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Article | Executive Pay Memo North America

Dodd-Frank clawbacks (1 in the series)

A game plan for harmonizing your holdback and clawback policies

By Steve Seelig and Stephen Douglas | March 16, 2023

Make sure you chart your path before making any clawback policy changes
Executive Compensation

This is the first in a three-part series of articles detailing the steps to be taken and decisions to be made as companies adopt Dodd-Frank-compliant clawback policies mandated by the Securities and Exchange Commission (SEC). This post focuses on how companies should conduct a detailed inventory of what their plans and policies state will happen with compensation promised or paid after something bad happens.  We will also explore the different pressures being imposed by regulatory agencies to beef up those provisions, and what steps should be considered to holistically determine what job positions these policies should cover and what triggering events are appropriate.

This article will start you on your way in determining what additional clawback provision should be in place and provides insights into the recent Department of Justice (DOJ) directive issued on clawbacks.

1. What is the current state of your holdback and clawback provisions?

Although some companies may determine that all they need to do is plug in their Dodd-Frank clawback policy and call it a day, there are several reasons to consider more comprehensive actions.

Holdback provisions: The first step is to understand how existing bonus plans and long-term incentive plans deal with any number of potential events before that compensation is actually paid to employees. We call these “holdback” provisions, with many programs written with a “must be present to win” provision so that terminated employees would receive nothing if not employed at the payment date. If in place, these provisions help take the pressure off the compensation committee to decide to hold back pay after a “for-cause” termination. Often, where there is a “not-for-cause” termination, the same rule would apply, but not always. There is often an interplay with severance benefits in not-for-cause terminations that should be examined.

Action step: Understand those actions that would give rise to a holdback of pay and whether there are circumstances where severance would be inappropriate depending on a bad action even for a not-for-cause termination. This requires a detailed analysis of all plan documents, grant agreements, employee communications and the like to populate a matrix that will reveal any inconsistent treatment across the board. Companies will then need to resolve and harmonize those inconsistencies.

Clawback provisions: At first blush, it would seem that adopting a Dodd-Frank-compliant policy would obviate the need to have any other policy in place, but we think companies could have at least two and perhaps three separate clawback policies in place before the end of 2023.

For example, many companies have in place what can be called a “Dodd-Frank lite” policy, whereby a clawback would be invoked only for an executive whose fraudulent actions end up triggering an accounting restatement, likely referencing only what is known as a “big R” restatement where prior financials are reissued. Cataloguing those triggers in a matrix is the first step here.

Action step: Companies should conduct an inventory of the current state in their pay programs in the same manner as the holdback review discussed above. Here, the focus will be narrower in that clawback policies tend to exist within a single document; however, this may not be the case for every company in every industry. Care must be taken to identify clawback provisions embodied in other documents just to make sure there are no overlaps. The goal is to understand the current policy, its triggers and to whom it applies.

2. Determining how many clawback policies you will need

The obvious next step will be for the company to consider where it wants to be after it adopts the required Dodd-Frank policy and whether it wants to carry over any additional elements of its existing clawback policy into the future. We think the recent DOJ directive (discussed below) may very well change this equation. Determining how to respond will need to be handled by the company’s legal team, particularly those with expertise in criminal defense work. Yet, because this involves issues regarding the details of how a clawback policy can and should be invoked, the legal team will need to consult with compensation professionals to help them develop the program.

The DOJ calls its recent effort The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks. It is based on the notion that compensation programs that clearly and effectively impose financial penalties for misconduct can also deter risky behavior and foster a culture of compliance. Thus, as part of this pilot program, effective March 15, 2023, and running for a three-year period, the DOJ may permit companies to reduce fines in criminal cases where these companies 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 are beyond the scope of our Compensation practice and must be discussed with criminal counsel.

We observe that for access to this pilot program, companies must determine if they must have a clawback policy in place before a criminal case arises. Our read is that companies will have a very difficult time plugging in an expanded clawback policy after the fact and therefore may lose the ability to utilize the DOJ’s penalty reduction program. If our read is correct, this means companies will need to consider putting in place this year an additional layer of clawbacks that may go deeper in the organization for those who commit, aid or abet, or ignore criminal acts.

Action steps: These are the questions companies should consider as they determine the various levels of clawbacks that apply to compensation programs:

    1. When would the policy be triggered? Should those who commit fraud or engage in willful misconduct that does not trigger a restatement be subject to a clawback? While not an exhaustive list, other triggers — which vary by industry — can include:
      • Committing, aiding and abetting, or ignoring commission of criminal conduct
      • Violating the company’s Code of Conduct (which may cover #MeToo situations)
      • Failure to supervise that leads to a restatement (for those outside the executive officer ranks); or
      • Taking actions, in the absence of a restatement, that lead to reputational harm or cause a financial impact

    2. Who is covered by the policy? It may be justifiable to have the clawback apply deeper in the organization where the triggering events are acts of commission. Each potential triggering event should be examined as to the depth of coverage, with perhaps the DOJ’s clawback program reaching very deep but the other triggering events limited to upper management.

    3. What compensation is covered by the policy? We would expect that some policies would 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. Our view is this decision would be based largely on the triggering event. If that event caused a restatement or caused 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, a compelling 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 they should hardwire this determination into the clawback policy or create sufficient discretion for the compensation committee to make that decision. In addition, the company will need to determine 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’s discretion.

    4. How and when will the policy be enforced? Dodd-Frank provides an exception where the cost of doing so would make the clawback too costly to undertake. Most existing clawback policies simply leave how the policy is enforced up to the compensation committee to decide. We would expect most additional policies would be less directive about their execution than Dodd-Frank.

    5. Who is in charge of this policy? Enforcing clawback policies that cover executives is within the compensation committee’s remit. Fundamentally, this is because it is management’s money being recouped. The further down in the organization the clawback covers, the more likely it is that management and counsel will be the ones to enforce this policy. It is not clear how that coverage split would work for a DOJ clawback policy that, by definition, would cover all employees.

    As these questions show, companies have a lot of work to do, in conjunction with their compensation and legal advisors.

    Our next article will cover the detailed actions companies must take to understand what is considered incentive compensation that is subject to the Dodd-Frank clawback rules. Some of the answers might surprise you.


Senior Director, Executive Compensation

Senior Director, Retirement and Executive Compensation

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