the next big compensation challenge: clawbacks
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May 21, 2012
The Next Big Compensation Challenge:
Clawbacks
2© 2012 Hay Group. All rights reserved
Discussion areas
Introductions
Overview of clawbacks/Q&A
Key considerations in 2012 and beyond/Q&A
Early adoption and key rulings/Q&A
Q&A
1
2
3
4
5
01Introductions
4© 2012 Hay Group. All rights reserved
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
5© 2012 Hay Group. All rights reserved
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
6© 2012 Hay Group. All rights reserved
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
02Overview
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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
9© 2012 Hay Group. All rights reserved
What's next?
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
A false sense of security?
10© 2012 Hay Group. All rights reserved
Clawback history
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 individual's 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.
Pre Dodd-Frank
11© 2012 Hay Group. All rights reserved
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
12© 2012 Hay Group. All rights reserved
Clawback history
Sarbanes Oxley
Section 354
TARP
SEC Rulings
Dodd-Frank
Section 954
FDIC
How did we get here?
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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
03Key considerations for 2012 and beyond
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Defining the clawback terms
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
What is the rule?
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Participation
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
Who should we include?
17© 2012 Hay Group. All rights reserved
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?
18© 2012 Hay Group. All rights reserved
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?
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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
20© 2012 Hay Group. All rights reserved
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
21© 2012 Hay Group. All rights reserved
Design options
Bonus Banks
Deferrals
Other?
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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?
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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?
24© 2012 Hay Group. All rights reserved
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
04Early adopters and status of rulings
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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
27© 2012 Hay Group. All rights reserved
What they did…
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.
The maybe’s…
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What they did…
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.
The wills…
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What they did…
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
The wait and see’s…
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Dr. Pepper Snapple – 3/15/12 proxy
The clawback policy provisions provide that:
If there is a restatement of the Company's 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
Company's 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.
Clawback part 1
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Dr. Pepper Snapple – 3/15/12 proxy
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 Company's 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.
Part 2 – clawback for fraud or misconduct
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When will we see the ruling?
Current timeline is...
According to the SEC's 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
What to expect?
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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
Q&A
35© 2012 Hay Group. All rights reserved
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
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