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The Next Big Compensation Challenge: Clawbacks
 

The Next Big Compensation Challenge: Clawbacks

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Presented at WorldatWork 2012 by Hay Group's Dan Moynihan and Irv Becker, Winston & Strawn's Mike Melbinger

Presented at WorldatWork 2012 by Hay Group's Dan Moynihan and Irv Becker, Winston & Strawn's Mike Melbinger

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    The Next Big Compensation Challenge: Clawbacks The Next Big Compensation Challenge: Clawbacks Presentation Transcript

    • The Next Big Compensation Challenge:ClawbacksMay 21, 2012
    • Discussion areas 1 Introductions 2 Overview of clawbacks/Q&A 3 Key considerations in 2012 and beyond/Q&A 4 Early adoption and key rulings/Q&A 5 Q&A© 2012 Hay Group. All rights reserved 2
    • 01Introductions
    • Introductions Presenters  Irv Becker, National Practice Leader, Executive Compensation, Hay Group  Irv.Becker@haygroup.com | 215.861.2495  Mike Melbinger, Lead Partner and Global Head of Employee Benefits and Executive Compensation, Winston & Strawn  Dan Moynihan, Principal, Executive Compensation, Hay Group  Daniel.Moynihan@haygroup.com | 201.557.8423© 2012 Hay Group. All rights reserved 4
    • About Hay Group Global organizational and human resources consulting firm  Compensation and benefits consulting  Employee, organizational and customer research  Executive coaching/leadership development  Organizational effectiveness and management development  Work design/strategy alignment  Information business  Founded in 1943  Offices in 49 countries  Ten US offices© 2012 Hay Group. All rights reserved 5
    • About Winston & Strawn An international law firm with:  1,000 attorneys among 15 offices  Beijing, Charlotte, Chicago, Geneva, Hong Kong, Houston, London, Los Angeles, Moscow, New York, Newark, Paris, San Francisco, Shanghai, and Washington, D.C.  The firm serves the needs of enterprises of all types and sizes, in both the private and the public sector  Winston & Strawn has built its reputation on the quality and character of its lawyers  Our history of more than 150 years is a chronicle of individuals and events that have helped shape the firm and create the strong foundation on which we continue to build© 2012 Hay Group. All rights reserved 6
    • 02Overview
    • Overview What are the key issues?  Dodd-Frank provided a “perfect storm” of shareholder empowerment around executive pay  The Act arms shareholders with more information and power than before, while making it harder for management to accumulate votes  In response to increased pressure from shareholders and proxy advisory firms, companies continue to monitor their executive compensation programs  Only 41 companies failed in 2011, and thus far we have had 4 fail in 2012…is the hubbub worth it? (as of 4/20/12)  Given today’s intense scrutiny of executive compensation, we are seeing companies and compensation committees re-evaluate their programs annually  New governance standards include implementing updated clawback policies© 2012 Hay Group. All rights reserved 8
    • Whats next? A false sense of security?  The 2011 voting results have some compensation committees more relaxed than they were before the results were known.  Too soon to tell for 2012  We believe that the single biggest factor influencing the say on pay voting trends last proxy season was strong company performance  The fact that pay programs have been “cleaner” has certainly had impact  But at the end of the day, shareholders will make 2012 all about company performance again  Don’t be fooled by the modest shareholder reaction of 2011 – if performance declines while pay does not, you can be sure that shareholders will make themselves heard in 2012!  Citibank is the most notable Say on Pay failure to date© 2012 Hay Group. All rights reserved 9
    • Clawback history Pre Dodd-Frank  Rationale for implementation of the clawback policy  Good governance credit from institutional shareholders and the media  Influenced by SOX requirement for CEO and CFO  Only for compensation that was earned by fraud?  Only from those individuals who perpetrated the fraud?  Unjust enrichment theory  If the financial result or performance measure were incorrectly reported, then the company should claw back all compensation earned as a result of that error, regardless of any individuals fault.  Regardless of fault, employment level or the passage of time, and even if the fraud was outside the US, no one should receive or keep dollars to which he or she was not entitled.© 2012 Hay Group. All rights reserved 10
