Clawbacks: Recovery of Erroneously Awarded Compensation
The countless scandals and crises of our financial system have revealed several flaws in our compensatory system for top executives that leave many wondering how is it possible for top leaders of a company to make hasty, essentially unethical decisions and dishonestly walk away with millions. A paradigm to support our case is the obvious Enron scandal of 2001, particularly notable are the top executives at Enron who made “fundamentally flawed” decisions that ultimately led to the collapse of the company, once ranked as the nation’s seventh-largest corporation. In 2001, the top executives at Enron strolled away with roughly $1.1 billion in the three previous years. More specifically, Ken Lay and Jeff Skilling of Enron, cashed out nearly $160 million in stocks, while unwitting investors lost virtually $6 trillion overall.
The Dodd-Frank Wall Street Reform and Consumer Protection Act expands on the compensation “clawback” concept introduced in § 304 of the Sarbanes-Oxley Act in 2002, which required that in the event of any restatement of earnings based on executive misconduct, public companies must recoup incentives to the company’s CEO and CFO that were paid out within 12 months preceding the restatement. Many public companies have incorporated similar clawback provisions into their bylaws—which may be one reason §304 is used less frequently.
The new Dodd-Frank Act, has bolstered the section to encompass all executives and cover a three-year period as oppose to just the 12-month period. §954 (b) Recovery of funds: requires all listed companies to adopt and implement their own internal “clawback” policies covering incentive-based compensation, placing the burden on the individual corporations because it understands the need for tailor-made clauses.