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What started as a way to prevent reckless corporate behavior and protect shareholders' interests due to Wells Fargo's cross-selling scandal, clawback soon became a practice adopted by multiple companies across the globe. Moreover, it put the need to ground the Dodd-Frank Act into the policy.  

The incident occurred in 2016, prompting Wells Fargo to revise its management, risk, and control frameworks. Fargo also changed its culture and clawback policies to rebuild trust and address the issues that led to the scandal. However, it opened an opportunity for companies across different industries worldwide to revise their clawback policies. 

The clawback policy is seen as a tool in organizations to discourage excessive and inappropriate risk-taking by the representatives. In 2016, Wells Fargo employees, 5,300 to be exact, opened 2 million unauthorized accounts, leading to the bank clawing back 185 million dollars in executive compensation. This reinstates the purpose of the clawback policy.  

The purpose was to enable a company to recoup incentive-based compensation paid to an executive if it later turns out that the financial statements containing such metrics were flawed or unethically sourced. Keeping Wells Fargo as the contemporary example of 'clawing back', one can say that the consequences of violating a clawback policy can be significant.  

What is clawback? 

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Clawback, according to NASDAQ, refers to "an arrangement whereby the equity owners commit to using dividends they have received in the past to finance the cash needs of the project or corporation in the future." 

Easily put, clawback is a contractual provision that allows a company to take previously disbursed compensation or benefits, typically associated with performance-based pay like bonuses.  

Its purpose is to uphold accountability among employees. It allows the organization to recover compensation if an employee engages in misconduct or if there is a significant correction of financial records. 

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For example, let us assume that a company gives out bonuses to its top executives based on their performance.

One executive receives a big bonus because the company had a profitable year. But later, it was discovered that the executive used dishonest tactics to boost the company's profits, which weren't sustainable.

The company then uses the clawback provision in that executive's contract to take back the bonus they gave because the actions weren't honest and didn't benefit the company in the long run.

Now that we have understood the meaning of clawback, let us scrutinize how the mechanism of clawback provision works.

How does clawback provision work? 

Clawback provisions refer to contractual clauses that require the return of money or other compensation under specific circumstances or events. They are often used in financial employment agreements to regulate bonus payments and protect against financial losses, fraud, or misconduct. Clawbacks are designed in a way to also promote better financial practices, deter fraudulent activity, and encourage sustainable sales behavior. 

In the financial sector, clawbacks are commonly applied to employment contracts to control executive compensation and prevent fraud. They can be triggered by long-term variations of financial instruments, misconduct, or erroneous financial reporting. The Dodd-Frank Act aimed to expand clawbacks even further, but the proposed rule has not been approved.  

For sales organizations, clawback clauses allow a business to reclaim commission or other performance-based compensation paid to a salesperson when a customer churns or cancels their purchase within a specified period.

This helps protect the business from financial losses due to customer churn and encourages sales reps to pursue high-quality deals and improve customer experience. 

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A quantified study on clawback:

- Between 2005 and 2010, the number of big companies in the Fortune 500 using clawbacks went up a lot. At first, less than 3% used them, but then it jumped to 82%. 

- According to ISS Corporate Solutions, over 90% of S&P 500 companies have rules for clawing back money and stocks. But for the Russell 3000, which doesn't include the S&P 500, only a bit more than half have similar policies. 

- A Harvard-based research has shown a 94% adoption rate among S&P 500 healthcare companies. However, only about 31% of healthcare companies outside of the S&P 500 have such policies in place. 

The quantified study of the clawback seeds in the significance of placing the clawback policy in the agreement. However, there are more reasons to include clawback policy in the sales commission plans. 

Why should you include clawback clauses in your sales commission plans?  

Clawback clauses are essential to include in sales commission plans to protect the company from financial losses due to fraudulent activities, illegal sales, or non-compliance with company policies. Consider including clawback clauses in your sales commission plans for several key reasons: 

1. Reduced financial risk 

Clawbacks can help mitigate financial risk by recouping commissions on sales that don't translate into long-term benefits for the company. This could be due to customer churn, product returns, or fraudulent activity.

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Example: Airbnb has adopted a clawback policy to recover incentives, equity awards, and other compensation in the event of certain acts of misconduct by employees and executive officers. 

The policy applies if Airbnb's publicly disclosed financial statements must be restated due to fraudulent or willful misconduct by the employees or executives.

It provides the Leadership Development, Belonging, and Compensation Committee or the board of directors with the discretion to recover cash incentives, equity awards, or other compensation of at-fault employees. 