    • Clawbacks – broader than SOX  Dodd-Frank requires national securities exchanges to implement clawback policies (a.k.a., recoupment policies) that are broader than current requirements under Section 304 of SOX  Under Dodd-Frank:  The clawback policy must be triggered any time the company prepares an accounting restatement  Once the clawback policy is triggered, it would apply to all incentive-based compensation paid to current and former executive officers  The look back period for which incentive-based compensation is subject to clawback is the three-year period preceding the date of restatement  The amount subject to the clawback is the difference between the amount paid and the amount that should have been paid under the accounting restatement© 2012 Hay Group. All rights reserved 11
    • Clawback history How did we get here?  Sarbanes Oxley  Section 354  TARP  SEC Rulings  Dodd-Frank  Section 954  FDIC© 2012 Hay Group. All rights reserved 12
    • Today Dodd-Frank  Section 954 of Dodd-Frank adds new Section 10D, entitled "Recovery of Erroneously Awarded Compensation Policy" to the Exchange Act  Requires SEC to direct the national securities exchanges to prohibit the listing of any security of an issuer that does not develop and implement a clawback policy  Requires companies to disclose compensation clawback policy in their proxy statement  Proposed rules not yet issued  Waiting for them…is like waiting for Godot  Endlessly waiting in vain© 2012 Hay Group. All rights reserved 13
    • 03Key considerations for 2012and beyond
    • Defining the clawback terms What is the rule? The rule  Incentive-based compensation that is based on financial information required to be reported under the securities laws  The issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws  Incentive-based compensation (including stock options awarded as compensation) based on the erroneous data  During the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement  In excess of what would have been paid to the executive officer under the accounting restatement© 2012 Hay Group. All rights reserved 15
    • Participation Who should we include?  Must cover  Individuals who are executive officers, and  Individuals who formerly were executive officers  Who else?  Board of Directors  Senior finance personnel  All plan participants? How deep into the organization?  Key Issues to discuss  Unjust enrichment?  Only those at fault?  Fairness?  Balance the cost vs. amount of recovery© 2012 Hay Group. All rights reserved 16
    • Implementation challenges What forms of compensation should be affected by the clawback?  Annual incentive bonus plan  Stock options, vested but unexercised stock options  Restricted stock; Performance shares; RSUs How far back in time does the provision reach?  For what period do we clawback  All $ gained in past 12 months?  Consider the breadth of the clawback policy and the reason for the clawback Different treatment of cash vs. equity?  Precise equity gains are more difficult to calculate – and harder to recover Tax Issues?  What about compensation that has already been taxed?© 2012 Hay Group. All rights reserved 17
    • Implementation challenges  Should Company require full payback, partial payment or reduce future payments?  Annual Incentive Bonus Plan measures many factors  Desire to capture terminated employees  Whether to apply the clawback provisions retroactively to payments and awards or prospectively  Subject to legal document review  When should the determination of the clawback be made?  At the time of restatement?  Other?© 2012 Hay Group. All rights reserved 18
    • Impact on pay design & philosophy Philosophy  Revisit pay philosophy to ensure that pay strategy and pay reality are intersecting  Consider including documented statements of clawback philosophy and key design attributes as part of re-tooled comp philosophy Design  Look at participation  Understand ramifications of clawbacks and perceived value of compensation  Adjust size of awards?  Consider banking and deferrals of awards  Tighten up language for employees exiting company© 2012 Hay Group. All rights reserved 19
    • Perceived value of compensation Detrimental aspects of clawback provisions  As a result of the possibility of forfeiture, there is a need to create a strong line of sight and motivational framework for incentives  Employees may discount value of awards as a result of the potential clawback due to a material restatement  Awards may need to become larger as an offset  May drive need for insurance protection© 2012 Hay Group. All rights reserved 20
    • Design options Bonus Banks Deferrals Other?© 2012 Hay Group. All rights reserved 21
    • Reality of the clawback Who has the right/responsibility to recover?  Only the Company/Board  Not the SEC or the Exchanges What if the Company does not or cannot recover?  How hard must it try? Best efforts?© 2012 Hay Group. All rights reserved 22
