This “Governance Intelligence” (formerly “Corporate Secretary”) article walks through practical steps compensation committees need to take to implement a clawback policy. The article highlights the benefits of advanced planning to determine the process to be followed in the event the policy is triggered.
In preparing to implement a clawback, the compensation committee should establish a written process and related timeline for required actions, as well as the identification of potential members of a clawback implementation group. This group should comprise people from the company and any outside experts necessary to implement the process.
Working through some of this in advance seems helpful because the many complexities may be more difficult to navigate when “under the gun.” For example:
If it is determined by the audit committee or the full board that a restatement is required, the compensation committee should meet to implement the clawback review process, set timeframes for required actions and establish the clawback implementation group members responsible for the collection of relevant information and the determination of the impact of the restatement on incentive compensation. The compensation committee should also consider the potential for conflicts of interest when management is involved in determining clawback amounts and making judgment calls with respect to calculations, sources of funds and taxation matters.
Depending on the dollar amounts involved, the compensation committee may decide to hire independent compensation or accounting experts and counsel to work with the internal clawback implementation group. Considerations of attorney-client privilege may dictate that counsel hire outside experts in order to maintain the privilege.
The panelists in our spring webcast “Clawbacks: Navigating the Process After a Restatement” had a similar message. I’ve even heard of companies working through a “dry run” with their counsel to work out (some) kinks in a hypothetical situation.
Join us at our 2024 Proxy Disclosure & Executive Compensation Conferences on October 14-15 in San Francisco to hear the latest on tricky clawback issues and market practice during our “Living with Clawbacks: What Are We Learning?” panel. There are now a number of examples of disclosures regarding mandatory clawbacks, disclosures that no clawbacks were required and SEC comments, and I’m looking forward to hearing our panelists’ perspectives. You can peruse our agenda to see what else our expert practitioners will cover and register here for in-person or virtual attendance.
We were just wondering over here what was happening in the other Tesla compensation litigation — the one where the Police and Fire Retirement System of Detroit sued Tesla’s board alleging excessive director compensation. Thankfully, the folks at The Activist Investor have been following it closely — attending hearings and submitting letters — and came out with this timely update!
You may recall that the parties announced a proposed settlement in July 2023. It was a particularly notable settlement by dollar value alone but also had some interesting governance terms. As the TAI post explains, the settlement has yet to be approved, partially because Tornetta threw a wrench in the works, but that’s starting to become a problem for the settlement terms because…stock options.
In Tornetta, the plaintiff attorneys requested TSLA shares that are currently valued at $5-6 billion. They argued for these at a hearing In July 2024. The letter indicates Chancellor McCormick expects the legal arguments over the Tornetta legal fees will affect those in Detroit. She has yet to rule on the Tornetta legal fees, although it should be sometime soon. Thus, Detroit waits for the final Tornetta opinion.
Last week the plaintiff and defendants sent a letter to Chancellor McCormick, the first substantive communication in the case since January.
The Detroit settlement includes a mix of cash, shares, and unexercised options that sum to the $750 million clawback. Options of course have an exercise period. If the option holder fails to exercise them by the end of that period, they expire worthless.
That could start to happen to some of the options that the plaintiff and defendants want to include in the settlement. A tranche of options belonging to BoD Chair Robyn Denholm expired August 18 (two days ago). The parties intended to include those options in the clawback. They planned to return those (now-expired) options once Chancellor McCormick approved the settlement, which she obviously has not done.
Instead of those expired (and presumably exercised, no one with any sense whatsoever lets TSLA options issued in 2017-2020 expire unexercised) options, the parties said they will include other unexercised-but-in-the-money Denholm options in the total clawback. The letter notes replacing the expiring options with other options having a later expiration increased the value of the settlement by $209. Presumably Denholm “paid” the extra $209, since it had to come from somewhere.
The parties want to avoid having to again swap out expiring options for unexpired ones. The next tranche of options they plan to return expires in June 2025. They worry that future exchanges will cost one or another director much more than $209. Thus, the parties urge Chancellor McCormick to approve the settlement promptly, before the next tranche of options expires. They even ask her to sever the consideration of the attorney fee request from that approval. She would decide later on the $250 million in legal fees, presumably after she rules on the $5-6 billion in legal fees in Tornetta.
