As you may be able to tell, clawback policies are consuming a lot of my brain space right now. Listed companies will need to have a policy in place by December 1st of this year, which will apply to incentive-based compensation received by executive officers on or after the effective date of those rules, which is October 2, 2023.
As Dave blogged earlier this week on TheCorporateCounsel.net, while the requirements for the policy that are dictated by SEC Rule 10D-1 are very specific (and restrictive), the actual implementation of clawback provisions in response to those requirements is proving to be somewhat complex for listed companies. I blogged yesterday about state law contract considerations – and research also shows that, because the decisions that surround implementation of these policies could create unintended consequences down the road, you need to tread carefully.
This Equity Methods blog walks through “readiness steps” – focusing on these broad action items:
3. Documenting a playbook of actions to take in the event a clawback is required
On the step of policy creation, which is where most of us are living right now, the blog covers a few basic decision points (some of which Dave also discussed in his blog earlier this week). Here are some relevant excerpts:
– Single or Dual Policy – We anticipate most companies adopting a two-policy framework in which the Dodd-Frank-mandated clawback will sit next to a broader but more flexible (discretionary) clawback.
– Calculation Methodology – Although we expect the use of an event study to be the de facto standard, our advice is to not commit to a particular calculation methodology for stock price or TSR-based awards. Instead, we suggest drafting the clawback policy to state that the compensation committee will evaluate the facts and circumstances and select a methodology that, in its judgment, yields a reasonable estimate of the accounting restatement’s effect on the stock price or TSR metric.
– Enforcement Method – We think practices will evolve, so we suggest drafting the policy to confer flexibility. We have experience setting up web-based choice platforms and think it may improve the odds of success if participants have multiple repayment options.
The blog goes on to recommend producing “work papers” that sit outside of the policy and give you a playbook to guide decisions that will need to be made quickly if a restatement occurs – similar to what many companies do for cyber incidents and other sensitive events. Check out the chart in the blog for a starting point.
For even more color, Dave, Ron & Mark gave their take on clawback policies (and many other topics) during Tuesday’s webcast on this site. The audio archive for that program is available now – with the clawbacks discussion starting around the 90-minute mark – and the transcript will be posted in the next few weeks. This is also one of the many important areas on which we will be providing practical guidance at our “Proxy Disclosure & 20th Annual Executive Compensation Conference” – coming up virtually September 20th – 22nd. Register now to make sure you have the latest action items before you finalize your policy!
Earlier this week, a federal district court judge issued an unpublished opinion in a long-running clawbacks case. Even though the case doesn’t create formal precedent, it may affect decision-making as we all look to finalize Dodd-Frank clawback policies by December 1st of this year. Specifically, it emphasizes that it’s important to follow state law contract principles when you put a policy in place, if you want to be able to enforce the company’s rights under that policy down the road. Enforceability matters because under the new listing standards and SEC rule, companies aren’t required to merely adopt a clawback policy, they are also required to comply with the policy by recovering erroneously paid incentive compensation reasonably promptly – with delisting at stake.
In Monday’s case, the judge granted summary judgment in favor of Hertz’s former CEO, shutting down the company’s 2019 claim that he had breached the company’s clawback policy – as well as representations in his separation agreement – by creating a “tone at the top” that may have led to inappropriate accounting decisions. Although the former CEO settled with the SEC in 2020, he continued to fight reimbursing the company. Mike Melbinger blogged about this case at the “motion to dismiss” stage in 2021.
Hertz alleged that this was a case of misconduct that caused a restatement. It sought to claw back incentive-based compensation that was paid in prior years based on achievement of later-restated revenue, by way of the company clawback policy. It also sought to rescind golden parachute payments that it made to the former CEO under his separation agreement. Both the clawback policy and the separation agreement required a finding of gross negligence, fraud or willful misconduct.
