This post is from Dechert attorneys Andrew Boutros, David Kelley, Anthony Kelly, Hartley M.K. West, and D. Brett Kohlhofer.
Prosecutors and regulatory officials have recently fixed their enforcement sights on corporate compensation clawbacks. Recent public remarks from leaders at the Department of Justice (“DOJ”) and the Securities and Exchange Commission (“SEC”) Enforcement Division reveal how the agencies are leveraging (and intend to continue to leverage) clawbacks in carrying out their enforcement mandates. Here we examine the context behind these pronouncements, how the focus on clawbacks may affect Foreign Corrupt Practices Act enforcement, and the planning opportunity these announcements present for the business community.
The SEC’s Focus on Clawbacks
The SEC’s enforcement authority related to clawbacks derives from Section 304 of the Sarbanes-Oxley Act of 2002 (“SOX 304”). SOX 304 applies where an issuer “is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws.” 15 U.S.C. § 7243. In such cases, SOX 304 requires CEOs and CFOs to “reimburse” the company for (i) “any bonus or other incentive-based or equity-based compensation” paid during the 12-month period following the first public issuance of the restated financial report, and (ii) profits realized from the sale of the issuer’s securities during the same 12-month period. The SEC can pursue claims against CEOs and CFOs for violations of SOX 304 where a qualifying restatement occurs, but the executive has not reimbursed the company as the statute requires.
Since its enactment some 20 years ago, the SEC has pursued SOX 304 charges infrequently—typically when the SEC alleged that the covered executive had a role in the misconduct underlying the restatement. Over the past twelve months, by contrast, the SEC has settled actions or commenced proceedings for SOX 304 violations against 11 different executives. Nine have come in the last five months alone.
Several of the Commission’s recent SOX 304 cases are settled actions involving executives with zero alleged culpability. According to SEC Deputy Director of Enforcement Sanjay Wadhwa, featured at Practicing Law Institute’s annual “SEC Speaks” conference in September, the Enforcement Division views “the Commission’s use of SOX 304 orders against executives who were not charged under any additional provisions” as an “important element” of the recent SOX 304 enforcement actions, with the enforcement theory being that such actions “create[] accountability and establish[] incentives to prevent corporate wrongdoing.”
SEC Enforcement Division Chief Counsel Sam Waldon also has highlighted three key aspects of how the current Enforcement Division is applying SOX 304:
- It is pursuing these cases regardless of whether the CEO and CFO at issue were culpable for the underlying securities law violation.
- The Division views SOX 304 as not “limited by [a] fraud delta,” meaning the SEC intends to seek “the full amount of the reimbursement that is required by the statute” not merely the amount by which the executive’s compensation was allegedly inflated due to the reporting problem.
- It will seek to prevent director and officer insurance policy proceeds from being used to indemnify covered executives for SOX 304 reimbursements.
The Enforcement Division’s increased attention to SOX 304 coincides with the SEC’s recent adoption of a rule that will require exchanges to adopt listing standards requiring issuers to implement a policy regarding the recovery of incentive-based compensation erroneously awarded to current or former executive officers. In certain cases, the rule will require public companies to pursue clawbacks from executives in circumstances even broader than where SOX 304 applies.
DOJ’s Focus on Compensation Clawbacks
Likewise, DOJ recently announced its own initiative to encourage companies to claw back executive compensation. When announcing revisions to DOJ policies regarding corporate criminal enforcement, Deputy Attorney General (“DAG”) Lisa Monaco highlighted individual accountability as a primary focus for DOJ. Among several policy changes, DAG Monaco announced that when evaluating corporate compliance programs for purposes of making charging and settlement decisions, DOJ will now direct prosecutors to assess whether a company’s compensation arrangements promote a culture of compliance. Part of that assessment will evaluate whether a company’s compensation program has been “crafted in a way that allows for retroactive discipline, including through the use of clawback measures, partial escrowing of compensation, or equivalent arrangements.”
There’s more: DAG Monaco instructed that when making charging and resolution decisions, prosecutors “will evaluate what companies say and what they do, including whether, after learning of misconduct, a company actually claws back compensation or otherwise imposes financial penalties.” Shortly after DAG Monaco’s announcement, Principal Associate Deputy Attorney General (“PADAG”) Marshall Miller offered additional color, explaining that: “[a]ll too often [DOJ] see[s] companies scramble to dust off and implement dormant policies once they are in the crosshairs of an investigation.” At that point, PADAG Miller noted, it may be too late: “A paper policy not acted upon will not move the needle—it is really no better than having no policy at all.”
The Criminal Division is expected to release new clawback-related guidance before the end of the year.
How the Recent Clawback Initiatives May Affect FCPA Enforcement
Although the SEC and DOJ both enforce the FCPA, DOJ’s recent clawback initiative is more likely to impact FCPA enforcement. DOJ’s new focus on compensation clawbacks applies more broadly than SOX 304 in two significant ways: First, companies would be expected to implement and enforce clawback provisions that reach a larger swath of executives beyond just the CEO and CFO. Second, these clawbacks would not be limited to financial restatements; they could apply to any and all acts that contribute to criminal conduct—including FCPA violations.
As a practical matter, DOJ will scrutinize an FCPA corporate target’s clawback policies (and practices) when assessing whether to credit the company for a voluntary self-disclosure and/or cooperation. DOJ policy is to condition credit on “timely and appropriate remediation,” which includes, among other things, “implementation of an effective compliance and ethics program,” as well as the “[a]ppropriate discipline of employees.” Justice Manual 9-47.120. Based on the recent announcements, we expect clawbacks to be a particular focus as prosecutors weigh these criteria.
Key Considerations Going Forward
The recent SEC Enforcement Division and DOJ announcements provide an important opportunity for the business community to evaluate, design, and implement an effective clawback policy. As PADAG Miller observed, “[w]hat [DOJ] expect[s] now, in 2022, is that companies will have robust and regularly deployed clawback programs.”
All companies operating in an environment with any meaningful enforcement risk should carefully consider how their own compensation programs and executive employment agreements would fare should the company find itself under DOJ (or SEC) scrutiny. If adjustments are warranted, the recent clawback initiatives could afford employers helpful talking points (and, if necessary, leverage) when dealing with employees whose consent may be necessary to make the change. Separately, for companies seeking to comply with the new guidance, a thornier question may be when to pursue clawbacks. Indeed, companies often find that the cost of pursuing a clawback action can exceed the amount the company may hope to recover. In those cases, companies are faced with the unenviable position of throwing good money after bad. (For public companies, the SEC’s recently adopted clawback regulation, which is beyond the scope of this post, may also affect this analysis.)