Clawbacks provide a layer of legal protection in cases of fraud or misconduct by a salesperson. If a commission was earned through illegal or unethical means, the clawback clause allows the company to recover those funds.  

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Example: Charah Solutions, Inc. has a clawback policy in their contract that applies to any amounts paid or payable under the agreement, subject to applicable law, securities exchange listing standards, or as otherwise determined by the Board. 

3. Alignment with business goals

Clawback clauses can incentivize sales behaviors that contribute to the company's long-term growth. By potentially recouping commissions on short-term gains that don't translate into customer retention or satisfaction, clawbacks encourage salespeople to focus on building sustainable value. 

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Example: Amazon's clawback policy states that if its financial statement has to be corrected because it does not follow securities laws, it will recover any excessive incentive-based pay received by top executives for the three previous fiscal years.

This rule applies to incentive pay received after October 2, 2023. A committee appointed by the board will oversee this and follow Nasdaq Rule 5608. 

However, to include clawback policy in your provision, you must know the types of clawback that there are.  

Types of clawback clauses

Here are the types of clawback clauses with brief explanations and examples: 

1. Negative quota credit

This type of clawback reduces an employee's commission or bonus if they fail to meet a specific sales target. Let's say a salesperson earns a $5,000 bonus for exceeding their quota by 10%.

But, if the clause includes a negative quota credit, and the salesperson falls short of their quota by 5%, a portion of their base salary or previous commissions might be reduced by an amount proportional to the missed quota. 

2. Retroactive negative quota credit

Similar to a negative quota credit, this provision allows the employer to claw back commissions or bonuses already paid to the employee if they fail to meet their quota within a specified timeframe, which can extend beyond the current sales period.

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For instance, an employee might receive a commission payout at the end of each quarter. But, if a retroactive negative quota credit clause is in place, and the employee doesn't meet their annual quota by the end of the year, the company can demand repayment of some or all of the commissions earned throughout the year.

3. Commission-only clawback

This clawback applies only to commissions earned by the employee. If the employee fails to meet specific performance metrics or breaches their contract, the company can withhold or recoup all or a portion of the commissions paid out.

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For example, a commission-only clawback might be triggered if the employee is terminated for misconduct. Once included in the policy, one must know the important benchmarks to determine the effectiveness of the clawback provision in sakes.

What are some common benchmarks used to determine clawback in sales? 

The most common benchmarks used to determine clawback in sales are: 

1. Quota attainment

This is the most fundamental benchmark. Clawback provisions often kick in if a salesperson falls below a pre-defined percentage of their assigned sales quota for a specific period. 

2. Sales accelerators

These are bonuses or incentives offered to salespeople for exceeding specific targets. Clawback can be applied to these accelerators if the salesperson doesn't achieve the underlying base quota or other performance metrics. 

However, companies should communicate clearly with sales reps about integrating the clawback clauses and their implications. This can help prevent misunderstandings and ensure that sales reps understand the potential consequences of their actions. For such an aspect, maintaining the best practices in clawback navigation would help.  

Best practices for navigating clawback clauses 

To navigate clawback clauses effectively, it is important to follow several best practices. These practices include: 

It is crucial to consult with legal experts when creating clawback clauses to ensure they are legally valid and enforceable. This can prevent potential disputes and legal proceedings. 

2. Establishing clear and fair clawback conditions

Clawback clauses should be straightforward and fair, with transparent conditions outlining when commissions can be reclaimed. This helps prevent misunderstandings and ensures that sales representatives are aware of the potential consequences of their actions. 

3. Regularly reviewing and updating clawback clauses

Companies should periodically review and revise them to maintain their effectiveness and relevance. This process may involve analyzing past instances where the clause was invoked to assess its impact on both the business's financial performance and sales outcomes. 

Recent laws regarding clawback clauses 

  • The new rules, implemented in October 2022, are part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  
  • Listed companies must follow new SEC Clawback Rules.  
  • These rules require companies to get back incentive-based compensation awarded based on mistakes in financial statements. This applies to most companies on major stock exchanges, regardless of the officer's knowledge or misconduct.  
  • According to recent laws, companies cannot protect officers from these clawbacks, and both major and minor accounting errors can trigger them.  
  • New disclosure rules require companies to report details about clawbacks. The rules may also affect how companies conduct internal investigations. 

