- What is a clawback?
- A clawback is a provision in which incentive-based pay, like a bonus, is taken back from an employee by an employer following misconduct or declining profits.
- Clawback clauses in contracts are on the rise among Fortune 100 companies, increasing by 79% from 2005 to 2010.
Signing a new employment contract takes a lot of diligence – there are a lot of details to look over, from salary and benefits to copyrights and non-compete clauses.
But there’s one thing that’s often overlooked, typically because prospective employees don’t even know to look for it – or that it even exists, for that matter: a clawback clause.
What is a clawback?
A clawback is when incentive-based pay, like a bonus or stock options, is taken back from an employee by an employer, explains Corporate Finance Institute. They’re usually written into an employment contract, like this example of a Nike contract.
But a clawback is more than a repayment or refund – it’s often enforced as a punishment for misconduct or company scandal or following declining profits, according to SmartAsset.
Clawbacks are on the rise at Fortune 100 companies. The Corporate Finance Institute found clawback provisions were present in less than 3% of employee contracts in 2005. In 2010, that number had risen to 82%. And, according to the Wall Street Journal, clawbacks are particularly appearing in employee contracts at hedge funds, investment banks, and other businesses in the finance industry.
How does a clawback work?
You don’t have to be guilty of misbehaving for a clawback to be enforced on you. Often times, clawbacks are implemented to enforce better financial practices and combat fraud and accounting errors, explains SmartAsset. Salary and benefits such as 401(k) contributions are immune to clawbacks.
Consider this example from Corporate Finance Institute about a CEO at a big company:
“The annual reports of the company show that the CEO worked hard to keep the company profitable. So, the company wants to reward his efforts and a contract is signed, stating that if the sales of the company increase by at least 10% within the next two years, then the CEO will be paid a bonus of $200,000.
“In the corporate financial statement, it shows that the company registered a profit of 13% in the two years and as a result, the CEO is rewarded with the promised amount.
“After an audit of the company, it is found that the profits were over-reported and the profit was actually 9.5% and not 13% as stated in the previous report. In a situation like that, under the clawback provision, the company can take back the bonus amount previously paid out to the CEO. Depending on the specific clawback clause, the CEO may also have to pay a penalty because the original financial reports submitted were flawed.”
But here’s the thing: You don’t have to be found guilty of misbehaving for a clawback to be enforced.
Another scenario, as explained by SmartAsset, could include a company executive running a business that’s under allegations of fraud. Even if the executive isn’t responsible for the fraud, a clawback may be enforced for two reasons: to provide recognition of wrongdoing that can help restore trust among the public and to recover lost profits.
The 2002 Sarbanes-Oxley Act allows companies to clawback incentive-based compensation for CEOs and CFOs in the event of misconduct that results in a refiling of financial reports.
In 2015, a proposed rule to The Dodd-Frank Act of 2010 strengthened US clawback laws by enabling companies to take back incentive-based compensation in the event of an accounting restatement after an error or misconduct. The amount between original compensation and revised compensation can be claw backed, according to SmartAsset.
In a high-profile example, in 2017 Wells Fargo clawed back $69 million from former CEO John Stumpf and $67 million from the former head of community banking, Carrie Tolstedt, over a fake-accounts scandal in which Wells Fargo employees opened as many as 2 million credit card and retail banking accounts without customers’ knowledge. This was the largest clawback in US banking history, according to the New York Times.
Do I need to worry about a clawback?
That depends. If you’re high on the corporate ladder or work at a large, successful company, your contract is likely to include a clawback provision – and you probably can’t negotiate it out of the contract, according to SmartAsset.
It’s also worth noting that clawback provisions can be evoked following an executive’s breach of agreement, particularly with a non-compete clause.