Compensation clawbacks: The initial disclosures

The impact of Section 10D of the Securities Exchange Act of 1934 has been a long time coming. Originally added to the federal securities laws in 2011 by Section 954 of the Dodd-Frank Act of 2010, it took the SEC until 2015 to propose - and until 2022 to adopt - final rules implementing the provision. Even then, it took another seven months for the national securities exchanges to receive SEC approval of new listing standards prescribing exactly how the compensation recovery ("clawback") rule would work. Effective as of Oct. 3, 2023, listed companies then had until Dec. 1, 2023 to adopt an exchange-compliant clawback policy.

Applying to erroneously-awarded incentive compensation received by a current or former executive officer on or after Oct. 2, 2023 (even if the compensation was received pursuant to an award granted before adoption of the required clawback policy), the initial disclosures that a company's clawback policy had triggered a recovery analysis began appearing in annual reports on Form 10-K and proxy statements in mid-2024. The Adopting Release provides that each listed issuer is required to provide the disclosures required by Exchange Act Rule 10D-1 and Item 402(w) of Regulation S-K in the applicable SEC filings required on or after October 3, 2023, the date on which the exchanges' listing standards became effective. Although 2025 represents the first full year in which the Section 10D-mandated listing standards will be in operation, we have been able to obtain a glimpse of the initial clawback disclosures over the past few months.  In spite of some initial confusion as to the disclosure required in a proxy statement where the applicable "check box" on the cover of Form 10-K has been marked, Approximately two dozen companies filed proxy statements in 2024 indicating that, as a result of the correction of an error to previously issued financial statements, they had conducted a recovery analysis of the incentive-based compensation received by their executive officers during the relevant recovery period. These initial disclosures should be instructive as to scope and detail of the information that will be provided to investors and other stakeholders going forward.

Disclosure requirements

In addition to adopting and enforcing an exchange-compliant clawback policy, each listed company is  required to file its clawback policy as an exhibit to its annual report on Form 10-K and, assuming that a recovery analysis was required, disclosing in its proxy statement how they have applied the policy if, at any time during the last completed fiscal year, either a financial restatement that triggered the clawback policy was completed or there was an outstanding balance of excess incentive-based compensation from the application of the policy to a prior restatement. 

Where a listed company completes the financial restatement that triggered the clawback policy, it is required to disclose:

The date on which it was required to prepare the restatement;

The aggregate dollar amount of excess incentive-based compensation attributable to the restatement, accompanied by an analysis of how the recoverable amount was calculated);

If the incentive-based compensation was determined based on a stock price or TSR-related financial reporting measure, the estimates used to determine the excess incentive-based compensation attributable to the restatement, accompanies by an explanation of the methodology used to calculate such estimates);

The aggregate dollar amount of such excess incentive-based compensation that remains outstanding at the end of its last completed fiscal year;

If the aggregate dollar amount of erroneously-awarded compensation has not yet been determined, an explanation of the reasons why;

If recovery would be "impracticable" (as defined in the applicable listing standard), for each named executive officer and for all other current and former executive officers as a group, the amount of recovery and forgone and a brief description of the reason for the decision not to pursue recovery; and
 For each named executive officer, the amounts of incentive-based compensation that are subject to clawback that are still outstanding for more than 180 days since the date the company determined the recoverable amount.

Disclosures reporting recovery

As of the end of 2024, only two companies (both Russell 3000 companies, one of which is a smaller reporting company) had disclosed that their recovery analysis resulted in the recovery of erroneously-awarded incentive-based compensation. While both companies inserted a separate section into their CD&A to provide the required disclosure, each company satisfied its disclosure obligations slightly differently.

One company supplemented its narrative discussion with a table setting forth the applicable numerical information (e.g., the date on which it was required to prepare the restatement and the aggregate dollar amount of excess incentive-based compensation attributable to the restatement and outstanding as of fiscal year end). It also provided an explanation of how the recovered amounts were calculated in the separate sections of its Compensation Discussion and Analysis describing its annual incentive plan and performance-based incentive compensation awards. This company also included additional information on the impact of its clawback policy on the incentive compensation awards in a footnote to its Summary Compensation Table.

The second company provided a narrative chronology of the events leading up to and following its recovery of excess compensation, along with the identity of each affected named executive officer, a detailed description of how its financial restatement impacted the recalculation of awards under its short-term incentive plan and performance stock unit awards, and the actions taken to recover the erroneously-paid amounts. While it reported the initial amounts awarded under its STIP in the "Non-Equity Incentive Plan Compensation" column of its Summary Compensation Table, it added a footnote to the column setting forth the specific amount recovered from each named executive officer.

In addition to the foregoing, at least two companies which filed their annual reports during the fourth quarter of 2024 indicated that they were conducting a recovery analysis, but have yet to disclose the results of that process.

Disclosures reporting recovery not required

Even where an actual clawback does not occur, a listed company is required to disclose that it has conducted a recovery analysis and concluded that recovery was not required and to briefly explain why application of the recovery policy resulted in this conclusion. Interestingly, even though several listed companies checked the box on the cover of their annual report indicating that they had undertaken a recovery analysis, as of the end of 2024 only approximately 20 companies provided this information in their CD&A. Further, not all of them included the explanation for this result with their conclusory statement.

Where an explanation was provided, the reasons ranged from "the restatement did not affect any of the incentive compensation approved, awarded, or granted" (11 companies) to "no incentive compensation was 'received' within the meaning of the clawback rules" (four companies). Notably, one company disclosed that the correction of the error in its financial statements resulted in an increase in the impacted executive's incentive compensation, while a second company that included a TSR modifier in its performance-based equity awards disclosed that it had retained a nationally recognized valuation consulting firm in reaching this conclusion.

While some practitioners had hoped that the initial disclosures might provide some insights into the processes that companies are using to enforce their clawback policies and calculate recoverable amount under various incentive program designs, to date that has not happened. In addition, only one company disclosed that TSR was a component of its incentive compensation program and did not appear to reach the need for an "event study" or other methodology to conclude that recovery was not required. Given that incentive program designs that employ either a stock price or TSR-related financial reporting measure require using an estimate to determine the excess incentive-based compensation attributable to the restatement, a task that is likely to require a fair degree of subjective judgment, it remains to be seen how companies generally will approach this calculation. However, with the number of financial restatements remaining consistent in recent years, we may not have to wait much longer to get a better picture of how listed companies are enforcing their clawback policies.