When the new clawback listing standards came out, there was a lot of discussion about how companies would go about the necessary calculations for stock price or TSR-based awards. While event studies were identified as the likely standard, advisors were recommending that the clawback policy not identify the calculation methodology in advance and instead allow the compensation committee to select a methodology based on the facts and circumstances.
This recent WTW memo, 4 Steps for Executing Clawbacks After Your Restatement, agrees — noting “not all stock plans or total shareholder return-based plans will require an event study for every restatement.” If you’re wondering how a compensation committee would go about making the decision of whether to commission an event study, a helpful table addresses several factors that will influence whether one is needed. The listed factors include inflection points in the comp plan, the quantum of stock price movement, market volatility, percentage of pay impacted and the magnitude & cause of the restatement.
For more on the complexities of implementing a clawback, tune in for our upcoming webcast “Clawbacks: Navigating the Process After a Restatement” on Wednesday, April 17, at 2 pm Eastern to hear from two of the authors of the memo, Steve Seelig & Rich Luss, who will be joined by Gibson Dunn’s Ron Mueller and Latham’s Maj Vaseghi. They’ll discuss how to run a thoughtful, thorough and organized process if you find yourself in mandatory clawback territory.
The 2024 update to Skadden’s Compensation Committee Handbook is now available — now in its 10th edition, it reflects key developments since last spring, including updates for the clawback rules and developments in pay-versus-performance disclosures. In the discussion of clawbacks, it briefly touches on the interplay with other legal requirements, including SOX and state laws:
Committees should keep in mind that certain states, such as California, have laws that generally prohibit the recovery of wages that have already been paid. While the Dodd-Frank clawback rules are currently expected to preempt conflicting state law, litigation activity may be on the horizon to definitively confirm this.
CEOs and chief financial officers (CFOs) remain subject to the clawback provisions of the Sarbanes-Oxley Act of 2002 (SOX), which provide that if a company is required to prepare an accounting restatement because of “misconduct,” the CEO and CFO are required to reimburse the company for any incentive or equity-based compensation and profits from selling company securities received during the year following issuance of the inaccurate financial statements. To the extent that a Dodd-Frank Clawback Policy and SOX cover the same recoverable compensation, the CEO or CFO would not be subject to duplicative reimbursement. Recovery under the Dodd-Frank Clawback Policy will not preclude recovery under SOX to the extent any applicable amounts have not been reimbursed to the issuer.
PLI’s “SEC Speaks” program continued yesterday, with an emphasis on enforcement. As I noted yesterday, all Staff remarks were made subject to the standard disclaimer that they are made in the person’s official capacity and don’t represent the views of the Commission, the Commissioners or other Staff members.
In yesterday’s program, Stacy Bogert, Associate Director of the Division of Enforcement, noted that Sarbanes-Oxley Section 304 clawbacks are a continued issue of focus for the Enforcement Division. The Division has issued several warnings about this – and the DOJ is also interested. If the Staff is talking about it at a conference, we should pay attention.
Stacy noted that the enforcement approach is guided by the policy underlying the statute: to incentivize CEOs and CFOs to implement robust internal controls designed to detect and prevent misconduct in financial reporting and encourage an appropriate tone at the top. So, you can expect the Commission to seek recovery in these cases beyond the “fraud delta” (the amount of executive enrichment that resulted from the misconduct at issue). It’s likely that they’ll pursue reimbursement to the company of the full amount of all forms of compensation – including profits that the executives received upon the sale of equity. Stacy also gave a reminder of the view that the clawback can apply regardless of whether the CEO or CFO personally engaged in the misconduct that caused the restatement.
These remarks send a “deterrence” signal that may cause many companies to take (yet another) look at their controls & trainings….
At yesterday’s SEC Speaks, the Corp Fin Staff noted that they are still getting a lot of questions about the new(ish) checkboxes on the Form 10-K cover page that may be triggered by correcting financial reporting errors and a clawback analysis. As a reminder, the Form now says:
– If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements.
– Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b).
Jessica Barberich, who is Assistant Chief Accountant in Corp Fin, shared some color about the Staff’s views on interpretive questions. Here are key takeaways (with the caveat that the standard Staff disclaimer applies and this summary is based on our real-time notes):
– The first box is required to be checked by listed issuers when the financials included in the filing reflect the correction of an error to previously issued financial statements.
– The Staff looks to the definitions in US GAAP when considering whether a change to previously issued financial statements is an “error” – and companies should do the same.
– The term “error” can include mathematical errors, mistakes from the application of GAAP, or oversight or misuse of facts that existed at the time the financials were issued. Examples of things that are not errors include: Adoption of new accounting standard that requires retroactive application; disaggregation of financial statement line items; or a change in account principle (including a change in the method of applying the principle, as long as the prior application wasn’t an error in US GAAP). See the adopting release for other examples.
