The Next Big Compensation Challenge: Clawbacks

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May 21, 2012 The Next Big Compensation Challenge: Clawbacks

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Presented at WorldatWork 2012 by Hay Group's Dan Moynihan and Irv Becker, Winston & Strawn's Mike Melbinger

Transcript of The Next Big Compensation Challenge: Clawbacks

Page 1: The Next Big Compensation Challenge: Clawbacks

May 21, 2012

The Next Big Compensation Challenge:

Clawbacks

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2© 2012 Hay Group. All rights reserved

Discussion areas

Introductions

Overview of clawbacks/Q&A

Key considerations in 2012 and beyond/Q&A

Early adoption and key rulings/Q&A

Q&A

1

2

3

4

5

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01Introductions

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4© 2012 Hay Group. All rights reserved

Introductions

Presenters

Irv Becker, National Practice Leader, Executive Compensation, Hay Group

[email protected] | 215.861.2495

Mike Melbinger, Lead Partner and Global Head of Employee Benefits and

Executive Compensation, Winston & Strawn

Dan Moynihan, Principal, Executive Compensation, Hay Group

[email protected] | 201.557.8423

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5© 2012 Hay Group. All rights reserved

About Hay Group

Global organizational and human resources consulting firm

Compensation and benefits consulting

Employee, organizational and customer research

Executive coaching/leadership development

Organizational effectiveness and management development

Work design/strategy alignment

Information business

Founded in 1943

Offices in 49 countries

Ten US offices

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About Winston & Strawn

An international law firm with:

1,000 attorneys among 15 offices

Beijing, Charlotte, Chicago, Geneva, Hong Kong, Houston, London, Los Angeles,

Moscow, New York, Newark, Paris, San Francisco, Shanghai, and Washington, D.C.

The firm serves the needs of enterprises of all types and sizes, in both the private and

the public sector

Winston & Strawn has built its reputation on the quality and character of its lawyers

Our history of more than 150 years is a chronicle of individuals and events that have

helped shape the firm and create the strong foundation on which we continue to build

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02Overview

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Overview

What are the key issues?

Dodd-Frank provided a “perfect storm” of shareholder empowerment around

executive pay

The Act arms shareholders with more information and power than before,

while making it harder for management to accumulate votes

In response to increased pressure from shareholders and proxy advisory firms,

companies continue to monitor their executive compensation programs

Only 41 companies failed in 2011, and thus far we have had 4 fail in 2012…is

the hubbub worth it? (as of 4/20/12)

Given today’s intense scrutiny of executive compensation, we are seeing

companies and compensation committees re-evaluate their programs annually

New governance standards include implementing updated clawback policies

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What's next?

The 2011 voting results have some compensation committees more relaxed

than they were before the results were known.

Too soon to tell for 2012

We believe that the single biggest factor influencing the say on pay voting

trends last proxy season was strong company performance

The fact that pay programs have been “cleaner” has certainly had impact

But at the end of the day, shareholders will make 2012 all about company

performance again

Don’t be fooled by the modest shareholder reaction of 2011 – if

performance declines while pay does not, you can be sure that

shareholders will make themselves heard in 2012!

Citibank is the most notable Say on Pay failure to date

A false sense of security?

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Clawback history

Rationale for implementation of the clawback policy

Good governance credit from institutional shareholders and the media

Influenced by SOX requirement for CEO and CFO

Only for compensation that was earned by fraud?

Only from those individuals who perpetrated the fraud?

Unjust enrichment theory

If the financial result or performance measure were incorrectly reported,

then the company should claw back all compensation earned as a result

of that error, regardless of any individual's fault.

Regardless of fault, employment level or the passage of time, and even if

the fraud was outside the US, no one should receive or keep dollars to

which he or she was not entitled.

Pre Dodd-Frank

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Clawbacks – broader than SOX

Dodd-Frank requires national securities exchanges to implement clawback

policies (a.k.a., recoupment policies) that are broader than current

requirements under Section 304 of SOX

Under Dodd-Frank:

The clawback policy must be triggered any time the company prepares an

accounting restatement

Once the clawback policy is triggered, it would apply to all incentive-based

compensation paid to current and former executive officers

The look back period for which incentive-based compensation is subject to

clawback is the three-year period preceding the date of restatement

The amount subject to the clawback is the difference between the amount

paid and the amount that should have been paid under the accounting

restatement

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Clawback history

Sarbanes Oxley

Section 354

TARP

SEC Rulings

Dodd-Frank

Section 954

FDIC

How did we get here?

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Today

Dodd-Frank

Section 954 of Dodd-Frank adds new Section 10D, entitled "Recovery of

Erroneously Awarded Compensation Policy" to the Exchange Act

Requires SEC to direct the national securities exchanges to prohibit the listing

of any security of an issuer that does not develop and implement a clawback

policy

Requires companies to disclose compensation clawback policy in their proxy

statement

Proposed rules not yet issued

Waiting for them…is like waiting for Godot

Endlessly waiting in vain

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03Key considerations for 2012 and beyond

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Defining the clawback terms

The rule

Incentive-based compensation that is based on financial information required

to be reported under the securities laws

The issuer is required to prepare an accounting restatement due to the

material noncompliance of the issuer with any financial reporting requirement

under the securities laws

Incentive-based compensation (including stock options awarded as

compensation) based on the erroneous data

During the 3-year period preceding the date on which the issuer is required to

prepare an accounting restatement

In excess of what would have been paid to the executive officer under the

accounting restatement

What is the rule?

