The Advisors' Blog

– Jeffrey London, Mary Lou Zwick and Brian Witkowski, Kaye Scholer

As noted in our recent memo on clawbacks, there are a number of open issues that the SEC will presumably address with its regulations, including the definition of “executive officers” as explained above. What follows is a list of some of the more interesting issues left open by the statute:

1. Unilateral Policy versus Bilateral Agreements – The statute imposes an affirmative duty upon companies to recover excess incentive compensation but is silent as to whether the executive officer must consent to the clawback. Applying this rule literally, companies may be required to recover amounts that they are not contractually entitled to recoup. For example, most employment agreements provide that bonuses are vested once earned and, therefore, may not contractually be recovered. Similarly, mutual releases of claims entered into with departing executives presumably bar the company from asserting any claims to recover compensation. The regulations will need to address whether companies can unilaterally implement a clawback policy or whether they must obtain the executive officers’ consent.

2. Retroactivity – One of the more significant issues left open by the statute is whether the clawback requirements will apply retroactively to incentive compensation awards granted or paid prior to the effective date of the regulations. Along those lines, if the regulations do provide for retroactive application, it is unclear whether executive officers whose employment terminates before the regulations become effective will be subject to the clawback requirements. The regulations will also presumably address whether an individual who was not an executive officer at the time of an award of incentive compensation, but who becomes an executive officer prior to an accounting restatement, is subject to the clawback requirements.

3. Equity and Equity-Based Awards – Equity and equity-based incentive compensation awards present a number of issues open to interpretation under the statute. For example, the statute generally does not provide guidance as to the meaning of “incentive-based compensation.” However, it does reference stock options as one type of “incentive-based compensation.” The regulations could adopt a narrow definition of “incentive-based compensation” that excludes purely time-based stock options and restricted stock (i.e., limit the clawback only to performance-based compensation).

Another question is whether equity-based awards that were granted based on reported metrics, but which have not yet vested, will be considered “received” under the statute and therefore subject to the clawback requirements? And when are awards valued for purposes of determining excess compensation? Perhaps the rules will compare the value at the date of grant, or alternatively immediately prior to the announcement of the restatement (when the markets presumably have not priced in the accounting discrepancy), to the value immediately following the restatement or some other time?

4. Indemnification Obligations – It is common practice for public companies to provide for indemnification of executives for certain costs incurred by the executive in defending against or settling a lawsuit, provided certain good faith requirements are met. As Dodd-Frank clawbacks are not limited to restatements due to misconduct, these indemnification provisions could potentially cause a company to be legally obligated to repay an executive officer for amounts the company recovers under its clawback policy. Companies could go a step further and enter into indemnification agreements specifically covering any amounts recovered under a clawback policy. As these agreements would undermine the purpose of the statute, and would be against public policy, the SEC will presumably need to address how Dodd-Frank will impact these arrangements.

5. Wage Laws – Clawbacks under Dodd-Frank could potentially violate applicable state wage payment laws or similar foreign laws. Although many state laws exempt incentive compensation, companies should be prepared to perform a review of the laws in the applicable jurisdictions once the regulations are implemented. Presumably, Dodd-Frank, as a federal statute, will preempt state wage payment laws, but this is not certain.

6. De Minimis Clawbacks – As drafted, the statute does not permit companies to forego a clawback in cases where the “excess” incentive compensation paid is de minimis or if the costs of recovery would exceed the recoverable amount. Whether the regulations will permit exceptions under these scenarios remains to be seen.