Compensation clawback policies are once again in the spotlight.
In 2015, the U.S. Securities and Exchange Commission (SEC) proposed rules under the Dodd-Frank Act that required companies to adopt policies to recoup, or claw back, incentive compensation paid to current and former executives based on inaccurate financial results. Many companies adopted policies in the spirit of these proposed rules; some organizations, including large financial institutions, go farther to include malice or misconduct as clawback triggers.
But companies are now asking if these policies go far enough, in light of renewed investor and public interest following recent events at companies like CBS Corp., Equifax and Nissan Motor Co. Boards are discussing if these policies should include broad misconduct, which includes behaviors that can lead to reputational harm.
Goldman Sachs Group is one bank that revised its policy to add a provision relating to a recent scandal in which senior executives were charged with crimes, including money laundering. The provision allows Goldman to cancel or reduce awards if the related legal proceedings would have impacted the grants.
The following questions are a helpful guide in determining if your bank’s current clawback policy meets the board’s and company’s objectives.
What events should trigger a clawback?
Many companies have clawback policies that provide for the recoupment of incentive compensation in the event of a material financial restatement. In light of corporate scandals relating to sexual harassment and activities that are harmful to consumers, some companies are considering if they should expand their policies to include activities that are harmful to the company and its shareholders, but may not have resulted in an error in a financial statement. Triggers include violations of the company code of conduct including sexual harassment and unethical behavior, reputational harm, supervisory failures and cybersecurity data breaches.
Once triggered, should clawbacks be mandatory or at the discretion of the board and company?
Though automatic clawback triggers may alleviate some of the burden on boards by removing judgment from the process, most companies and boards prefer to maintain a degree of discretion in determining when to enforce a clawback. Board judgment will become even more critical as companies expand the list of clawback triggers beyond financial restatement. Companies should balance this discretion with the need to be transparent to covered employees, as well as any potential legal or accounting implications.
Who should be covered?
Most companies have policies that apply to executive officers. Some have considered expanding their clawback policies to cover additional employees, such as all incentive-eligible employees. Extending the policy to include additional employees may help increase accountability at all levels of the organization, although this may only be relevant for certain triggers like violation of the company code of conduct. Companies interested in this shift should consider limiting certain triggers, such as material financial restatement, to executive officers who are responsible for setting policy and signing financial statements.
How long should incentive compensation be subject to clawback after it is paid?
The SEC’s proposed clawback rules require policies to cover incentive compensation paid in the last three years. Expanding the time frame beyond three years can provide additional flexibility, but can also carry additional cost, administrative complexity and potential difficulties in recruiting that may outweigh the benefits of a longer lookback period.
Are there drawbacks to broadening the clawback policy?
From an employee perspective, broad clawback policies could reduce the perceived value of incentive compensation programs or lead to difficulties in recruiting. From a company perspective, broad clawback policies can be more costly, administratively complex and difficult to enforce. In some cases, companies may find that a cancellation or forfeiture of unvested or unpaid incentive compensation may provide them with a mechanism to hold employees accountable while alleviating some of these difficulties. But boards and management may find themselves in an undesirable position if their clawback policies are too narrow.
A robust clawback policy signals to investors that the board and management are committed to protecting the organization. A proactive review of clawback triggers to address issues that may cause reputational harm is prudent in today’s environment. Failure to do so may leave boards exposed if a situation arises and the board has limited recourse. Now is a good time for companies to review their clawback policies to ensure they safeguard the organization without being so onerous to administer or deterring top talent from joining the company.