The holding underscores that adopting a clawback policy is only one step in the process of recovering compensation – a point that Ron Mueller reiterated in yesterday’s webcast on this site and has been preaching at our “Executive Compensation Conference” for many years. If there were doubts about whether to have executives agree in writing to be bound by company policies, this decision supports the notion that you do need a contractual basis for enforcement. And according to this opinion, simply incorporating a general policy into other agreements doesn’t work. Here’s an excerpt (citations omitted):
Hertz argues that the Clawback Policies were incorporated into “various other agreements” with Frissora and as such, are enforceable through this incorporation (“Incorporation Argument”). Specifically, Hertz argues that the following documents incorporate one or both Clawback Policies: (1) Frissora’s Employment Agreement, which Hertz argues incorporates both Clawback Policies because it states that the violation of a “material company policy” constitutes a defined cause to terminate Frissora’s employment; (2) the Separation Agreement, which Hertz argues incorporates the 2014 Clawback Policy by reference; and (3) Hertz’s “bylaws,” which Hertz argues incorporate both Clawback Policies because they “impose on [Frissora] and other senior executives the solemn duty of abiding by and enforcing company policies.” …
The Court agrees with Frissora that Hertz can only argue that the Clawback Policies are stand-alone contracts. Accordingly, if the Court finds that they are not enforceable contracts, then Hertz’s breach of contract claims under Counts I and II will fail.
The court went on to explain that the company’s clawback policies – which were set forth in board resolutions, incorporated into the company’s standards of business conduct, and described in public filings – were simply mechanisms by which Hertz would enter future contracts, and were not themselves enforceable contracts. The court also determined that the company’s general standards of business conduct weren’t enforceable contracts because (according to the court) they:
– Contained “only vague and aspirational language,”
– Had no yardstick by which to measure compliance with the standards,
– Stated that they were a “guide” not a “contract,” and
– Did not expressly have employees indicate that they would agree to be legally bound by the document.
There were some procedural & litigation strategy issues at play throughout all these findings, which also affected the court’s decision to reject the company’s attempt to rescind the payments under the separation agreement. And it’s possible Hertz will appeal. Nevertheless, this case shows that you need to keep basic contract principles in mind for company policies if you want to be able to enforce them. Also see question #1467 in our “Q&A Forum” on this site, which discusses contractual interpretations of bylaws vs. policies.
We’ll be posting memos about this case in our “Clawbacks” Practice Area – and rest assured we’ll also be discussing the implications at our “20th Annual Executive Compensation Conference,” which is coming up virtually on September 22nd and, as always, follows our “Proxy Disclosure Conference” on September 20-21. Here are the agendas for that pair of conferences. If you haven’t already signed up, now is the time! You can register online (via the “virtual conferences” drop-down), call 800.737.1271, or email sales@ccrcorp.com.
ISS announced last week that their peer group submission window will be open from 9 am ET on Wednesday, July 5th until 8 pm ET on Friday, July 14th, for companies that have annual meetings slated to be held between September 15, 2023 and January 31, 2024. Here’s an excerpt:
As part of ISS’ peer group construction process, on a semi-annual basis, corporations are requested to submit changes they have made to their self-selected peer groups for their next proxy disclosure. ISS considers companies’ self-selected peer groups as an important input as part of its own peer group construction methodology…
Submissions should reflect peer companies used (or to be used) by the submitting company for pay-setting for the fiscal year ending prior to the company’s next upcoming annual meeting.
Companies who haven’t made any changes to their previously disclosed peer groups, or don’t want to provide this information in advance, aren’t required to participate. If you don’t submit new info, the proxy-disclosed peers from your last proxy filing will automatically be factored into ISS’ peer group construction process. We have more info on this topic in our “Peer Groups” Practice Area.
Join us tomorrow at 2pm Eastern for our annual webcast, “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn analyze this season’s highlights & lowlights. We’ve also extended the duration of this program to 90 minutes so that our experts can share practical insights that will help you finalize your Dodd-Frank clawback policy!
For all the lawyers out there, if you attend the live version of this 60-minute program, CLE credit will be available. You just need to fill out this form to submit your state and license number and complete the prompts during the program.
Members of CompensationStandards.com are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, try a no-risk trial now. Our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. If you have any questions, email sales@ccrcorp.com – or call us at 800.737.1271.
Late last year, Liz and John blogged about the new rules that will require institutional investment managers to disclose their say-on-pay votes on Form N-PX. This post on Latham’s Global Financial Regulatory Blog reminds Form 13F filers that they will need to file their first Form N-PX by August 31, 2024. The form will cover July 1, 2023 to June 30, 2024, so 13F filers must update their policies, procedures, and systems now to capture the required information starting this July. This also means, for issuers and investors, that we’ll have greater transparency next summer into managers’ voting decisions on say-on-pay proposals in the 2024 proxy season.
