Malus and clawback – is it time you reviewed your policy and process?

The U.K. Corporate Governance Code (the 'Code') has for some time stated that remuneration policies should include 'provisions that would enable the company to recover and/or withhold sums or share awards and specify the circumstances in which it would be appropriate to do so'. The latest edition of the Code encourages greater visibility of such mechanisms with the addition of a new provision that states that companies should include in their annual report a description of their malus and clawback provisions, including:

• The circumstances in which malus and clawback provisions could be used
• A description of the period for malus and clawback and why the selected period is best suited to the organization
• Whether the provisions were used in the last reporting period. If so, a clear explanation of the reason should be provided in the annual report

We are observing an increasing prevalence of the use of malus and clawback provisions with four companies in the FTSE 350 applying such provisions during the 2023 reporting year and early 2024. This represents an uptick from the period 2019-2022 where only three companies disclosed the use of malus or clawback. While most companies subject to the Code already report on their malus and clawback provisions, recent high-profile executive departures in the U.K. have emphasized the importance of having a robust and enactable malus and clawback policy and process.

In this edition of Executive Pay Memo we present a summary of WTW's malus and clawback 'health check' to prompt thinking of whether there is room for improvement in your malus and clawback policy and process.

Identify the relevant trigger events and time period applicable to your industry and sector

In 2018 the Investment Association ('IA') stated that remuneration committees should establish a more substantial list of trigger events in which malus and clawback could be enacted. Previously, the typical trigger events for malus and clawback were limited to situations like gross misconduct and misstatement of results. The IA expressed concerns that these triggers in isolation were difficult to prove and thus were rarely used in practice.

Revisions to the IA Principles aimed to address this by encouraging companies to establish a broader and more specific set of trigger events that could be clearly defined and measured. Setting appropriate trigger events requires a deep understanding of the company's specific context, culture and risk profile. Since 2018, we have observed the typical FTSE 100 organization establish a more comprehensive and substantial set of trigger events. Typical triggers may now include:

• Restatement due to financial reporting failure or misstatement of audited results
• Incorrect award outcomes due to miscalculation or based on incorrect information
• Fraud, misconduct or an exceptional event which has had, or may have, a material effect on the Company
• Material failure impacting safety or environmental sustainability

In respect of the time period, some of the larger U.K. financial institutions are required to make variable remuneration awarded to Material Risk Takers subject to clawback typically for a minimum of seven years from the date of the award, or ten years in some circumstances for certain Prudential Regulation Authority (PRA) Senior Managers. Across other industries, clawback periods can vary. Where a time limit is stated, clawback periods vary from two to five years after an award has vested, with the most common period being two or three years. Where a time limit isn't expressed, this may lead to a legal challenge based on proportionality if a significant period has elapsed since vesting and there's no stated clawback period. In line with the change to the Code, we expect companies will provide enhanced disclosure on clawback periods in the years ahead.

U.K. companies need to also consider the wider regulatory landscape. The Securities and Exchange Commission has recently adopted clawback rules mandated by the Dodd-Frank Act which requires all listed companies, including foreign private issuers, to adopt and comply with a written clawback policy and disclose compliance in forthcoming filings.

Review and align all applicable documentation

As malus and clawback arrangements have been implemented over time on a fragmented basis, it's common for companies to have provisions scattered across different documents with inconsistent terms used across all documentation – employment contracts, plan rules, the remuneration policy and even separate malus and clawback policies. In WTW's experience, the precise terms vary between the documents and it's not always clear what applies to whom and when.

• Clear, concise and consistent: All documentation should be written in clear, concise and consistent language that's easily understandable by participants. Companies should clearly outline the steps that'll be taken when a suspected trigger event occurs, including investigation procedures, notification to the individual and the appeals process.
• Share plan rules: Where a significant change has been made to malus and clawback provisions, this should be reflected in the plan rules as appropriate. Given share plan rules are agreed with a ten-year term, malus and clawback provisions in plan rules often lag behind the current malus and clawback policy.
• Annual signing: Some companies mandate that participants who are subject to malus and clawback sign a letter confirming their understanding of the underlying provisions. An annual reminder can help ensure participants are aware of the terms and conditions of the malus and clawback provisions, including trigger events and consequences. If the malus and clawback policy changes or there are significant alterations to the participant's role or responsibilities, an annual signing can serve as a record of their updated understanding. Annual signings are more commonly observed in 'higher risk' industries such as finance and extractive.
• Employment agreements: It's critical employment agreements are reviewed periodically and relevant provisions aligned to mitigate the risk of any legal challenge.
• Legal and regulatory compliance: Ensure the documentation aligns with all relevant legal and regulatory requirements. This may include other relevant jurisdictions where a participant may be based. It's important to note that clawback may not be enforceable from a legal perspective in some jurisdictions so companies should assess enforceability on a country-by-country basis when adopting a group wide approach.

Establish the process for enacting malus and clawback

Experience tells us that companies will get little advanced warning when situations arise that may require the enactment of malus and clawback provisions. A clear and transparent process which has been documented in policies/procedures advance of time, fosters trust between all parties and helps clarify the responsibilities of all stakeholders. Key areas to consider are:

• Investigation and evidence gathering: Define what functions are responsible for conducting the initial review of any relevant documentation and interviewing key individuals. There may be a need to set up a sub-committee containing representatives from HR, Employee Relations, Legal, Compliance, Risk and Finance. External advice should be sought where necessary.
• Remuneration Committee decision making: While not directly involved in initial investigations, the Remuneration Committee plays a vital role in assessing the findings and making decisions on applying malus or clawback. Maintaining thorough documentation of all committee discussions, decisions and the rationale behind them is crucial for transparency and responding to legal challenges.
• Notification and approval: HR would normally be responsible for communication with affected individuals, however the Committee plays a key role in ensuring clear and accurate communication detailing the reason for any and consistent messaging and adherence to established company communication protocols.
• Ongoing monitoring: The Committee should periodically review the effectiveness of the policy in achieving its objectives, ensuring alignment with evolving regulations and best practices. This should include reviewing the list of trigger events in line with industry market practice and investor views.

If you would like to discuss your current malus and clawback policy, or other executive pay or reward matters, please do contact your WTW representative or one of our executive compensation and board advisory specialists.