TAI takes issue with the letter’s assertion that there are no open issues at issue in the settlement — pointing to TAI’s prior objection regarding “lack of allocation of the aggregate clawback among directors, and unenforceability of the shareholder vote on director pay.”
A client has a grant policy that allows for grants a few times a year at set times. They have asked if they can and should make an exception to this policy and grant on a different date to a new executive they are hiring instead of making the exec wait. I don’t like the precedent this would set or the possible future disclosure if this person becomes an NEO or the potential for investors to say that they are gaming the system. Am I being too conservative?
Here was John’s response:
Many equity compensation award policies address grants to new hires, and those policies often accommodate off-cycle grants of that type. I think the practice described in a Mercer publication summarizes the approach taken by most companies:
“For off-cycle grants (e.g., new hire, promotion, and retention awards), the policy will typically specify monthly or quarterly dates for approval, particularly for grants to non-executives. Companies sometimes make exceptions to this cadence to recruit or retain key executives or other employees.”
These grant procedures are all the more important given the “new” requirements under Item 402(x) to discuss policies and practices on the timing of awards of options in relation to the disclosure of material nonpublic information and provide tabular disclosure regarding option awards granted to NEOs contemporaneous with the release of material nonpublic information.
Bloomberg recently reported on research from Nonlinear Analytics assessing 205 companies that checked the first Form 10-K checkbox noting correction of an error. They found that only 15% (29 companies) said they reviewed the error to see if they needed to enforce a clawback (by checking the second box denoting that a recovery analysis was required).
The article quotes Latham’s Maj Vaseghi (a frequent contributor to our events!) reminding readers that accounting errors discovered in early 2024 may not have triggered a clawback since 2023 bonuses were not yet paid and the listing rules were not effective until late 2023. But SEC Staff has suggested that the circumstances in which the first box should be checked but not the second are very limited. Nonetheless, there seems to be continued confusion about when to check the second box (and inconsistent practices).
Perhaps most importantly, the article identifies two companies that reported that they were required to recoup compensation from executives:
– NCR Voyix Corp. See page 33 of the 10-K and pages 36, 41 and 49 of the proxy.
– Katapult Holdings Inc. (emerging growth company). See pages 35 to 36 of the proxy.
Here’s a snippet from the NCR Voyix proxy statement:
As disclosed above the Company revised its financial statements for interim periods in 2023 as reported in our 2023 Form 10-K. In March 2024 the Compensation Committee determined that, based on the revisions, the achievement of 2023 AIP and the adjustment of the 2021 PBRSUs and 2022 PBRSUs was impacted. Under the Company’s clawback policy, in April 2024, the Company recovered a portion of the 2023 bonus payouts paid to certain Departed Executives in December 2023 as well as a portion of the adjusted restricted stock units that were issued in December 2023 in connection with the performance-related adjustments for the 2021 PBRSUs and 2022 PBRSUs.
No amounts were recovered from the bonus payments made to current executives. Their bonuses were not impacted by the restatement because the Committee previously exercised its negative discretion to reduce their bonus levels below what they would have received after the revised financial statements. In addition, as discussed below, Mr. Oliver’s annual incentive payout also was not subject to recovery because he did not receive any 2023 AIP payout from the Company as he was appointed the Chief Executive Officer of NCR Atleos in connection with the Spin-Off. The amounts recovered in April 2024 satisfied the entirety of the Company’s clawback obligations under its clawback policy. See the 2023 Annual Incentive Plan and 2023 Long Term Incentive Program sections above for further analysis of how the clawback amounts were calculated and executed the impacted executives.
The disclosure then includes a chart with the following: (i) the date of the restatement; (ii) the aggregate dollar amount of erroneously awarded incentive-based compensation attributable to the accounting restatement; and (iii) the aggregate amount of the incentive-based compensation erroneously awarded and that remains outstanding at the end of the last completed fiscal year; and (iv) the outstanding amounts from any current or former named executive officer for more 180 days or more.
Earlier this summer, the Internal Revenue Service updated its “Equity-Based Compensation Audit Technique Guide.” It’s the first time the Guide has been updated since 2015 – and as Bruce Brumberg notes in this Forbes article, the new version came as a bit of a surprise.