Yesterday, the SEC announced that it settled charges against a company and a former executive related to an alleged failure to disclose approximately $1.3 million worth of perquisites predominantly related to personal use of corporate aircraft by four of its executive officers and one of its directors over four years. During the years in question, the company’s proxy did not disclose any compensation related to personal use of a corporate plane.
The SEC’s order against the company states that the company’s process did not apply the “integrally-and-directly-related standard” to certain expenses, which resulted in the company understating the executives’ and director’s “All Other Compensation” by $325,000 per year, on average.
In the SEC’s order against the former executive, the SEC alleges that the executive failed to disclose approximately $280,000 in personal expenses charged to the company, including chauffer services, other travel, meals, apparel, and car repair services, in response to the company’s D&O questionnaire and after reviewing drafts of the proxy statement. As a result of the executive’s submission of these reimbursements and approval of payments to vendors, the company incorrectly recorded these as business expenses and not compensation.
Perks disclosure is technical, nuanced and, if the number of related enforcement actions is any indication, easy to get wrong. The SEC’s order has a good reminder that the “integrally-and-directly-related standard” is very limited:
According to the Adopting Release, even where the company “has determined that an expense is an ‘ordinary’ or ‘necessary’ business expense for tax or other purposes or that an expense is for the benefit or convenience of the company,” that determination “is not responsive to the inquiry as to whether the expense provides a perquisite or other personal benefit for disclosure purposes.” Indeed, “business purpose or convenience does not affect the characterization of an item as a perquisite or personal benefit where it is not integrally and directly related to the performance by the executive of his or her job.”
While the perks footfault here may not be unusual, one notable aspect of this settlement is that the SEC declined to impose a civil penalty on the company, citing its self-reporting, cooperation and implementation of remedial measures. The former executive agreed to pay $75,000 in civil penalties to settle the charges.
In its latest report on say-on-pay, Semler Brossy’s findings are consistent with studies we’ve previously blogged about — that say-on-pay outcomes in 2023 so far have improved from 2022 — but the report also quantifies the impact of a low say-on-pay vote on director elections in recent years:
Over the past five years, average Director election vote support at companies that received a Say on Pay vote below 50% in the prior year is five percentage points lower than at companies that received above 70% support
A helpful chart in the report shows average director election results stepping down a few percentage points in the year following a say-on-pay vote of 50-70% and below 50%. As Liz recently reminded us, if you receive less than 70% support (ISS) or 80% support (Glass Lewis), both proxy advisors have expectations for engagement and responsiveness and will recommend against the reelection of compensation committee members or the entire board in subsequent years when companies fail to demonstrate that responsiveness.
For more on say-on-pay, join us Tuesday, June 27th, at 2 pm Eastern for our “Proxy Season Post-Mortem: The Latest Compensation Disclosures” webcast to hear from Compensia’s Mark Borges, Morrison Foerster’s Dave Lynn and Gibson Dunn’s Ron Mueller.
One of the common questions that companies are facing with respect to the (thankfully extended) Dodd-Frank clawback policy rule is whether the prohibition on indemnifying covered executives against the loss of erroneously awarded compensation means that the company cannot cover executives’ legal costs in connection with a clawback dispute. K&L Gates’ Ali Nardali sent me this view:
“Indemnification” is used pretty broadly in the release and covers legal costs:
“The Proposing Release acknowledged that state indemnification statutes, indemnification provisions in an issuer’s charter, bylaws, or general corporate policy and coverage under directors’ and officers’ liability insurance provisions may protect executive officers from personal liability for costs incurred in a successful defense against a claim or lawsuit resulting from the executive officer’s service to the issuer. However, Section 10D’s listing standard requirement that “the issuer will recover” is inconsistent with indemnification because a listed issuer does not effectively “recover” the excess compensation from the executive officer if it has an agreement, arrangement, or understanding that it will mitigate some or all of the consequences of the recovery.”
We do not believe that it is necessary to amend indemnification agreements, because the release contemplates that they are auto-nullified to the extent they are inconsistent with the clawback rule, per Section 29(a) of the ’34 Act.
