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What is a 'Clawback'

A clawback is an action whereby an employer or benefactor takes back money that has already been disbursed, possibly with an added penalty. Several proposed and enacted federal laws provide for clawbacks of executive compensation based on fraud or accounting errors. Companies may also write clawback provisions into employee contracts, whether such provisions are required by law or not, so that, for example, they can take back bonuses that have already been paid out. 

BREAKING DOWN 'Clawback'

Clawbacks are particular contractual clauses for money paid for services to be returned under circumstances as stated in the contract. These are provisions that are put in place to prevent people from using the incorrect information; in the case of the financial industry, they usually are to avoid the misuse of accounting information. They are used to put a balance between economic/community development and corporate welfare. An interesting point to note is that clawback provisions for Fortune 100 companies were less than 3 percent before 2005. By 2010, they rose to about 82 percent. 

Clawbacks in Private Equity

The term clawback can also be found in some other settings. In private equity, it refers to the limited partners' right to reclaim part of the general partners' carried interest, in cases where subsequent losses mean that the general partners received excess compensation. Clawbacks are calculated when a fund is liquidated. Medicaid can claw back costs of care from deceased patients' estates. In some cases, clawbacks may not even refer to money: Lawyers can claw back privileged documents accidentally turned over during electronic discovery.

Clawbacks and Executive Compensation

The first federal statute to allow for clawbacks of executive pay was the Sarbanes-Oxley Act of 2002. It provides for clawbacks of bonuses and other incentive-based compensation paid to CEOs and CFOs, in the even that misconduct on the part of the company – not necessarily the executives themselves – leads it to restate financial performance.

The Emergency Economic Stabilization Act of 2008, which was amended the following year, allows for clawbacks of bonuses and incentive-based compensation paid to an executive or the next 20 highest-paid employees. It applies in cases where financial results are found to have been inaccurate, regardless of whether there was any misconduct. The law only applies to companies that received TARP funds.

In July 2015, a proposed SEC rule associated with the Dodd-Frank Act of 2010 would allow companies to claw back incentive-based compensation paid to executives in the event of an accounting restatement. The clawback is limited to the excess of what would have been paid under the restated results. The rule would require stock exchanges to prohibit companies that do not have such clawback provisions written into their contracts from listing.

Other Examples of Clawbacks

Clawbacks can also be found in the following areas:

  • Life insurance: A provision could dictate that the policy is canceled, payments will need to be returned.
  • Dividends: These can be clawed back under certain circumstances. 
  • Government contracts: Contractors may be subject to clawbacks if some requirements of the contract are not met. 
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