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Payback Time: How to Prepare for Required Clawbacks Under Dodd-Frank

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

December 15, 2011

Compensation attorney and fellow blogger Mike Melbinger recently gave an excellent presentation in Minneapolis on the clawbacks required under the Dodd-Frank Act. His message – start getting prepared now for some complex and sensitive issues. His presentation was sponsored by the
Twin Cities Chapters of the National Association of Stock Plan Professionals and the Society of Corporate Secretaries and Governance Professionals.

Melbinger’s presentation, “Payback Time: Issues and Answers on Clawback Provisions” (PDF), at page 7, includes the operative language of Section 954(b)(2) of the Dodd-Frank Act requiring the SEC to adopt rules that will require listed public companies to recover compensation from executives in the event of a financial restatement. The SEC has not yet proposed its rules under Section 954, although the SEC’s website still states that the proposed rules are planned for December 2011, with final SEC rules planned for January-June 2012. However, even when the final rules are adopted, the requirements will not be effective until the New York Stock Exchange, Nasdaq and other exchanges adopt their own rules incorporating clawbacks into their listing requirements. This could take several additional months.

However, now is the time to consider how to prepare for the requirements. Melbinger’s “Compensation Committee Action Items” include the following:

  • Take an inventory of all plans, programs and arrangements that provide for incentive compensation tied to financial metrics.
  • Review the structure of compensation packages.
  • Review who within the company should be subject to the clawback policy – i.e., just the present and former executive officers required under Section 954, or others, such as directors, senior finance personnel, or all participants (possibly limiting the last category to those actually at fault)?
  • Check indemnification and mandatory arbitration clauses for clawback litigation issues.
  • Check enforceability of choice-of-law provisions – this may be especially important for employees in states such as California with wage and hour laws that may affect the employer’s ability to recover compensation.
  • Include clawback language that references Dodd-Frank to incorporate the final rules into any new executive compensation grants and agreements – until the rules are final, this language need not be very specific, but it will help document the parties’ intention to incorporate the final rules into all executive arrangements.

Melbinger reported an interesting development – at least one insurance company is offering director and officer liability coverage to insiders in some cases of clawback liability. Obviously, if the individual was involved in misconduct, public policy would prevent them from being indemnified or insured, but this policy might not apply if the individual is not at fault.

Melbinger also touched briefly on tax issues involved in clawbacks, and suffice it to say that the tax treatment will not be simple. Generally, the clawback will be invoked in a later year than the year the compensation was earned, and applicable rulings will prevent the executive from amending the prior year’s return. Further, it will be tricky to offset the clawback obligation against future deferred compensation owed the executive, because this could lead to an inadvertent violation of the rules under Code Section 409A.


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