New SEC Clawback Rules Create a ‘Two-Policy’ Corporate Conundrum

Starting Dec. 1, public companies have had to adopt and enact a policy that complies with recent SEC guidance on clawing back wrongful incentive-based compensation awarded to executives. The challenge companies now face is what to do with the compensation clawback policies they’ve had on the books for years.

The Securities and Exchange Commission’s new rules require a publicly traded company to claw back incentive-based compensation erroneously awarded to an executive officer if the award was due to the company’s material noncompliance with any financial reporting requirement—in other words, if there are accounting errors.

The SEC guidance provides a greater level of certainty about what constitutes a compliant policy and formalizes rules enacted as part of the Dodd-Frank Act of 2010.

But during the long wait since then, numerous public companies implemented policies based on their unique circumstances and policymaking decisions. Those policies often differ in material ways from the new policy, such as with the compensation covered and triggering events.

In many cases, companies have left their existing clawback policies in place and have simply adopted a new, second policy that serves as the one to meet the SEC requirements. However, with some diligent planning and attention to detail, companies can keep both policies and have them work in harmony.

Disparate Documents

There is nothing inherently insurmountable from a documentation or operational perspective with having two compensation clawback policies that overlap or cover different aspects of a company’s overall compensation program.

Although an SEC-compliant clawback policy may have a different scope than a company’s original policy—different groups of executives and employees who are subject to the policy or different enforcement mechanisms—two separate policies can be conformed to each other with careful drafting by including coordinating provisions in one or both of the documents.

For example, the SEC-compliant policy could include a provision to the effect that, if it applies to a given set of facts, its terms will override any other policy and will apply exclusively in those circumstances.

This type of coordinating provision is common with equity plans and related grants: The provisions of the governing equity incentive plan document, the related equity award agreement, and any applicable employment agreement or offer letter must all work together. The documents talk to each other.

It is typical to draft ordering principles into these and similar documents that serve to tie-break and decide which document will govern if there’s a conflict or discrepancy.

It seems clear that policy ought to govern where the SEC-compliant policy applies. This would be true even if the different clawback policies were to be merged into a single, omnibus clawback policy. In a merged policy, such an ordering rule would still kick in and apply to those situations where the SEC rules dictate that the new policy must be enforced for incentive-based compensation.

Question of Goals

Many corporate clawback policies adopted before the new SEC guidance have somewhat different goals, and mechanisms for achieving those goals, than SEC-compliant clawback policies. Older policies’ goals might include appropriately penalizing employee misconduct or malfeasance, for example.

Such policies also may reserve to the board or the compensation committee discretion as to whether, and how, to enforce the policy in given scenarios.

It seems implausible that, at the moment right after the SEC’s issuance of requirements for establishing a compliant policy, the reasons for having a pre-existing policy evaporated. Rather, a reasonable expectation is that goals of existing clawback policies, which have stretched beyond SEC-compliant rules, will continue to be desirable, as they were right before the SEC issued its guidance.

An example could be when a company encounters a “bad leaver” situation where an executive is dismissed prematurely for unsatisfactory behavior.

Outside the new mandated clawback system, a board of directors might determine it’s in the company’s best interests to exercise discretion to cause a forfeiture of various types of compensation.

Or the compensation committee (or other policymaker for non-executive employees) might determine, based on factors that the committee itself has decided are most relevant, that a clawback of previously paid compensation wouldn’t be cost effective.

As a result, older clawback policies presumably will continue to be a relevant and useful part of a company’s overall executive compensation program.

The main question about what to do with a two-policy scenario seems to be how to make it fit on a documentary and operational level so the existing policy works effectively alongside the SEC’s provisions.

As an example, discretionary authority given to the board or compensation committee in older policies can be expressly granted, clarified, or extended to provide flexibility so the older policy fits more readily with the new mandated SEC-compliant policy.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Mitchel Pahl is partner in Katten’s employee benefits and executive compensation group, representing public and privately held companies and private equity interests.

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