Just as companies began to focus on adopting clawback policies mandated by the Securities and Exchange Commission (SEC) under the Dodd-Frank Wall Street Reform and Consumer Protection Act,1 the Department of Justice (DOJ) issued a memorandum on March 3, 2023, detailing The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks. While Dodd-Frank clawbacks focus on no-fault clawbacks of officer incentive compensation following a financial restatement, the DOJ program is focused on how companies can limit potential criminal penalties if anyone in the organization commits a criminal act while working for the company.
This article is the first in a three-part series on actions companies should consider as they attempt to reconcile existing clawback policies with the mandated SEC rules and their desire to become eligible under the DOJ pilot program.
Our next two articles will review specific actions needed to implement the Dodd-Frank clawback policy.
Holdback provisions cover scenarios before compensation is actually paid to employees. Many holdback provisions are embodied within the terms of the annual plan or long-term incentive plan itself, so that if the employee has separated before the end of the performance period, he or she would receive no compensation. This would mean, for example, an employee would receive no compensation after a “for-cause” termination. Often, but not always, the same rule would apply for a “not-for-cause” termination; however, employers will want to examine the interactions between holdbacks and severance benefits in not-for-cause terminations to determine if this is the result they envision for every potential early separation.
Action step: Analyze all plan documents, grant agreements, employee communications and the like to understand what actions trigger a holdback of pay and when severance would be inappropriate, in both for-cause and not-for-cause terminations. Find and resolve any inconsistencies this approach may have with the clawback policy already in place and those to be installed later this year.
Adopting a Dodd-Frank-compliant clawback policy does not necessarily remove the need for other policies. For example, more than one policy might be necessary if a company has a so-called Dodd-Frank lite policy, under which a clawback would be invoked only for an executive whose fraudulent actions end up triggering an accounting restatement and the company wants to continue to invoke a clawback where the executive is culpable for bad behavior, with or without a restatement.
Action step: Companies should consider conducting an inventory of current clawback policies in their pay programs to understand the current policy, its triggers and to whom it applies. The focus may be narrower than the holdback review discussed above, as clawback policies tend to exist within a single document; however, this is not always the case. Companies should look for clawback provisions in other documents to make sure there are no overlaps.
In addition to looking at the existing clawback policy, the recent DOJ memo should be considered by companies’ legal teams.
The DOJ’s three-year pilot program outlined in the memo is based on the notion that imposing financial penalties within compensation programs for misconduct can deter risky behavior and foster a culture of compliance. Thus, as part of the program, effective March 15, 2023, the DOJ may permit companies to reduce fines in criminal cases where they seek to recoup compensation from culpable employees and others who both a) had supervisory authority over the employee(s) or business area engaged in the misconduct and b) knew of, or were willfully blind to, the misconduct. Additional details in this program and within the DOJ’s Criminal Division’s Corporate Enforcement Policy, the Evaluation of Corporate Compliance Programs and the Principles of Federal Prosecution of Business Organizations must be discussed with legal counsel.
To access the DOJ’s pilot penalty reduction program, companies should determine if they must have a clawback policy in place before a criminal case arises rather than attempting to plug in an expanded clawback policy after the fact.
Action steps: Companies should consider the following questions as they determine the various levels of clawbacks that apply to compensation programs:
What compensation is covered by the policy? Some policies could go further than covering only incentive-based compensation per Dodd-Frank and could apply also to time-based equity grants that were paid before the triggering event was discovered. If the triggering event caused a restatement or financial or reputational harm, it could make sense to limit coverage only to incentive compensation that would not otherwise have been earned, although perhaps some time-based equity also should be recouped.
On the other hand, an argument can be made that all compensation paid before the discovery of criminal conduct or a violation of the Code of Conduct that led to a for-cause termination should be recouped. Companies will need to decide if this determination should be part of the clawback policy or left to the compensation committee’s discretion. In addition, the company will need to decide if the policy will specify a time frame for recoupment similar to the three-year period in place for Dodd-Frank or whether that decision should also be left to the compensation committee.
Companies face a considerable amount of work in preparing to adopt a Dodd-Frank-compliant clawback policy and determining whether additional policies are needed. Compensation and legal advisors should be consulted to map out a plan before making any policy changes. The next article in this series will cover the detailed actions companies must take to understand what incentive compensation is subject to the Dodd-Frank clawback rules.
1 For more information on the final clawback rules, see “SEC adopts final clawback rules on incentive-based executive compensation,” Insider, November 2022
