The Increased Prevalence and Focus on Clawback Policy

In 2002, as a result of a few high profile cases of corporate wrongdoing and scandalous financial behavior, Congress passed The Sarbanes-Oxley Act of 2002 that required clawback of incentive compensation from the CEO and CFO.  According to Equilar’s 2009 Fortune 100 Clawback Policy Report, between 2006 and 2009 the percentage of companies reporting Clawback Policies jumped from 17% to 72%.  Furthermore, as a requirement of all banks participating in the Troubled Asset Relief Program (TARP), all incentive compensation paid to the top 20 highest paid executives must be subject to clawback policies in the case of materially inaccurate financial data or performance metrics.  So, the public company arena has an increasingly heightened awareness of such a risk reduction policy.   And now most recently, The Dodd-Frank Wall Street Reform and Protection Act of 2010 includes a provision requiring Clawback Policies.

Dodd-Frank Wall Street Reform and Consumer Protection Act 2010

The new law signed by President Obama on July 21, 2010 requires all companies listed on national security exchanges to develop and adopt a policy to recoup incentive-based compensation upon the discovery of misreported or erroneous financial information.  The requirements under the new law are more far reaching than those under Section 304 of the Sarbanes-Oxley Act (SOX 304).

Provisions of the Dodd-Frank Act

  • Any time a company is required to prepare an accounting restatement as a result of material noncompliance with any financial reporting requirement the clawback policy will be triggered.  This expands the requirement under SOX 304 which applied only when a restatement of financial statements is “required” and is the result of “misconduct”.
  • The clawback policy would apply to all incentive-based compensation (cash or equity) paid to any former or current executive.  SOX 304 applied only to the CEO and CFO.
  • The look-back period is for the thirty-six (36) months preceding the date on which the restatement is required.  The look-back period under SOX 304 is only twelve months.
  • The amount to be recovered would be the difference in the amount actually paid based on the erroneous data and the amount that would have been paid based on the corrected data.

Policy Design/Review Considerations

  • Review any existing policies to determine any possible changes required by new law.
  • Identify the specific party required to enforce the policy (i.e. senior risk assessment officer, Compensation Committee, full Board of Directors)
  • Determine what method of recoupment will be necessary for recovery of any incorrect payments (i.e. deduction from future payments/awards, enforcement of re-payment by executive or potential litigation against former executives)
  • Determine whether policy should be more expansive than required by Dodd-Frank Act to include poor performance, violation of non-competes, negligence, etc.
  • Determine if policy is strong enough to be a mitigating factor to deter excessive risk under SEC rules which requires narrative disclosure in the CD&A in proxy.
  • Conduct a review of all compensation arrangements (i.e. incentive plan documents, employment agreements, equity award agreements) to insure proper integration with a new clawback policy.

So, while there may be many “unintended consequences” of the Dodd- Frank Act and there is much final government regulation yet to be published, it appears that Clawback Policies contribute to risk mitigation in compensation and are likely here to stay.

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