    • Legal challenges Key legal issues  Neither SOX Section 304 nor Dodd-Frank Section 954 has any provision creating a private cause of action for stockholders  Courts have held that SOX Section 304 does not create a private right of action for stockholders, e.g., In re Digimarc Corp. Derivative Litig. (9th Cir. 2008); Neer v. Pelino (E.D. Pa. 2005)  Plaintiffs’ bar likely to test in court whether the same is true for Dodd-Frank More issues  Actual recoupment of the overpayment  Calculation of overpayment  Subject to interpretation  How do we handle former employees?© 2012 Hay Group. All rights reserved 23
    • Insurance issues Insurance  Should D&O insurance and/or indemnification provisions make whole an innocent executive whose compensation is clawed-back under Dodd-Frank Act Section 954?  Insurance policies being sold to protect innocent executives - that is, those who did not commit misconduct leading to a financial restatement - against compensation clawbacks  Public policy ordinarily would prevent an individual (or company) from insuring or being indemnified against his own misconduct (as opposed to negligence)  However, where a clawback occurs due to a financial restatement necessitated by the misconduct or errors of another, insurance or indemnification provisions may be permitted to make whole an innocent executive whose compensation was clawed-back© 2012 Hay Group. All rights reserved 24
    • 04Early adopters and status ofrulings
    • Who has implemented new clawbacks? A short list of companies who made changes in 2011/2012  L-3  B&G Foods  Integrys Energy  Trustmark  Guess  Dr. Pepper Snapple Group  Cummins  Entergy  Praxair© 2012 Hay Group. All rights reserved 26
    • What they did… The maybe’s… Integrys Energy – 3/26/12 proxy  Pursuant to this policy, our board of directors may seek reimbursement of incentive compensation paid to our named executive officers in certain situations including material restatements of our financial statements or instances of willful misconduct or fraud that cause harm to the company. This policy was implemented in the first quarter of 2012 and will be refined as appropriate following the release of final regulations by the SEC. Guess - 5/24/11 proxy – executive compensation clawback policy  In April 2011, the Board of Directors adopted a new policy. The Clawback Policy provides that the Board or the Compensation Committee may require reimbursement or cancellation of all or a portion of any performance-based short or long-term cash or equity awards made to an executive officer to the extent that:  (1) the amount of, or number of shares included in, any such payment was calculated based on the achievement of financial results that were subsequently revised and  (2) a lesser payment of cash or equity awards would have been made to the executive officer based upon the revised financial results.© 2012 Hay Group. All rights reserved 27
    • What they did… The wills… L-3 Communications – 3/12/12 proxy -- compensation clawback policy  The Committee adopted a clawback policy in 2012 that allows the Company to recoup and/or cancel any incentive compensation, including equity-based compensation, awarded to executives on or after January 1, 2012 under the following circumstances:  The award was predicated upon the achievement of financial results that were subsequently the subject of a material restatement of L-3’s financials  The executive’s fraud or willful misconduct was a significant contributing cause to the need for the restatement, and  A smaller award would have been earned under the restated financial results. Subject to the discretion and approval of the Board of Directors, the Company will, to the extent permitted by law, seek to recover the amount of incentive compensation paid or payable to the executive in excess of the amount that would have been paid based on the financial restatement.© 2012 Hay Group. All rights reserved 28
    • What they did… The wait and see’s… B&G Foods – 3/30/12 proxy -- executive compensation clawback policy  B&G Foods does not currently have an executive compensation clawback policy. However, the compensation committee plans to adopt a clawback policy after the SEC issues final rules implementing the clawback provisions set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC has stated that it expects to issue preliminary rules during the first half of 2012 with final SEC rules to be adopted thereafter. Trustmark – 3/30/12 proxy -- executive compensation recoupment  Ethical behavior and integrity remain an important priority for Trustmark. In support of this, and in anticipation of adopting a comprehensive executive compensation recoupment policy (also known as a “clawback” policy), the Committee began including a clawback provision in the performance-based restricted stock awards beginning with awards granted to the executive officers in 2011.  Also in 2011, the Committee began including a similar clawback provision in the management incentive plan with respect to annual cash bonuses that may be earned under the plan. Under these provisions, any performance-based restricted stock that vests or cash bonus paid is subject to recovery by Trustmark as required by applicable federal law and on such basis as the Board determines.  The Committee anticipates adopting a comprehensive executive clawback policy once the SEC publishes final rules implementing the clawback requirements from the Dodd-Frank Act© 2012 Hay Group. All rights reserved 29