Here’s something John recently blogged on TheCorporateCounsel.net:
For many companies, this is a “say-on-pay frequency” year, and as Dave pointed out a few months ago, failing to timely file an Item 5.07(d) Form 8-K disclosing the company’s decision, in light of the results of that vote, about how frequently it will include a say on pay vote in its proxy materials can have significant negative consequences for public companies, including the loss of S-3 eligibility & WKSI status.
There are a number of ways to skin the cat when it comes to complying with the Item 5.07(d) disclosure requirement, and this excerpt from a recent Goodwin blog sets out a few common approaches:
– Report Item 5.07(b) and Item 5.07(d) in a Single Form 8-K Report. The company can simultaneously report the results of the annual meeting shareholder votes under Item 5.07(b) and its decision on the frequency of say-on-pay votes under Item 5.07(d) in the same Form 8-K report. It is important to review the Form 8-K report to confirm that it complies not only with Items 5.07(a)-(c) but also with Item 5.07(d) before filing.
– Report Item 5.07(b) in a Form 8-K Report followed by Item 5.07(d) in a Form 8-K/A Amendment. If the company reports its annual meeting voting results in an Item 5.07(b) Form 8-K report but does not, or cannot, include the information required by Item 5.07(d) in the same Form 8-K report, the company can report its frequency decision in a Form 8-K/A amendment to the original Item 5.07(b) Form 8-K report. In this case, the Item 5.07(d) report should not be filed as a new Form 8-K report.
– Report Item 5.07(b) in a Periodic Report followed by Item 5.07(d) in a Subsequent Form 8-K Report. The company can report the annual meeting voting results in a Form 10-Q or Form 10-K report that is filed on or before the due date for the Item 5.07(b) Form 8-K, as permitted by General Instruction B.3 to Form 8-K. If the company does not, or cannot, report its decision on the say-on-pay frequency vote in the periodic report, it should file a new Item 5.07(d) Form 8-K to report its decision. In this case, the Item 5.07(d) report should not be filed as an amendment to the periodic report. If the filing of the Form 10-Q or Form 10-K report is delayed to a date more than four business days after the company’s annual meeting, the company should comply with Item 5.07 by filing a Form 8-K report before the filing deadline for the Item 5.07(b) report on the shareholder votes on other matters at the meeting.
It’s nice to have alternative ways to comply with this disclosure requirement, but I wish the SEC would consider eliminating it. It made sense when the say-on-pay requirement was introduced and there was uncertainty about how often votes would be held, but with an annual say-on-pay resolution now an almost ubiquitous practice among public companies, this requirement is little more than a trap for the unwary. It seems to me that a better approach would be to require this disclosure only if a company decided to hold its say-on-pay vote on something other than an annual basis.
Here’s the good news that Meredith blogged yesterday on TheCorporateCounsel.net:
Liz blogged last week that the NYSE and Nasdaq proposed amendments to their listing standards to implement the Dodd-Frank clawback rules. The amendments would extend the effective date of the rules to October 2, 2023. The consequence is that companies will have until December 1, 2023 to adopt compliant clawback policies and that they’ll apply to incentive-based compensation received by executive officers on or after October 2, 2023.
The open question was whether & how the SEC would approve these amendments, since Friday was the last day that they could act on the original proposals. The Commission came through at the 11th hour with notices for the NYSE and Nasdaq (and other exchanges) that granted accelerated approval of each exchange’s proposal, as modified by the amendment.
Although a number of companies have already adopted a Dodd-Frank clawback policy in anticipation of these listing standards, there are also a significant number who were going to be attempting to cram it into summer board agendas. This is a welcome development that gives companies & boards more breathing room to carefully consider their policies. We’ve posted several helpful samples in our “Clawbacks” Practice Area for members of this site!
This FW Cook blog has a nice chart that summarizes regulatory developments to-date on this topic. As is the case with any new rule, there are some lingering interpretive & implementation questions. We’ll be discussing these questions and sharing practical pointers for handling them at our “Clawbacks – Key Action Items Now” session of our “20th Annual Executive Compensation Conference,” which is combined with our “Proxy Disclosure Conference” and happening virtually September 20th – 22nd. Register today for this pair of conferences to get all the info you need – and ongoing access to the archives afterwards. You can sign up online or email sales@ccrcorp.com.