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Participation

Must cover

Individuals who are executive officers, and

Individuals who formerly were executive officers

Who else?

Board of Directors

Senior finance personnel

All plan participants? How deep into the organization?

Key Issues to discuss

Unjust enrichment?

Only those at fault?

Fairness?

Balance the cost vs. amount of recovery

Who should we include?

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Implementation challenges

What forms of compensation should be affected by the clawback?

Annual incentive bonus plan

Stock options, vested but unexercised stock options

Restricted stock; Performance shares; RSUs

How far back in time does the provision reach?

For what period do we clawback

All $ gained in past 12 months?

Consider the breadth of the clawback policy and the reason for the clawback

Different treatment of cash vs. equity?

Precise equity gains are more difficult to calculate – and harder to recover

Tax Issues?

What about compensation that has already been taxed?

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Implementation challenges

Should Company require full payback, partial payment or reduce future

payments?

Annual Incentive Bonus Plan measures many factors

Desire to capture terminated employees

Whether to apply the clawback provisions retroactively to payments and

awards or prospectively

Subject to legal document review

When should the determination of the clawback be made?

At the time of restatement?

Other?

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Impact on pay design & philosophy

Philosophy

Revisit pay philosophy to ensure that pay strategy and pay reality are

intersecting

Consider including documented statements of clawback philosophy and key

design attributes as part of re-tooled comp philosophy

Design

Look at participation

Understand ramifications of clawbacks and perceived value of compensation

Adjust size of awards?

Consider banking and deferrals of awards

Tighten up language for employees exiting company

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Perceived value of compensation

Detrimental aspects of clawback provisions

As a result of the possibility of forfeiture, there is a need to create a strong line

of sight and motivational framework for incentives

Employees may discount value of awards as a result of the potential clawback

due to a material restatement

Awards may need to become larger as an offset

May drive need for insurance protection

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Design options

Bonus Banks

Deferrals

Other?

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Reality of the clawback

Who has the right/responsibility to recover?

Only the Company/Board

Not the SEC or the Exchanges

What if the Company does not or cannot recover?

How hard must it try? Best efforts?

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Legal challenges

Key legal issues

Neither SOX Section 304 nor Dodd-Frank Section 954 has any provision

creating a private cause of action for stockholders

Courts have held that SOX Section 304 does not create a private right of

action for stockholders, e.g., In re Digimarc Corp. Derivative Litig. (9th Cir.

2008); Neer v. Pelino (E.D. Pa. 2005)

Plaintiffs’ bar likely to test in court whether the same is true for Dodd-Frank

More issues

Actual recoupment of the overpayment

Calculation of overpayment

Subject to interpretation

How do we handle former employees?

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Insurance issues

Insurance

Should D&O insurance and/or indemnification provisions make whole an

innocent executive whose compensation is clawed-back under Dodd-Frank

Act Section 954?

Insurance policies being sold to protect innocent executives - that is, those

who did not commit misconduct leading to a financial restatement - against

compensation clawbacks

Public policy ordinarily would prevent an individual (or company) from insuring

or being indemnified against his own misconduct (as opposed to negligence)

However, where a clawback occurs due to a financial restatement

necessitated by the misconduct or errors of another, insurance or

indemnification provisions may be permitted to make whole an innocent

executive whose compensation was clawed-back

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04Early adopters and status of rulings

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Who has implemented new clawbacks?

A short list of companies who made changes in 2011/2012

L-3

B&G Foods

Integrys Energy

Trustmark

Guess

Dr. Pepper Snapple Group

Cummins

Entergy

Praxair

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What they did…

Integrys Energy – 3/26/12 proxy Pursuant to this policy, our board of directors may seek reimbursement of incentive compensation

paid to our named executive officers in certain situations including material restatements of our

financial statements or instances of willful misconduct or fraud that cause harm to the company. This

policy was implemented in the first quarter of 2012 and will be refined as appropriate following the

release of final regulations by the SEC.

Guess - 5/24/11 proxy – executive compensation clawback policy In April 2011, the Board of Directors adopted a new policy. The Clawback Policy provides that the

Board or the Compensation Committee may require reimbursement or cancellation of all or a portion

of any performance-based short or long-term cash or equity awards made to an executive officer to

the extent that:

(1) the amount of, or number of shares included in, any such payment was calculated based on

the achievement of financial results that were subsequently revised and

(2) a lesser payment of cash or equity awards would have been made to the executive officer

based upon the revised financial results.