    • Dr. Pepper Snapple – 3/15/12 proxy Clawback part 1  The clawback policy provisions provide that:  If there is a restatement of the Companys financial statements filed with the SEC (other than to comply with changes in applicable accounting principles) covering any of the three fiscal years preceding the payment or grant of incentive compensation, then the Company will,  subject to the approval of the Compensation Committee, recover from each member of the Companys executive leadership team (and from each person who was a member of the executive leadership team during the three year period preceding the first day of any accounting period for which the financial statements are restated) the incentive compensation paid to that executive that was in excess of the incentive compensation that would have been paid to the executive based on the restated financial statements, with such excess to be determined by the Company and approved by the Compensation Committee, and may recover from any other award recipient, whose fraud or willful misconduct resulted in the restatement, any incentive compensation paid to that award recipient that was in excess of the incentive compensation that would have been paid to the award recipient based on the restated financial statements, with such excess to be determined by the Company.© 2012 Hay Group. All rights reserved 30
    • Dr. Pepper Snapple – 3/15/12 proxy Part 2 – clawback for fraud or misconduct  If the Company determines that any award recipient is guilty of fraud or willful misconduct that would give rise to a termination for cause, but not result in a restatement of the Companys financial statements, then the Company will have the right to recover from that award recipient, any incentive compensation paid to that award recipient during the period of time the award recipient was engaged in such fraud or willful misconduct.  The value with respect to which recovery shall be sought will be determined by the Company (or Compensation Committee in the case of a member of the executive leadership team) based on such factors as considered relevant, including, but not limited to, the difference between the amount that was actually paid and what would have been paid based on the restatement.  The Company may also seek any additional equitable or legal remedies from any person and which arise under the facts which give rise to a claim by the Company under the Clawback Policy.© 2012 Hay Group. All rights reserved 31
    • When will we see the ruling? What to expect?  Current timeline is...  According to the SECs Dodd-Frank rule-making schedule, proposed rules addressing clawbacks will be issued within the January-July 2012 time frame  Final rules will be adopted within the July-December 2012 time frame  As of 4/20/12, we know...nothing© 2012 Hay Group. All rights reserved 32
    • Checklist for management & the committee  Take an inventory of all plans, programs and arrangements that provide for incentive compensation tied to financial metrics  Review the structure of compensation packages  At a minimum, enact a GAP plan which states the Company will clawback, but will amend based on new rules  Review who within the company should be subject to the clawback policy  Check indemnification and mandatory arbitration clauses for clawback litigation issues  Check enforceability of choice-of-law provisions  Include clawback language that references Dodd-Frank to incorporate the final rules into any new executive compensation grants and agreements  Wait for new rules  Development of principles and beliefs for Board/Management to use during the implementation  Implement new policy quickly© 2012 Hay Group. All rights reserved 33
    • Q&A
    • Presenters  Irv Becker, National Practice Leader, Executive Compensation, Hay Group  Irv.Becker@haygroup.com | 215.861.2495  Mike Melbinger, Lead Partner and Global Head of Employee Benefits and Executive Compensation, Winston & Strawn  Dan Moynihan, Principal, Executive Compensation, Hay Group  Daniel.Moynihan@haygroup.com | 201.557.8423© 2012 Hay Group. All rights reserved 35