The NASPP Blog

Basics

The Sarbanes-Oxley Act contains an umbrella clawback provision requires that the CEO and CFO give back incentive compensation and stock sale profits in a year prior to any restatement that was caused by misconduct or fraud. Last year, the SEC filed a landmark complaint against the CEO of CSK Auto Corp (see the SEC Press Release) that sought to recoup incentive compensation resulting from accounting fraud without actually alleging that the CEO participated in the fraud. While Sarbanes-Oxley does not require that the executive actively participate in the fraud in order for the clawback provision to be invoked, this case marked a first for the SEC to open a case against an executive without alleging actual misconduct on the part of the individual.

For individual companies, a clawback is a contractual provision that provides the company with a means of recouping incentive compensation or stock sale profit from executives or top employees. The provision may apply to fraud, incentive resulting from incorrect financials, violation of non-compete provisions, or other violation of other specific restrictions within the agreement. Companies may include both equity compensation and cash bonuses in clawback provisions.

The existence of a clawback provision does not mean that a situation that violates the restrictive provisions will automatically result in funds being returned to the company. Most likely, the company will need to initiate legal proceedings in order to recoup any profits. Additionally, unless the agreement between the company and the executive details the repayment process, the company may need to negotiate the timing and manner of repayment.

Shareholders

Shareholders are most interested in performance-based clawback provisions that recoup profits resulting from accounting fraud. These types of clawbacks provide a critical protection to shareholders by forcing the executives to share in the financial losses related to inaccurate financial statements. This goes beyond performance-based pay arrangements where the executive only benefits if certain goals are reached (with the intention of aligning executive pay-out with shareholder benefit) because it reaches back to profits already realized by the executive rather than reducing future payout.

The use of clawback provisions can be helpful when companies are justifying their executive compensation.

Recent or Pending Legislation

Companies participating in the TARP are required to have clawback provisions relating to “materially inaccurate” financial statements. Additionally, TARP companies are required to exercise their clawback rights except in cases where they can demonstrate that it would be “unreasonable” to do so. This was further highlighted in the October determinations from the Treasury (see our alert). For more information on the TARP or other provisions under the Emergency Economic Stabilization Act of 2008, see our Economic Stimulus Legislation portal.

The proposed Senate bill, Restoring American Financial Stability Act (also known as the Dodd bill), goes one step further and recommends that all public companies be required to set clawback policies pertaining to inaccurate financial statements.

For Stock Plan Administrators

Hopefully, you will not need to deal with enforcing any clawback provisions your company may have. However, it’s a good idea to know if the company has clawback provisions in place and if there is a corporate policy on initiating repayment if they are triggered. One issue with clawbacks is that they may not be included in documentation that is normally accessible to stock plan administrators. They may be part of an employment or other separate agreement.

If you want to really take it one step further, educate yourself on the additional implications of recouping profit under a clawback provision. This may include how to handle previously remitted tax withholding or whether there are any 409A issues relating to the repayment method.

For more information on clawbacks and other provisions, check out the materials and audio from the Executive Compensation Conference, which we offered free of charge this year to everyone who attended the NASPP Conference.

More NASPP Value

We’ve added a new portal to the NASPP site, Shareholder Approval. It includes information on shareholder approval of stock plans, compensation, and options exchanges. Additionally, you will find exchange listing rules, legislation, proxy advisory firm recommendations, and more!

-Rachel