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Clawbacks: Trending Now?

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June 08, 2018 | Jennifer Namazi

Clawbacks: Trending Now?

Have you ever noticed how some topics in the world of equity compensation seem to surface in waves? Clawbacks seem to be one of those topics. It’s been years since Dodd-Frank, and we still await final clawback rules. We speculated about final clawback rules for years, finally until the chatter died down and it seemed there wasn’t much left to talk about. While SEC Chairman Clayton has publicly confirmed within the last year that such rules will still be implemented as per the SEC’s obligation, he’s also noted that many companies are already being proactive with implementing such policies and making disclosures about them. This may be contributing to the SEC’s own prioritization of the rulemaking within the Commission's to-do list. While we wait final rules, some recent articles have brought forth new ideas around clawbacks, which brings me to wonder if this topic is trending once again.
 

A recent Semler Brossy memo, “The Business Case for Clawbacks,” (April 16, 2018 - by Kathryn Neel, Seymour Burchman and Olivia Voorhis) raises the idea of implementing a broad clawback policy now. The memo provides thought provoking insight into why expanding a policy beyond the SEC’s current mandates under Dodd-Frank may be more appropriate and frankly, in my opinion, better for companies and their shareholders. Accordingly, a strong business case often exists for thinking about clawbacks more broadly than regulators require. This case is derived from the typical objectives for clawback policies: protecting company and shareholder interests in the event of significant damage to the company, avoiding bad optics for the company and the board, and reducing potential motivation for inappropriate actions or decisions by reducing financial gain to be realized by executives. Many companies already maintain clawback policies that go beyond financial re-statements to cover detrimental conduct more broadly, particularly in industries where the potential for reputational or economic harm is high, such as financial services. The memo interestingly highlights four recent scandals, noting that in two of the cases (Wells Fargo and Equifax), the proposed rules under Dodd-Frank would not have resulted in clawbacks. The memo also highlights some companies that have adopted detrimental conduct policies that extend well beyond the Dodd-Frank parameters.

 
While some organizations may have reasonable reservations about pressing full steam ahead in adopting clawback policies with broad detrimental conduct provisions, a new memo by Shearman & Sterling, “Embracing the Quasi-Clawback” (April 19, 2016, by Doreen Lilienfeld and Matthew Behrens) raises an excellent point – “Regardless of the practical reasons for resisting a clawback, the failure to recoup compensation may lead investors to question a board’s dedication to corporate governance principles.” The memo goes on to highlight pending shareholder litigation at United Continental on this very matter. Quoted below, the Shearman memo offers some new ideas for constructing recoupment policies, in the form of a “quasi-clawback” feature (“the forfeiture of amounts that have not yet been earned, or have been earned but not yet paid.) The following are ways in which companies can implement quasi-clawback features in their compensation programs:
  • Forfeiture of unvested incentive based compensation. Compensation committees should consider retaining the discretion to reduce or eliminate target amounts of unearned incentive compensation upon uncovering behavior by an employee warranting such reduction or elimination. 
  • Deferred payment of earned incentive-based compensation. Once performance-based compensation has been earned (i.e., the targets have been achieved), consider delaying payment for a period of time to ensure there was no inappropriate risk-taking in earning the compensation. Upon discovery, the compensation can be forfeited without the need for a clawback.
  • Forfeiture of nonqualified deferred compensation. Although Section 409A of the tax code prohibits the use of nonqualified deferred compensation to offset current obligations, forcing a forfeiture of otherwise vested but deferred compensation can be utilized as a form of punishment for so-called “bad actors.” This type of provision may be the most troubling from a recruitment standpoint as it places a portion of retirement savings at risk.”
These two memos are highly worth the time investment to read, and both provide some actionable ideas for companies to consider in developing or expanding a clawback policy.

-Jennifer
 

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