‘Clawback’ Triggers Range from Misconduct to Disparagement

Despite more clawback provisions, it’s relatively uncommon to see them exercised

By Stephen Miller, CEBS Feb 5, 2015
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Pay recoupment (or “clawback”) policies, although not new, continue to challenge corporate boards and compensation committees—and to draw attention at annual shareholder meetings. To highlight popular clawback practices, consultancy PwC’s Executive Compensation Clawbacks—2014 Proxy Disclosure Study, released in January 2015, reviewed the clawback policies of 100 large public companies as disclosed in their year-end proxy statements.

CEOs and CFOs have faced shareholder pressure to return awards after a downward financial restatement, especially if earned as a result of misconduct, since passage of the Sarbanes-Oxley Act in 2002. More recently, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 directed the Securities and Exchange Commission (SEC) to craft new rules for clawbacks.

As a result, companies have been modifying their clawback policies in anticipation of the SEC rules, which have yet to be issued. According to the study, 40 percent of the companies reviewed made some type of change to their clawback plans during 2013.

“While we haven’t yet seen final rulemaking from the SEC on executive compensation clawbacks required by the Dodd-Frank Act, companies continue to add new clawback provisions to address increasing interest from investors, shareholder advisory firms, regulators and other stakeholders,” PwC partner Ken Stoler wrote in an e-mail to SHRM Online.

But despite more clawback provisions being added to compensation arrangements, it remains relatively uncommon to see them exercised, with only a few high-profile cases in recent years. “It is not clear whether this is due to a lack of enforcement (by choice or due to difficulties with enforcement by the company) or the absence of conduct that would trigger a clawback,” Stoler noted.

A Wide Range of Triggers

Overall, the companies sampled featured a wide range of clawback triggers, but the most common reasons companies seek to exercise clawbacks is when there is a downward financial restatement or evidence of misconduct.

Below are the top 10 triggers disclosed in the companies’ proxy statements and the percentages of companies that included the trigger in their policies:

Financial misconduct—76 percent of companies.

Restatement due to employee involvement—66 percent.

Fraud (criminal activity, a more serious charge than misconduct)—46 percent.

Misconduct other than financial—40 percent.

Misrepresentation of performance results to purposely attain higher incentive payments—25 percent.

Restatement not due to employee involvement—25 percent.

Breaking noncompete agreements—24 percent.

Unintentional misstatement of financial or performance results—20 percent.

Disparagement of the company—18 percent.

Violating nonsolicitation agreements during or just after the employment period—16 percent.

Awards Subject to Clawbacks

Compensation subject to recoupment includes equity incentives (stock), cash bonuses or a combination of both. The vast majority of companies studied (84 percent) may recover both cash and stock awards if clawback policies are triggered, with 9 percent recovering only equity awards and the remaining 7 percent recovering only cash incentives.

As for vesting, 11 percent of the studied companies recover only awards that have not yet vested, but most (89 percent) may recover awards regardless of their vesting status.

Employees Subject to Clawbacks

Clawback policies may apply only to certain levels of employees within an organization. In the companies studied, employees subject to clawbacks included:

Executive/senior management only (62 percent of organizations).

Broad-based, covering all employees or all incentive plan participants (28 percent).

Named executive officers only (9 percent).

Not disclosed (1 percent).

Look-back Periods

Recoupment policies may apply to awards granted during a particular period of time prior to the clawback-triggering event. Of the companies studied, 42 percent disclosed look-back periods, while 10 percent specifically indicated that there was no limit on the length of the look-back period under their policies.

Of the companies describing a look-back period, the most common periods were in the range of one to three years.

Prevalent Use of Discretion

The study found many examples of companies exercising discretion in determining the potential consequences, or extent of recovery of compensation, once a triggering event has occurred. Of the companies studied:

76 percent provide management with discretion to determine whether or not to enforce clawback policies on a case-by-case basis.

14 percent mandate the recovery of awards on discovery of any clawback-triggering behaviors.

10 percent provide discretion to determine whether or not to enforce clawback policies for certain triggers or awards.

“Discretion within equity compensation arrangements can be an issue because it may call into question whether there is a mutual understanding of the key terms and conditions of the award,” with potential accounting implications, Stoler said. For instance, depending on how discretion clauses in the clawback policy are structured, firms could be required to use “mark-to-market” accounting treatment for equity awards, pricing shares at their current market valuation.

“Significant judgment is required when analyzing the level of discretion found in clawback provisions and ‘how much is too much,’ ” Stoler noted.

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow him on Twitter @SHRMsmiller.

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