Business Point

While everyone is familiar with the executive compensation clawback requirements of Dodd-Frank, some companies may feel that those requirements do not provide enough protection to the company and its shareholders. An expanded clawback policy can provide an added layer of protection, can be tailored to cover specific items of compensation in specific circumstances and can be made subject to the discretion of the applicable governing body. In the age of increasing shareholder activism and proxy advisory firms (e.g., ISS), companies may want to consider such an expanded policy.

Technical Points

Under Dodd-Frank, a public company generally is required to adopt a clawback policy calling for recovery of erroneously paid incentive-based compensation if the company must prepare an accounting restatement due to the company's material noncompliance with federal reporting requirements under applicable securities laws. But what about companies that want to have clawback protections that do not require material noncompliance with accounting standards or that want such protections to apply to more than just incentive-based compensation?

One area where a company might consider implementing a broad-based clawback program (sometimes referred to as a detrimental conduct policy) could be in situations where an executive has engaged in misconduct but such misconduct does not trigger the Dodd-Frank clawback. Such a policy could apply in cases similar to those where a traditional "cause" definition (e.g., fraud, gross negligence, misconduct, criminal activity, activities harming the company's financial status or reputation) applies, seen often under employment agreements.

In addition, unlike under Dodd-Frank, such a policy could be drafted to grant enforcement discretion to the governing body so that the specific facts and circumstances of each situation can be reviewed individually on the merits. Furthermore, such a policy could cover forfeiture of incentive-based compensation that has not yet vested (which is often a consequence of a termination of an executive for "cause"). Finally, the policy could apply to non-incentive-based compensation, such as discretionary bonuses.1

While such an expanded policy may benefit the company and its shareholders, potential concerns, including the following, should be kept in mind:

  • If such a policy is not customary in the company's industry, it could hamper executive recruiting or retention efforts.
  • Seeking repayment of clawback amounts could be costly and time-consuming. What if an executive (or former executive) claims that he/she is not in a position to repay the amount?
  • Executives might act too conservatively out of concern of triggering the policy.
  • If a violation occurs, how much compensation should be clawed back? Should some sliding scale apply?

Footnotes

1 Companies should consult with their labor and employment counsel prior to implementation of a broad-based clawback policy to ensure that clawing back (or forfeiting) the applicable types of compensation does not run afoul of applicable state wage laws.

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