2. Clawbacks, Hedging & Pledging

a. Clawbacks

A clawback provision provides the company with the ability to recoup previously paid compensation to executives if a triggering event takes place. Sarbanes-Oxley mandated that incentive compensation for CEOs and CFOs be subject to clawback by the SEC in the event financial results are restated due to misconduct. Dodd-Frank includes a clawback provision that applies to all executive officers in the event of a financial restatement that would reduce incentive payments. A key distinction between the Sarbanes-Oxley and the Dodd-Frank clawbacks is that the latter does not require executive misconduct to trigger the clawback.

*Clawback Policy Feature*	*Market Practice*
Triggering Event	Most common approach is financial restatement (approximately 83% of CAP 120 companies) and/or misconduct that would have impacted incentive payments (74% of companies) Many companies have expanded their policy to include behavior or activity (e.g., violation of company policy) that results in a material financial or reputational impact to the company. Some companies include violation of restrictive covenants (e.g., non-solicitation or non-compete agreements) as a triggering event
Application	Among larger companies, typically applies to both annual and long-term incentive plans
Period of Time	1–3 years is the most common lookback period that companies use when seeking to reclaim compensation

The underlying rationale for a clawback is that incentive payments based on inaccurate financial statements have not been earned fairly by executives and should be returned to the company, particularly in cases where the restatement was due to executive misconduct. This rationale is compelling and is accepted as reasonable by most compensation committee members. In addition, most shareholder advisory firms support the use of clawbacks.

While the rationale for clawback policies is sound, in practice they are seldom used to recoup compensation from executives. It is often challenging to determine how much an executive was overpaid due to a financial restatement, particularly when the value of equity-based compensation is not directly linked to a company’s financial statements. There may also be legal barriers to recovering compensation from executives.

Clawback Policy Requirement

Effective December 2023, the SEC issued final rules that require all companies listed on the NYSE or NASDAQ to adopt and enforce a clawback policy in compliance with the following provisions mandated by the SEC.

According to the final rules, clawbacks are triggered by all accounting restatements, including both “big R” and “little r” restatements. A “big R” restatement occurs when an issuer is required to prepare an accounting restatement that corrects an error in previously issued financial statements that is material to the previously issued financial statements. This requires an 8-K disclosure. A “little r” restatement corrects an error that would result in a material misstatement if the error were not corrected in the current period or left uncorrected. This type of restatement is frequently deemed not to be material and does not require 8-K disclosure. This was the largest departure from the proposed rules, which only required a “big R” restatement to trigger a clawback.

Current and former executives are subject to the new rules. Compensation received by former executives will be subject to the clawback policy. Companies are not allowed to indemnify executives against the loss of erroneously awarded compensation. The clawback applies to incentive compensation that is determined based on financial measures (including TSR or stock price). Time-vested restricted stock/RSUs and stock options are not subject to clawback.

Boards generally do not have discretion in applying the clawback. They can determine not to pursue it if the direct cost of seeking it will be greater than the amount to be recovered. There are exceptions if the clawback is deemed to violate the executive’s home country law or if it would negatively impact a qualified retirement plan.

The company is required to look back to the three most recently completed fiscal years before the date that the issuer is required to prepare an accounting restatement.

The policy must be disclosed in any information statements that call for Item 402 disclosure, including the proxy statement and as an exhibit to the 10-K. If the policy is applied, the company must disclose in its proxy statement how the clawback policy was applied and amend SCT amounts for any named executives impacted by the recoupment.

Many companies maintain a broader clawback policy than that mandated by Dodd-Frank.

Key Questions for Committee Members to Ask:

Should we adopt a clawback policy beyond the Dodd-Frank requirements? If so, what triggers are best? Do we require misconduct, or should it apply to violations of employment covenants?
If we adopt a supplemental clawback policy, who will be responsible for informing the committee of the occurrence of a triggering event?
Who will be responsible for determining the amount of incentive compensation that needs to be clawed back?
How much discretion will be available to determine how a clawback will be applied?

b. Hedging

Hedging is a sophisticated technique where an investor attempts to limit losses created by movement in the stock price of a given security by taking an offsetting position. Common examples of hedging vehicles include short sales, put options, and futures. Only a few years ago, hedging of company stock by executives was mentioned rarely when discussing executive compensation. This has changed since Dodd-Frank was implemented and the proxy advisory firms began focusing on hedging.

Most committees have assumed that executives would not hedge equity-based compensation by selling company shares short or using other strategies to protect themselves from decreases in the value of the company’s stock. However, Dodd-Frank requires that companies disclose whether or not their employees or directors were allowed to hedge their interests in company stock. Companies that have implemented policies have generally taken a broad approach in prohibiting all hedges on the company’s stock.

Committees have generally embraced anti-hedging requirements as they help ensure that equity-based compensation aligns the interests of management with those of shareholders. Most agree that allowing executives or directors to hedge their positions in company stock undermines this goal.

Hedging Policy Disclosure Requirement

In December 2018, the SEC adopted new rules requiring disclosure of a company’s hedging policy. The hedging policy was initially proposed by the SEC on February 9, 2015 under Section 955 of the Dodd-Frank Act. It requires companies to disclose in the proxy (or information statements relating to the election of directors) any practices or policies regarding the ability of employees or directors to engage in certain hedging transactions with respect to company equity.

Per the final rules, companies are required to describe any practices or policies they have adopted regarding the ability of employees, officers, or directors to hedge. The SEC made clear that companies could satisfy the disclosure requirements by either providing a fair and accurate summary of the hedging practices or policies that apply, including the categories of persons they affect and any categories of hedging transactions that are specifically permitted or specifically disallowed, or, alternatively, by disclosing the practices or policies in full. If the company does not have any such practices or policies, the company must disclose this fact or state that hedging transactions are generally permitted.

Key Questions for Committee Members to Ask:

Do we have a policy prohibiting the hedging of company stock? If not, why?
Does our hedging policy apply to all employees and directors? If not, which employees does it apply to?

c. Pledging

Pledging of company shares occurs when an executive uses shares as collateral for a margin loan or other financial transaction. In its 2025 policy statement, ISS indicated that significant pledging of company shares could serve as the basis for recommending a withhold vote for directors. ISS’s concern stems from a risk that executives may need to sell pledged shares to satisfy their obligations, and that could undo the positive incentive effects of using equity as a shareholder alignment tool or limit executives’ ability to comply with ownership guidelines. Forced sales of company stock could also cause the executive to violate insider trading rules.

While pledging of shares was not a widespread practice, several high-profile cases involving company founders who owned large blocks of stock have received negative publicity. In addition, the prospect of a withhold vote for executives encourages companies to take share pledging seriously.

Key Questions for Committee Members to Ask:

Do we have a policy prohibiting the pledging of company stock? If not, why?
Do any executives or directors currently engage in pledging transactions?