Select Page

Recommendations for SEC Rules on Executive Clawback Provisions

It is my recommendation that past incentive-based compensations be exempt from the Recovery Policy required in §954 of the Dodd-Frank Act if the awards occur before the effective date of the SEC’s final rules under §954; under the basis that it is simply not cost-effective.  Boards or compensation committees should be entitled to evaluate the benefits of recoupment against an assessment of the costs involved, as they must mind their fiduciary responsibilities.  For instance, it is not wise to ‘clawback’ monies when the estimated expense (e.g. litigations costs) of actually recouping such payments will essentially exceed the amount of funds recovered.  In such cases, it is important for the board to decide whether to proceed with the recoupment process or not as it could prove detrimental to the shareholders.  In essence, the committee should adopt a de minimisstandard that would provide that issuers may, but are not required to, recover excess incentive-based compensation that does not exceed a minimum amount.

Likewise, corporation’s bylaws could be amended, thereby, adopting or enforcing the clawback policy while avoiding claims of unjust executive contracts.  Adding bylaws is another way to reduce the time, expense, and publicity involved in enforcement efforts.  It is also important to note that most litigation cases arising from this clause will most likely be dealt with at the state level, as every company will have specific bylaws in place.  

And of course with every new Act passed, we find that many unintended consequences arise as a result of them.  For instance, with this particular section, a committee of independent members of the board of directors will need to be created to manage the recoupment claim process, deal with the shareholder demands for prompt recovery, and approve the terms of any settlements.  Unfortunately, innocent executives will probably face dismissal and civil litigation if voluntary repayment terms cannot be arranged with the corporation.  Essentially, we are punishing an executive who is a high performer for the company and had no involvement with the actions that led to the restatement.  Due to the increasingly common accounting restatements, any restatements by a public company makes all the top managers immediately and simultaneously liable to the corporation for recoupment of their excess incentive-based compensation.  As with any new restriction placed on an employee, you will find that talent will be more difficult to attract. Case in point, retention of executives, and yet another negative downfall to this Act.

Consequently, executives are likely to request multiyear installment payment plans (which may not be compatible with the Sarbanes-Oxley Act’s restrictions on loans to executives), no security for repayment, and amendment of corporate and personal tax returns to recover the income taxes already paid on the “excess” compensation.  Likewise, it is particularly unjust to expect an immediate return to the company of the compensation, especially pre-tax compensation, that was paid to the executive(s).  Boards of directors may decide, in the company’s best interests, to recover the amounts over time, or even to recoup the amounts from future pay.  For these reasons, we recommend that boards of directors should be given the ability to exercise discretion in determining whether to pursue recoupment, the amount to be recovered and the and the best means to accomplish recovery.

The penalty for non-compliance with these clawback requirements is possible de-listing from the exchange(s).  Most public companies must comply, because they cannot afford to “go private” and lose access to capital markets caused by failure to create an independent compensation committee and a clawback policy in compliance with the SEC’s rules. SEC must be prepared to assure vigorous enforcement and oversight of public corporations and their executive compensation process.