The Guide isn’t an official pronouncement of the law. But it does provide a window into how the IRS uses SEC filings and other documents to examine whether equity compensation has been properly reported, subjected to withholding and recognized as income. Here’s an excerpt that illustrates the IRS’s expansive approach to examining compensation disclosures – and its willingness to expand an audit beyond the initial target, based on its findings:
Pertinent documents for compensation purposes filed with the SEC include Form 10-K (Annual Report), DEF 14A (Definitive Proxy Statement), and Form 4 (Statement of Changes in Beneficial Ownership). The individuals identified in the SEC reports are considered executives and directors under Security Exchange Act section 16(b).
Once the section 16(b) executives and directors with equity-based compensation arrangements have been identified, confirmation should be made on whether all compensation related to various compensation plans have been reported to the recipient (on the individual’s Form W-2 or Form 1099-MISC) and that the appropriate employment taxes have been withheld and paid. If the compensation awarded to the section 16(b) executives has not been properly recognized, the audit scope may need to be expanded to other executives, directors, and employees accordingly.
Bruce’s article highlights some of the issues that the Guide instructs IRS examiners to focus on:
– Loans to exercise options to ensure that they are recourse loans (i.e. you personally pay should you default) and whether they were forgiven/canceled or reduced.
– Qualifying and disqualifying dispositions for incentive stock options (ISOs) and tax-qualified ESPPs. These are shares from ISO exercises or ESPP purchases that were sold either before or after the statutory holding periods of two years from grant and one year from exercise/purchase that provide the best tax treatment.
– Annual limits on the size of ISO grants (only $100,000 can be vesting/first exercisable in one year) and ESPP purchases ($25,000 annual limit). While your company probably has a stock plan administration program to help it adhere to these limits (which are not adjusted for inflation), company mistakes can change your tax treatment by turning your ISO grant and ESPP into nonqualified stock options.
– Restrictions on transferred stock that create a substantial risk of forfeiture (SRF) which needs to lapse before taxes apply. The SRF concept is standard, for example, with most grants of restricted stock or RSUs, which must vest before you recognize taxable income and could be forfeited if you were to leave the company before the vesting date. A stock buyback right for your company at job termination is not seen by the audit guide as an SRF that postpones income recognition, as it defines those as “non-lapse restrictions.”
– Transfer of stock options to related persons, which makes them a “listed transaction” and could be an abusive tax shelter.
– Company reporting requirements for your ISO exercises (on Form 3921) and ESPP purchases (on Form 3922).
– Form W-2 reporting, including special reporting and codes for nonqualified stock options and other grants.
– Appropriate amounts and timely deposits of withholding for federal income tax, FICA (Social Security and Medicare), and FUTA.
– Timely IRC Section 83(b) elections for the early-exercise stock options used by private companies. Also for startups, whether any elections were made under IRC Section 83(i) to defer income.
If you are looking for something to keep you up at night, the Guide goes into a fair amount of detail on how examiners can use public disclosures to gather information and flag discrepancies.
Yesterday, in Ryan v. Federal Trade Commission, a federal judge in the Northern District of Texas struck down the non-compete ban that the FTC adopted earlier this year, saying that the agency exceeded its authority and that the rule was arbitrary and capricious. The court order blocks the rule on a nationwide basis – expanding the preliminary injunction that the judge issued last month. Specifically, the opinion says:
The Court sets aside the Non-Compete Rule. Consequently, the Rule shall not be enforced or otherwise take effect on its effective date of September 4, 2024 or thereafter.
This WaPo article says the FTC is considering an appeal, and that in the agency’s view, the decision doesn’t prevent the FTC from addressing non-competes through case-by-case enforcement actions. The article continues:
Julie Levinson Werner, an employment attorney and partner at Lowenstein Sandler in New York, said the varying opinions and likely appeals in the three cases make it probable that the noncompete rule will eventually be reviewed by the Supreme Court. But for now, the Texas court’s ruling puts the law around noncompetes back to the status quo, Werner said.
“Everybody who was under the impression that they were going to have to initiate sending out notices to employees and telling them that their noncompetes were no longer in effect are not required to do that,” she said.
Although the FTC’s national ban has been struck down, individual state restrictions on noncompete agreements remain in effect. For example, California, North Dakota and Oklahoma have had at least some prohibitions on noncompete clauses for more than a century. Laws in other states stipulate that noncompete agreements cannot be used for employees falling below a certain salary threshold or earning an hourly wage.
As always, you should consult your own employment lawyers on this topic. But many companies will view this ruling as favorable, and it marks another loss for the “administrative state.”
