The Advisors' Blog

– Broc Romanek

Here’s an excerpt from this blog by Professor Jack Coffee:

So what should a reasonable and prudent board or compensation committee do? Obviously, one answer is to avoid the kind of extreme equity award that Valeant used to motivate its former CEO. But another answer is to counter-balance the impact of incentive compensation with an appropriately designed clawback. Clawbacks mandate the forfeiture of incentive compensation (including unexercised stock options and equity awards) on the occurrence of specified trigger events. Section 10D of the Securities Exchange Act of 1934 only requires a clawback in the event of an accounting restatement that reduces the earnings that produced the incentive award. Still, a responsible board can design a broader clawback that does not require a restatement to trigger it.

In this light, let’s take a closer look at Wells Fargo & Co’s policy, because, in this one unique respect, Wells Fargo may supply a model for other companies to emulate. Wells Fargo’s 2016 Proxy Statement indicates that the triggers for clawbacks and recoupments include (with respect to restricted stock awards and performance shares):

1. “Misconduct which has or might reasonably be expected to have reputational or other harm to the Company or any conduct that constitutes ‘cause’;”
2. “Misconduct or commission of a material error that causes or might be reasonably expected to cause significant financial or reputational harm to the Company or the executive’s business group;”
3. “Improper or grossly negligent failure, including in a supervisory capacity, to identify, escalate, monitor or manage, in a timely manner and as reasonably expected, risks material to the Company or the executive’s business group;”
4. “An award was based on materially inaccurate performance metrics, whether or not the executive was responsible for the inaccuracy;” and
5. “The Company or the executive’s business group suffers a material downturn in financial performance or suffers a material failure of risk management.”

These are broad provisions that go well beyond financial restatements (but do leave business judgment discretion in the board as to whether to implement them). In reality, most boards will stonewall and not impose clawbacks when they have discretion. Still, the real lesson of Wells Fargo may be that pressure can mount to the point where the board will be compelled to invoke a clawback. Also, shareholders can sue derivatively, and Wells Fargo has been sued in a derivative action in California, which may prove hard to dismiss.

In the approaching Era of Trump, clawbacks may be the last line of defense for shareholders. Clearly, incentive compensation is here to stay, but it should be reasonable and needs to be counterbalanced by broad clawbacks. If activists lobby Institutional Shareholder Services, using the Wells Fargo clawbacks as their model, the proper design of clawbacks could move to front and center on the corporate governance stage.