation paid to executive officers. The requirement is not effective until the U.S. Securities and Exchange Commission (SEC) issues interpretive guidance. The guidance is expected in the middle of 2011, and companies may need to act quickly once guidance is issued.

Background on Clawbacks

A clawback is a provision or policy that allows a company to demand that an executive repay some or all of a bonus or other compensation previously paid. Typically, a clawback is applicable upon some triggering event, such as a discovery that the executive was involved in the preparation of inaccurate financial statements. Until 2002, the use of clawbacks was fairly limited, although some employment agreements contained “bad boy” clauses that applied when an executive violated a confidentiality, noncompete or similar covenant.

The Sarbanes-Oxley Act of 2002 expanded the prevalence of clawbacks by requiring the CEO and CFO of a public company to repay bonuses and other incentive compensation received after the release of financial information that is later restated because of noncompliance due to misconduct. Since 2002, broader clawbacks applicable to executives beyond the CEO and CFO have become more common, particularly as institutional shareholders and shareholder advocacy groups have emphasized the importance of these policies.