Employee Benefits Update

Compensation Clawbacks

Compensation “clawbacks” are of increasing importance, due in part to interest by shareholder rights groups such as RiskMetrics. Many public companies have adopted clawback policies and these policies vary widely in scope and severity. Boards struggle to arrive at a balance between the sometimes competing goals of reserving appropriate rights and safeguards to the company while operating compensation programs that are positively perceived by employees. Compensation practices that have a “hold till retirement” element create additional implications for balancing these goals.

A recent federal district court decision on the clawback provisions of Sarbanes-Oxley (“SOX”) provides another point for boards to consider in designing and implementing clawback policies (SEC v. Jenkins, 2010 WL 2347020 (U.S.D.C. Arizona). Under SOX Section 304: 

“If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12 month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of the issuer during that 12 month period.”

An issue under SOX Section 304 is whether a clawback can be imposed on an executive who did not engage in “misconduct” but may have benefited in some way from misconduct that resulted in erroneous financials, such as by larger compensation awards than would have been made had the misconduct not occurred. In Jenkins, the court refused to dismiss a claim by the SEC for disgorgement of compensation under SOX Section 304, even though the SEC had not alleged any misconduct by Jenkins that affected the amount or timing of the compensation. In fact, according to the court, the SEC alleged that others in the company concealed the scheme from Jenkins. If the SEC is ultimately successful, recovery of compensation can be had from “innocent” employees under SOX Section 304.

The Jenkins case may have implications on clawback policies adopted by boards as many of these policies only provide for recovery or adjustment of compensation when the particular individual has engaged in inappropriate activity. There has been some speculation that RiskMetrics and other shareholder rights groups might reconsider their “requirements” with respect to clawback policies as a result of the SEC’s success in Jenkins. For example, under RiskMetric’s GRId system, the mere absence of a clawback policy affects a company’s compensation “score” for corporate governance purposes.

Baker Botts L.L.P. can assist you in designing clawback policies and procedures, including advising you with respect to both compensation and governance issues.

IRS Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.