– For judgment questions – things like fixing a typo, or a change to a prior-year footnote disclosure – your accountants should be involved to help you analyze whether this is considered an “error” under US GAAP.
– The most common question is whether this first checkbox really applies to all corrections. The answer is yes. It must be checked for all restatements: “Big R” restatements, “little r” restatements, as well as restatements that were made voluntarily by the issuer.
– What’s a “voluntary” restatement? Jess gave this example: If the error is immaterial to the prior year, and correction in the current year would also be immaterial, the company is permitted to correct the financials through an out-of-period adjustment to the current year, and the company isn’t required to restate the prior year. If the company chooses to correct the error via a restatement of the prior year, it will need to check the box. If the company instead uses an out-of-period adjustment to the current year, it does not need to check the box, because it hasn’t revised previously issued financial statements.
– The second checkbox has a narrower scope than the first. It indicates whether a recovery analysis is triggered by any of the restatements indicated in the first checkbox.
– It won’t be checked for voluntary restatements that don’t trigger a recovery analysis.
– If there is a “Big R” or a “little r” restatement, a recovery analysis will be triggered under the company’s clawback policy. However, the extent of the analysis will vary. For example, although there would be no recovery amounts to determine if no financial-based incentive compensation was received during the relevant period, the box would still need to be checked, because the analysis was triggered.
Jess noted that both checkboxes only relate to restatements of prior years, not current-year errors corrected in the same year. She also highlighted one other question they’ve been receiving, that is unrelated to scope:
If the 2023 10-K was amended in 2024 for a restatement of errors related to 2023, and the company properly checked boxes in the 2023 Form 10-K/A that it filed, does the company need to check in the 2024 Form 10-K (since it still includes FY 2023 financials)? Jess noted that assuming no other restatements occurred, the company would NOT need to check the box on the 2024 cover in this situation.
Lastly, the Staff noted that the Disclosure Review team will be monitoring filings to ensure that the clawback policy is correctly filed as an exhibit and that the checkboxes are correctly completed if a restatement occurs.
I blogged last month about the “aircraft audit” initiative that the IRS recently launched. In the latest 20-minute episode of the “Pay & Proxy Podcast,” Meredith interviewed Cooley’s Brad Goldberg and Jet Counsel’s Stewart Lapayowker about this development – and all the latest ins & outs of corporate aircraft compliance & disclosure. They covered:
1. The demand for aircraft by corporations and executives, during and coming out of the pandemic
2. Tax issues for companies and executives
3. What we know about the IRS audit plans
4. The complicating factors of commuting benefits and remote work
5. The recent trend of individual executives or directors purchasing aircraft
6. Related party transaction considerations when a company charters an executive or director’s plane
7. Confirming & improving your controls and record keeping
If you have an executive compensation topic that would be good for a podcast, reach out to Meredith! She’s at mervine@ccrcorp.com.
Inquiring compensation committees want to know: Are ESG metrics moving the needle for long-term shareholders? Incorporating climate and diversity goals has certainly taken off as a trend at big companies over the past few years. But even outside of the “anti-ESG” camp, the approach isn’t universally loved. In fact, some of the biggest investors & asset managers have expressly stated that if ESG metrics are included in pay plans, the metrics should be rigorous, transparent, and aligned with corporate strategy – which as our 8-page checklist and this blog demonstrate, is easier said than done.
This Bloomberg article says that proponents and the media are now also casting a more critical eye towards ESG incentives. Here’s an excerpt:
As companies increasingly tie executive pay to ESG, there’s evidence to suggest the add-on is being used to enable bigger remuneration packages without leading to any meaningful environmental, social or governance improvement.
In response, activist shareholder groups are demanding more disclosures around ESG-linked pay to force companies to produce transparent metrics. Currently, many of these bonuses are shrouded in vague language, according to US-based nonprofit As You Sow, which focuses on investor issues ranging from climate change to gender inequalities.
The article discusses criticism of a pharma CEO who received a payout based on reduced emissions, even though the company’s overall emissions increased when all Scope 3 emissions were taken into account. Given the complexities of reducing (or even tabulating) Scope 3 emissions, it isn’t surprising that the target was structured this way – but it’s another example of ESG metrics potentially being riskier than first meets the eye. “Human capital” metrics aren’t any easier, either. For example, we’ve noted that companies using DEI metrics must tread very carefully. It’s enough to make “simple” executive pay packages sound pretty appealing.
All that said, if you have already incorporated – or are considering incorporating – environmental or social metrics into your pay plans, make sure to check out our “ESG Metrics” Practice Area for benchmarking and tips. Remember that setting & measuring these goals should be a cross-functional effort – and your team should include employment lawyers.
