Evaluating Your Clawback Triggers

Say-on-Pay! Clawbacks! Additional Disclosure Requirements!

The headlines blaring in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act paint a daunting picture. Combine this news with the Dodd-Frank compliance guidance streaming from compensation consulting practices and law firms, and you might begin to view 2011 as the Year of Executive Compensation Risk. Will it be a period defined by shareholders shooting down executive pay packages, activists wielding the clawback provision as a "weapon," and the SEC trying to empty the pockets of CEOs and CFOs?

I don't think so.

What we have here is a failure to distinguish between compliance requirements and risk management. This gap could lead many companies to embrace a myopic focus on Dodd-Frank compliance while neglecting larger compensation risks and opportunities.

The vast majority of Dodd-Frank compliance guidance from consultants and lawyers that I have read is good stuff. While some of these articles, reports, and bulletins occasionally veer into fear-mongering territory, nearly all of this content brims with sound and practical guidance.

I expect the executive compensation compliance burden in 2011 to be far more manageable within companies whose leaders keep in mind the lessons learned from the initial (and in hindsight, unnecessarily excessive) Sarbanes-Oxley Section 404 compliance crunch.

The degree to which companies need to scramble to address current and future compensation compliance efforts depends on the strength of their approach to compliance risk.

Compliance Questions

On July 21, 2010, President Obama signed into law what has been mischaracterized as "financial reform" and "Wall Street reform." The truth is that Dodd-Frank contains several provisions that extend well beyond Wall Street. All U.S. publicly listed companies -- not just those in the financial services sector -- must comply with several provisions, including those requiring

1. Nonbinding shareholder votes on executive compensation packages;
2. Internal policies on "clawbacks," or recovery of executive pay, for any instance of financial restatements; and
3. Additional disclosure requirements, including sharing with the public the "median of the annual total compensation" of all of the company's employees excluding the CEO, the annual total compensation of the CEO, and the ratio between the two (complex determinations that hinge on numerous factors).

Companies must comply with these provisions, period.

Most compensation committees of the board and senior leadership team should have a firm idea of whether a majority of shareholders approve existing executive compensation packages. Fifty-nine percent of public-company respondents to a July 2010 Towers Watson survey indicated that proxy advisory firms already have "substantial influence" on executive pay decision-making processes in the U.S. companies. If this is the case, we probably can expect to see relatively few executive-pay votes fail to achieve majority support. Some 500 U.S. companies already know how shareholders feel about their executive pay packages. Roughly 400 companies in the Troubled Asset Relief Program (TARP) have been required to hold these votes, and another 100 or so already do so voluntarily.