Design Compensation Clawback Policy

---
name: design-compensation-clawback-policy
description: Use when a public company is establishing the mandatory policy for recovering erroneously awarded incentive-based executive compensation following an accounting restatement — applying the recovery requirement without regard to individual executive fault, and disclosing the policy and any recovery actions per SEC and exchange listing requirements, rather than treating clawback as a discretionary or fault-based decision.
source: Dodd-Frank Wall Street Reform and Consumer Protection Act, Section 954; SEC Rule 10D-1; NYSE and Nasdaq clawback listing standards (effective 2023)
tags: [law, corporate, compensation-clawback, executive-compensation, accounting-restatement, corporate-governance]
related: [apply-say-on-pay-governance, design-equity-compensation-plan, design-audit-committee-charter]
---

# Design Compensation Clawback Policy

Establish the mandatory policy for recovering erroneously awarded incentive-based executive compensation following an accounting restatement, applying the recovery requirement without regard to individual executive fault, and disclosing the policy and any recovery actions per SEC and exchange listing requirements — rather than treating clawback as a discretionary or fault-based decision.

## Why This Is Best Practice

**Adopted by:** Dodd-Frank Act Section 954, implemented through SEC Rule 10D-1 and mandatory NYSE and Nasdaq listing standards effective 2023, requires every listed company to adopt a written clawback policy and recover erroneously awarded incentive compensation from current and former executive officers following any accounting restatement — a requirement now universal among NYSE- and Nasdaq-listed companies.
**Impact:** The mandatory clawback requirement was specifically designed as a no-fault recovery mechanism — unlike prior voluntary clawback policies that often required proving executive misconduct (a high bar rarely met in practice), the current rule requires recovery whenever an accounting restatement shows incentive compensation was erroneously awarded, regardless of whether any individual executive was at fault, substantially increasing the practical likelihood that erroneously awarded compensation is actually recovered.
**Why best:** A fault-based clawback standard requiring proof of individual misconduct rarely results in actual recovery, since proving fault is difficult and companies have limited incentive to pursue litigation against their own current or former executives — the no-fault standard removes this practical barrier entirely, requiring recovery based solely on the objective fact of an erroneous award following a restatement, regardless of whether misconduct can be proven.

Sources: Dodd-Frank Wall Street Reform and Consumer Protection Act, Section 954; SEC Rule 10D-1, "Listing Standards for Recovery of Erroneously Awarded Compensation"; NYSE and Nasdaq clawback listing standards (effective October 2023)

## Steps

### Step 1: Adopt a written clawback policy meeting the mandatory requirements

Adopt a written policy, filed as required with the SEC, that applies to all current and former executive officers, covers incentive-based compensation received during the three fiscal years preceding a restatement determination, and requires recovery on a no-fault basis — not merely a policy addressing voluntary or discretionary clawback.

### Step 2: Define the trigger event precisely

Define the policy's trigger as any accounting restatement required to correct a material error, including both "Big R" restatements (correcting a material misstatement of previously issued financials) and "little r" restatements — the rule's scope is broader than what many companies' prior voluntary clawback policies covered.

### Step 3: Calculate the recoverable amount based on the erroneously awarded excess

Calculate the specific amount to be recovered as the excess of incentive compensation actually received over what would have been received based on the restated financial results — a precise, objective calculation, not a discretionary or negotiated amount.

### Step 4: Pursue recovery without regard to whether the executive remains employed or was at fault

Pursue recovery from both current and former executive officers, and from executives regardless of whether they were personally at fault for the error requiring restatement — the no-fault, no-employment-status-dependent standard is a defining feature of the mandatory rule, distinct from prior voluntary practices.

### Step 5: Disclose the policy and any recovery actions as required

Disclose the clawback policy as an exhibit in required SEC filings, and disclose any actual recovery actions taken (or the specific reason recovery was impracticable, if applicable under the rule's limited exceptions) in the company's annual report.

## Rules

- Apply the clawback requirement on a strict no-fault basis — recovery is triggered by the restatement and erroneous award, not by proof of executive misconduct.
- Cover both current and former executive officers, and both material ("Big R") and immaterial ("little r") restatements within the rule's scope.
- Calculate the recoverable amount as the precise, objective excess of compensation received over what restated results would have supported — not a negotiated or discretionary figure.
- Disclose the policy and any recovery actions (or the specific basis for any impracticability exception) as required by SEC rules.

## Examples

**No-fault recovery following a restatement:** A company restates its financial results due to an accounting error unrelated to any individual executive's misconduct. Despite no fault being attributable to any specific executive, the company's clawback policy requires recovery of the excess incentive compensation paid based on the original, erroneous results — exactly the no-fault standard the mandatory rule is designed to require.

**Recovery pursued against a former executive:** An executive who has since left the company is nonetheless subject to clawback recovery when a restatement covering their tenure reveals erroneously awarded incentive compensation — illustrating that the policy's scope extends to former, not just current, executive officers.

## Common Mistakes

- **Applying a fault-based standard requiring proof of misconduct before pursuing recovery** — the mandatory rule specifically requires no-fault recovery; a fault-based policy doesn't satisfy the listing standard requirement.
- **Limiting the policy's scope to only material ("Big R") restatements** — the rule's recovery trigger extends to both Big R and little R restatements.
- **Assuming a departed executive is outside the policy's scope** — the mandatory rule explicitly covers former executive officers, not only those currently employed.
- **Failing to disclose the policy or recovery actions as required** — SEC rules require specific disclosure of the policy itself and of any recovery actions taken or the basis for any impracticability exception.

## When NOT to Use

- For a private company with no NYSE or Nasdaq listing — the mandatory clawback rule applies specifically to listed companies, though voluntary adoption of similar principles may still be sound governance practice.
- For compensation that doesn't qualify as "incentive-based" under the rule's definition (e.g., purely time-vested equity with no performance condition) — confirm the specific compensation type falls within the rule's scope before assuming clawback applies.
- As a substitute for other compensation governance practices — clawback addresses recovery after an erroneous award is discovered; it doesn't replace the separate practice of structuring compensation with a genuine performance link in the first place (see `apply-say-on-pay-governance`).

> **Legal disclaimer:** This skill encodes professional best practices for educational purposes. It is not legal advice. Compensation clawback policy requirements carry specific securities-law compliance obligations — consult licensed securities counsel before finalizing a clawback policy.