Earlier this month, ISS launched its Annual Global Benchmark Policy Survey. The survey is open for comment until Thursday, September 5th – and it represents a key step in the proxy advisor’s formulation of voting policies for 2025 AGMs.
As Dave pointed out on TheCorporateCounsel.net, this year’s survey includes several questions relating to executive compensation matters, including questioning whether ISS should continue to look for a high ratio of performance-conditioned equity awards in its qualitative pay-for-performance assessment, versus also giving “credit” for time-based equity awards with extended vesting periods. It would be a big step for investors to recognize that performance conditions aren’t always the “be all, end all” – although Norges and a few other investors have been pushing for time-based compensation for several years.
A new blog from Meridian Compensation Partners takes a deeper dive into this and the other compensation-related questions. Here are the key takeaways:
– Time-Based Equity Awards with Lengthy Vesting Period: The Survey asks respondents to identify whether ISS should consider the use of time-based equity awards with extended vesting terms as a positive mitigating factor in its pay-for-performance assessment, similar to performance-based awards. The Survey also asks whether ISS should consider equity awards with a meaningful post-vesting holding period as a positive mitigating factor in the context of a pay-for-performance misalignment.
– Discretionary Annual Incentive Programs: The Survey asks respondents to identify whether largely discretionary annual incentive programs, such as those adopted by some large financial sector companies, are problematic, even if the program structure is consistent with industry and/or peer practice.
– Shareholder Proposals on Workforce Diversity: Currently, ISS will evaluate, on a case-by-case basis, shareholder proposals requesting that a company report on: (i) pay data by gender, race or ethnicity, or (ii) policies and goals to reduce any gender, race or ethnical pay gap taking into account certain factors. The Survey asks respondents to identify whether certain human capital management metrics or disclosures should be considered by investors in evaluating a shareholder proposal on workforce diversity (e.g., EEO-1 data, promotion velocity data, retention rates, hiring rates, adjusted gender pay gap disclosure, unadjusted gender pay gap disclosure, board oversight, etc.).
Meridian notes that ISS’s survey questions could signal incremental changes to policies that apply to executive compensation and human capital matters in 2025. It’s also worth noting that Glass Lewis recently launched its annual survey, which, like ISS, includes some executive compensation topics.
Don’t miss the opportunity to hear from representatives from both proxy advisors at our “Proxy Disclosure & 21st Annual Executive Compensation Conferences” – coming up October 14-15th in San Francisco (with a virtual option also available)! They will be discussing what worked & what didn’t during 2024, as well as sharing some expectations for 2025 based on what they are hearing from clients. Check out the agendas – 16 fast-paced panels over two days – and the great speaker lineup. Register online or by calling us at 800-737-1271. I am very excited to see everyone and hope that many of you can make it!
Late last week, a federal district court in Florida ruled against the non-compete ban that the Federal Trade Commission adopted earlier this year, which is scheduled to go into effect on September 4th. The decision follows two other district court decisions – one from Texas that barred enforcement of the rule and one from Pennsylvania that said the FTC had acted within its authority. This Faegre Drinker memo summarizes the case and gives a recap of where we stand:
– In Properties of the Villages, Inc. v. Federal Trade Commission, U.S. District Court Judge Timothy Corrigan enjoined the FTC from implementing or enforcing the Noncompete Rule against the plaintiff, and was careful to note that he was granting an injunction against the FTC only for the plaintiff, and was not entering a nationwide stay of the Noncompete Rule.
– As such, all eyes remain on the Northern District of Texas, where the Ryan court has promised a final decision on or before August 30 as to whether it will issue a permanent injunction and a nationwide stay of the Noncompete Rule.
Without clear guidance one way or the other, it’s a good idea to consider whether your existing non-competes will operate the way you expect them to if the ban does go into effect. This FW Cook blog points out that if that happens, the FTC rule could render unenforceable non-compete forfeiture provisions that are contained in senior executive equity award agreements entered into after September 4th. Here’s an excerpt:
For example, we often see equity arrangements where certain types of terminations, for example, a qualifying retirement, result in favorable vesting, but the equity payout is delayed until the normal payout date. For example, the employer may issue performance share units with a three-year performance period. If the executive has a qualifying retirement during the performance period, he or she will be entitled to payout at the end of three years, based on the degree to which the performance metrics have been satisfied over the three-year period. In these situations, it is not uncommon for the employer to require the executive to refrain from competition during the performance period and/or the remainder of the normal vesting period in order to receive the payout.