In recent years, it’s felt like outside advisors pretty much always have a few clients battling significant stock price volatility. From time to time, those companies decide they need to make off-cycle retention grants to one or more executives, but they may have fewer headaches to deal with if they can maintain the competitiveness of their pay program while avoiding special, one-time awards. This NACD insight from Semler Brossy discusses how annual and long-term incentive plans can be adapted and share pools can be managed in a volatile environment. Specifically, it suggests that companies consider for both annual and LTI plans:
– Changing metrics
– Altering performance periods
– Widening goals or payout ranges
– Adjusting the LTI vehicle mix
If the company has share pool concerns due to the volatility, it recommends considering the following strategies to reduce the number of shares utilized for equity grants:
– Reduce the number of participants
– Reduce the dollar value of the annual grant per participant (e.g., focus on the number of shares instead of the dollar value)
– Substitute performance cash for a portion of equity
– Delay the timing of awards
Since the early years of say-on-pay votes, low outcomes have been considered a potential sign of broader problems — low say-on-pay support may signal that shareholders have performance concerns, putting the company at heightened risk for an activist attack. This post from Meridian Compensation Partners discusses why and how activist shareholders seeking more widespread changes also raise compensation issues — noting that they can be “a ‘wedge’ to gain broader shareholder and proxy advisor support,” and activists may gain leverage by using compensation issues to “embarrass the board and hamstring the executive team.”
The post identifies the following compensation issues likely to attract the attention of activist shareholders:
• Use of aspirational peer groups or aspirational pay positioning (top quartile target pay positioning)
• High ratio of CEO pay to pay of other named executive officers
• Pay programs that are different from those of peer companies or the broader market without a disclosed rationale that activists believe
• Incentive targets set to reward executives for performance that lags industry norms
• Large incentive payouts when company has “underperformed” on financials or stock price
• Designs that don’t align pay outcomes with performance
Meridian suggests companies work with their compensation consultant to take the following steps to avoid compensation making the list of issues an activist may raise:
• Audit compensation plans and programs
• Identify disconnects between realized pay and financial and stock performance
• Identify other potential compensation issues — peer group, CEO to NEO pay ratio, etc.
• Take steps (as appropriate) to change incentive design or target setting and/or enhance public disclosure of the business rationale for pay design and outcomes
Severance provisions continue to draw scrutiny from investors and proxy advisors, and severance has been the subject of a trending shareholder proposal two years in a row. With this focused attention, you may want to look at the latest edition of Alvarez & Marsal’s study (partnered with ESGAUGE) on change-in-control arrangements among 100 companies in the S&P Composite 1500 Index. This summary highlights these key data points:
– The most common cash CIC severance multiple is >2 and <3 times compensation (typically base plus bonus).
– Double-trigger accelerated vesting of equity remains a common CIC benefit (88%).
– Companies routinely provide other CIC benefits, including health and welfare benefits continuation (63%), outplacement services (22%) and enhancement of retirement benefits (15%).
– Excise tax protection is handled in a variety of ways, with most companies either not addressing (executives are solely responsible) (45%) or including a best-net provision (41%).
The complete report shares detailed data by market cap on the topics above for CEOs & CFOs. If you’re taking a look at your severance and CIC benefits and making changes, you may want to consider the impact of the Dodd-Frank clawback rules — for example, ensuring any severance agreements provide a contractual basis to enforce the company’s clawback policy and considering whether severance should be based on base plus target bonus (if you currently use actual).
WTW recently conducted a study of incentive structures and strategies companies use to retain key employees during an acquisition. The survey of approximately 160 respondents provides useful benchmarking information to shape retention programs more effectively. Here are some key takeaways from this release comparing the results to WTW’s 2020 study:
– Overall, retention pool size continues to decline, with nearly 70% of respondents that track and set aside a retention pool reporting that the retention pool was less than 2% of the purchase price for the acquired company. In a similar vein, fewer companies reported retention pools above 5% of the purchase price, compared to three years earlier.
– Companies also shortened the length of retention periods for top executives between 2020 and 2023. […] In 2020, two-thirds of companies that participated in WTW’s retention study reported retention timelines of two or more years for senior executives. Currently, fewer than 30% of participants reported structuring retention periods to last longer than two years, with the median lying between 13 months and 18 months. Shorter retention periods may reflect pressure to retain employees for only as long as necessary during the transition, which may cut costs for retention packages.
– The study also makes clear that performance pay is climbing, and the focus is shifting from cash bonuses alone to a mix of cash, stock options, RSUs and other awards that account for measurable metrics of success for the target or combined companies. This move toward performance pay almost certainly reflects the character of the purchasing companies. More than 70% of respondent buyers were publicly traded companies, with 66% of the acquired companies held privately.