The maybe’s…

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28© 2012 Hay Group. All rights reserved

What they did…

L-3 Communications – 3/12/12 proxy -- compensation clawback policy

The Committee adopted a clawback policy in 2012 that allows the Company to recoup

and/or cancel any incentive compensation, including equity-based compensation,

awarded to executives on or after January 1, 2012 under the following circumstances:

The award was predicated upon the achievement of financial results that were

subsequently the subject of a material restatement of L-3’s financials

The executive’s fraud or willful misconduct was a significant contributing cause to the

need for the restatement, and

A smaller award would have been earned under the restated financial results.

Subject to the discretion and approval of the Board of Directors, the Company will, to

the extent permitted by law, seek to recover the amount of incentive compensation

paid or payable to the executive in excess of the amount that would have been paid

based on the financial restatement.

The wills…

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What they did…

B&G Foods – 3/30/12 proxy -- executive compensation clawback policy B&G Foods does not currently have an executive compensation clawback policy. However, the

compensation committee plans to adopt a clawback policy after the SEC issues final rules

implementing the clawback provisions set forth in the Dodd-Frank Wall Street Reform and Consumer

Protection Act. The SEC has stated that it expects to issue preliminary rules during the first half of

2012 with final SEC rules to be adopted thereafter.

Trustmark – 3/30/12 proxy -- executive compensation recoupment Ethical behavior and integrity remain an important priority for Trustmark. In support of this, and in

anticipation of adopting a comprehensive executive compensation recoupment policy (also known as

a “clawback” policy), the Committee began including a clawback provision in the performance-based

restricted stock awards beginning with awards granted to the executive officers in 2011.

Also in 2011, the Committee began including a similar clawback provision in the management

incentive plan with respect to annual cash bonuses that may be earned under the plan. Under these

provisions, any performance-based restricted stock that vests or cash bonus paid is subject to

recovery by Trustmark as required by applicable federal law and on such basis as the Board

determines.

The Committee anticipates adopting a comprehensive executive clawback policy once the SEC

publishes final rules implementing the clawback requirements from the Dodd-Frank Act

The wait and see’s…

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Dr. Pepper Snapple – 3/15/12 proxy

The clawback policy provisions provide that:

If there is a restatement of the Company's financial statements filed with the SEC (other than to

comply with changes in applicable accounting principles) covering any of the three fiscal years

preceding the payment or grant of incentive compensation, then the Company will,

subject to the approval of the Compensation Committee, recover from each member of the

Company's executive leadership team (and from each person who was a member of the

executive leadership team during the three year period preceding the first day of any

accounting period for which the financial statements are restated) the incentive compensation

paid to that executive that was in excess of the incentive compensation that would have been

paid to the executive based on the restated financial statements, with such excess to be

determined by the Company and approved by the Compensation Committee, and may

recover from any other award recipient, whose fraud or willful misconduct resulted in the

restatement, any incentive compensation paid to that award recipient that was in excess of the

incentive compensation that would have been paid to the award recipient based on the

restated financial statements, with such excess to be determined by the Company.

Clawback part 1

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Dr. Pepper Snapple – 3/15/12 proxy

If the Company determines that any award recipient is guilty of fraud or willful

misconduct that would give rise to a termination for cause, but not result in a

restatement of the Company's financial statements, then the Company will have the

right to recover from that award recipient, any incentive compensation paid to that

award recipient during the period of time the award recipient was engaged in such fraud

or willful misconduct.

The value with respect to which recovery shall be sought will be determined by the

Company (or Compensation Committee in the case of a member of the executive

leadership team) based on such factors as considered relevant, including, but not

limited to, the difference between the amount that was actually paid and what would

have been paid based on the restatement.

The Company may also seek any additional equitable or legal remedies from any

person and which arise under the facts which give rise to a claim by the Company under

the Clawback Policy.

Part 2 – clawback for fraud or misconduct

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32© 2012 Hay Group. All rights reserved

When will we see the ruling?

Current timeline is...

According to the SEC's Dodd-Frank rule-making schedule, proposed

rules addressing clawbacks will be issued within the January-July 2012

time frame

Final rules will be adopted within the July-December 2012 time frame

As of 4/20/12, we know...nothing

What to expect?

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33© 2012 Hay Group. All rights reserved

Checklist for management & the committee

Take an inventory of all plans, programs and arrangements that provide for

incentive compensation tied to financial metrics

Review the structure of compensation packages

At a minimum, enact a GAP plan which states the Company will clawback, but

will amend based on new rules

Review who within the company should be subject to the clawback policy

Check indemnification and mandatory arbitration clauses for clawback

litigation issues

Check enforceability of choice-of-law provisions

Include clawback language that references Dodd-Frank to incorporate the final

rules into any new executive compensation grants and agreements

Wait for new rules

Development of principles and beliefs for Board/Management to use during

the implementation

Implement new policy quickly

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Q&A

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35© 2012 Hay Group. All rights reserved

Presenters

Irv Becker, National Practice Leader, Executive Compensation, Hay Group

[email protected] | 215.861.2495

Mike Melbinger, Lead Partner and Global Head of Employee Benefits and

Executive Compensation, Winston & Strawn

Dan Moynihan, Principal, Executive Compensation, Hay Group

[email protected] | 201.557.8423