Here’s the issue. Will a forfeiture-for-competition provision be valid if the award agreement is issued after September 4? This may depend on which document contains the noncompete provision. In particular, an arrangement we have often encountered is where the noncompete provision for each year’s award is embodied in that year’s award agreement. So, the 2023 award agreement contains a noncompete provision with post-employment vesting for that year’s award (and a corresponding forfeiture provision for competition), the 2024 award has similar provisions pertaining to the shares subject to that award, etc.
The blog says that if you act quickly, there may be a way to get a valid non-competition commitment that applies to future awards issued to current executives:
Assuming an employer faces this particular issue, there may be ways to solve the problem, so long as the appropriate arrangements are in place before September 5. For example, subject to state contract law requirements pertaining to sufficiency of consideration, one approach would be for the employer and the executive to agree today that, in consideration for the potential issuance of future equity awards, the executive agrees that such awards will be subject to a provision that any shares that would otherwise be delivered post-employment will not be delivered if the executive competes during the post-employment period.
As always, your mileage may vary – so it’s important to consult your own legal advisors about your specific scenario. Because September is rapidly approaching and invalidation of the rule remains uncertain, there is not much time to waste.
The late January decision by the Delaware Chancery Court that the 2018 compensation package awarded to Elon Musk was not fair to Tesla’s shareholders set in motion a complicated chain of events resulting in Tesla’s shareholders ratifying the 2018 award and Tesla reincorporating in Texas. The whole thing, award and all, may seem too Tesla-y to have many takeaways for other public companies that approach CEO compensation in a measured way with more typical annual packages. But, while the circumstances may be (somewhat) unique to Tesla, the court’s decision still has some important takeaways for other public companies (especially those with a controlling shareholder). In fact, I chatted with Paul Hodgson of ESGAUGE about some of them back in March in this podcast.
This Compensation Advisory Partners article takes a new look at the decision and lists some takeaways that may be more widely applicable to other public companies and compensation committees. Here are some pointers from the alert:
– Consider the retentive value of existing equity ownership
In its opinion, the Court points to Musk’s ownership of 21.9% of Tesla at grant as evidence that Musk was already significantly incentivized to drive Tesla’s performance. Testimonials also suggested that Musk had no immediate plans for leaving the Company, further putting the rationale for the grant in question.
– Carefully consider the board’s personal and professional relationships with the CEO and the impact of the company’s non-employee director compensation packages on the directors
Two directors out of the four Compensation Committee members had close personal and professional relationships with the Musk family, including the Chair of the Compensation Committee. The other two directors were found to have a significant portion of their wealth tied to their compensation as a Tesla director, which would sum to several million dollars. Such outsized director compensation was judged as atypical by the Court, and added to the question of whether the Committee members could truly be considered independent decision-makers.
– Ensure the compensation committee has control over the process and timing
When the initial schedule planned for the grant to be approved within two months, the Compensation Committee’s independent advisors asked for an extension but were denied. However, when Musk asked to pause the process from July to November 2017, the compensation process stopped entirely. The Board also found that Musk proposed new terms prior to six out of the ten Board or Compensation Committee meetings when the grant was discussed.
ESG metrics have grown in popularity despite the fact that many institutional investor policies still don’t expect or push for non-financial metrics in incentive plans. What is driving companies to include them? This recent CLS Blue Sky blog discusses a study that suggests that the “choice to include non-financial metrics in executive incentive plans is a strategic response to heightened regulatory scrutiny and reputational concerns within a firm’s industry.”
Using a sample of “corporate non-financial violations and executive annual bonus plans with available vesting metric details in S&P 1500 firms between 2006 and 2019,” the study compared rates of non-financial violations to rates of companies incorporating at least one non-financial metric into annual bonuses.
Our further analysis indicates that firms are more likely to include non-financial metrics in annual bonuses when there is a higher frequency of non-financial violations within an industry. Specifically, these adjustments are primarily driven by responses to ESG violations, especially environmental and social, rather than other types of non-financial violations. These results support our prediction that firms tailor their pay-for-performance policies to promote executive accountability on responsibility targets and demonstrate a commitment to responsible management.
We’ve seen some prominent examples of the adoption of ESG metrics following direct regulatory scrutiny just this year — I immediately thought of Microsoft and Boeing.