Études de cas

Here are 2 case studies for better clarity:

1. Wells Fargo cross-selling issue triggers clawback policy to be placed: 

Wells Fargo & Co., a well-renowned financial service provider, adopted the clawback policy in 2013. Although ‘clawback’ maintains a thorough and rigid meaning of ‘reclaiming the money’, Wells Fargo's clawback policy is an example of a company taking action to recoup compensation in a dire situation.

The Wells Fargo scandal highlights the need for properly designed compensation clawbacks to prevent reckless corporate behavior and protect shareholders' interests. 

The scandal: The Wells Fargo scandal refers to a series of misconduct and fraudulent activities that came to light in 2016.  The reps created millions of savings and checking accounts without the client's consent.

So, when clients began to notice unanticipated fees and received unexpected financial products, matters started to go underhill. As a result of this discovery, regulatory bodies, including the Consumer Financial Protection Bureau, imposed penalties and fined the organization $185 million in 2016. 

Retaliation by Wells Fargo: Wells Fargo's clawback policies are contractual clauses that allowed the company to reclaim compensation under specific circumstances, primarily related to executive compensation contracts, back in 2017.

Clawback provisions were used to reduce or cancel bonuses as a punitive measure against former and current employees actively integrated into the scandal. The employees included high-level executives like CEO John Stumpf and Tim Sloan.  

Results after placing the clawback policy: 

  • The placement of a clawback clause in their workplace helped them recoup $75 million in total.  
  • Maintain the ethical conduct of the organization.  
  • Created a solid structure for the future where such conduct can be pin-pointed in due time.  

The clawback clause, after the scandal served as financial and ethical safeguards. Moreover, it ensured that incentives align with the company's long-term objectives and protect the company's interests without being overly punitive towards employees. 

2. JP Morgan Chase "London Whale" issue prompts execs to put clawback in motion: 

Similar to the Wells Fargo cross-selling scandal, The 2012 JP Morgan Chase trading loss, also known to the public as the "London Whale" scandal, involved large trading losses at JP Morgan's Chief Investment Officer. The issue is based on transactions booked through its London branch. 

The ‘London Whale’ scandal that led to mayhem: 

A series of events led JP Morgan Chase to insert the clawback policies, however, the major scandal that ignited the process of derivative transactions involving credit default swaps (CDS) was entered, reportedly as part of the bank's "hedging" strategy.

The incident highlights the risks associated with complex financial matters. In the same month, regulators instructed JPMorgan to implement corrective measures to correct the shortcomings noticed in risk management that led to significant trading losses. In terms of losses, JP Morgan Chase saw, 

  • The London Whale trading scandal that caused $6.2 billion in losses was a significant event in the financial industry, and the clawback was a crucial part of the company's response to the scandal. 
  • An estimated trading loss of $2 billion was announced, but the loss amounted to more than $6 billion for JPMorgan Chase. 
  • $920 million in total fines to US and UK authorities.  

Success after implementing clawback policy: 

JPMorgan implemented a clawback of compensation due to "London Whale" trading losses and subsequent fraud charges brought by the SEC against former employees. As a result, JP Morgan Chase successfully,  

  • Recouped millions in compensation from implicated traders in the London Whale incident. This amount represents two years' worth of their pay. 
  • Defeated a London Whale shareholder lawsuit in the U.S. This further cemented the company's position in the case.  
  • Along with the board of directors cut the compensation of CEO Jamie Dimon by 50 percent. 
  • The scandal led to calls for tougher regulations and oversight of the banking industry, including the implementation of the Volcker Rule. This rule stops banks from engaging in proprietary trading and imposes limits on their investments in hedge funds and private equity funds. 

Conclusion

Clawback provisions play a significant role in frameworks by reinstating investors' confidence and fostering trust among the public. Their inclusion improves individual accountability and modifies incentive systems to reduce reliance on short-term payout results.  

One can say clawbacks are implemented across sectors such as private equity, insurance, dividends, and business contracts to ensure greater responsibility among the parties involved.  

However, to ensure a fair application of clawback policies among the sales reps, an incentive automation channel can be established for them to meet the expectations set out in the contract. Compass is a sales incentive management software that helps businesses manage and automate their sales incentive programs fairly. The platform simplifies the management of complex incentive plans by: 

  • Launching incentive plans  
  • Calculating and disbursing incentives, with real-time visibility into performance 
  • Generate commission information and on-time payouts. 
  • Integration with CRMs through webhooks, APIs, or SDKs, incorporating link and gate filters for managing multiple data sources.  

So facilitate the automation of incentive programs, simplify the process of establishing sales performance goals, and monitor employee advancement in surpassing them while maintaining decorum and fairness at all levels with Compass. 

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