Alert 01.27.23
SEC Enforcement: 2022 Year in Review
On the heels of record-breaking enforcement in 2022, expect continued aggressive pursuit of Chair Gensler’s priorities in 2023.
Alert
03.07.23
On March 2, 2023, Deputy Attorney General (DAG) Lisa Monaco announced a new Criminal Division policy for Department of Justice (DOJ) prosecutors to consider the implementation of compensation clawback policies as an important factor in corporate criminal resolutions. This policy is aimed at incentivizing both public and private companies to incorporate clawback clauses into contracts and compensation policies for employees, officers and directors.
As a result, companies may want to consider their response to the new DOJ policy in risk management and compliance planning, and coordinate with human resources, outside counsel and boards of directors to plan the process of updating agreements and policies. State-level and, where relevant, non-U.S. employment laws can create challenges and even impediments to the clawback policies envisioned by the DOJ, requiring a careful assessment depending on the location of companies and key executives/directors.
Further, in the event of potential criminal activity, companies and their counsel will need to have a clear understanding of executive compensation policies, and how they function within the bounds of state and non-U.S. employment law, when approaching federal prosecutors for settlement discussions.
DOJ Clawback Policy
The new Criminal Division clawback policy announced by DAG Monaco was expanded upon by Assistant Attorney General (AAG) Kenneth Polite on March 3, 2023. It is designed to shift the burden of corporate wrongdoing away from shareholders, who may play no role in the misconduct, onto the employees, officers and directors who are directly responsible. The program has two key components:
AAG Polite stated that companies can receive credit by way of fine reductions for compensation successfully clawed back during the resolution term. Even if a company is unsuccessful in clawing back compensation but can show a good faith effort by the time their resolution ends, companies can receive a fine reduction for up to 25% of the value of the compensation sought to be clawed back. Recognizing that clawback actions may be costly, DOJ expects that companies will assess the potential cost to shareholders and prospect of success of clawback litigation in the context of their corporate policies on executive compensation in determining if recoupment is appropriate.
Justice Manual section 9-28.800 (“Principles of Federal Prosecution of Business Organizations—Corporate Compliance Programs”) was updated with reference to compensation-incentive principles, including those of the clawback policy. The pilot program for the clawback policy will be in effect for three years, during which time DOJ will gather data on the effectiveness of the program and allow for recalibration of the program based on outcomes.
This week’s announcements reflect the implementation of a policy previewed in a September 15, 2022 memorandum, titled “Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group,” (the “Monaco Memo”).
Interaction with SEC Enforcement and Existing Clawback Policies
The DOJ’s focus on compensation clawbacks parallels increasing SEC activity. As a result, public companies face an implementation landscape with multiple regimes under different legal authorities, all focused on compensation and the ability to claw it back under appropriate circumstances.
Publicly traded companies have faced the prospect of clawbacks for over two decades, but with a focus on financial restatements and, until recently, a perceived lack of enforcement. Section 304 of the Sarbanes-Oxley Act (SOX), enacted in 2002, permits the SEC to order the disgorgement of bonuses and incentive-based compensation earned by the CEO and CFO in the year following a financial restatement due to misconduct. In the years immediately following its enactment, the SEC has limited its use of the SOX Section 304 clawback provision. However, under SEC Chairman Gary Gensler’s leadership, the SEC has increasingly pursued SOX Section 304 actions, including high profile settlements in 2021 and 2022.
More recently, the (long-awaited) final clawback rulemaking mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) and issued in October 2022 requires listed companies to adopt, enforce and disclose more expansive clawback policies that apply to all executive officers (not just the CEO and CFO) and cover “erroneously awarded” incentive-based compensation following from an accounting restatement—whether or not caused by misconduct.
The DOJ enforcement policy provides a further incentive driven by risk management and a broader scope. While DOJ goals are clear, there is a question of whether and how the new DOJ policy will spur public companies to adjust existing clawback policies to cover criminal conduct unrelated to financial reporting, and to claw back non-incentive based compensation.
Public companies have demonstrated a willingness to voluntarily adopt clawback policies in response to pressures from proxy advisory firms and investors or to signal a commitment to good governance. Even before the final adoption of the Dodd-Frank clawback rule, ISS Corporate Solutions data from 2022 shows that more than 90% of companies in the S&P 500, and over 50% of companies in the Russell 300, had adopted clawback policies covering both cash and equity incentive compensation. There has also been a continuing trend in recent years of clawback policies covering misconduct unrelated to financial reporting, such as behavior resulting in reputational harm to the company (including unethical business practices or #MeToo harassment), and breaches of noncompetition obligations (as discussed in this client alert).
A key consideration for public companies seeking to take advantage of the DOJ guidance will be whether to incorporate these guidelines into the company’s SEC-mandated clawback policy, or adopt a separate policy on criminal behavior. The latter approach may be more desirable for the following reasons:
From the perspective of the DOJ policy, there is a particular focus on the plans being actionable, as the DOJ clawback policy rewards successful clawback efforts and credible attempts.
Not Just for Public Companies – Clawback for Private Businesses
The DOJ clawback policy applies broadly to companies that may have criminal violations subject to U.S. jurisdiction and is not limited to public companies. For private companies that have not been exposed to the SEC rules and statutes discussed above, clawback policies will present a new challenge. However, similar to public company shareholders, private owners—including high-net-worth individuals and funds—may have limited input into the operational decisions of a company that give rise to criminal violations. These owners might view the implementation of clawback policies as another tool to manage risk for their investment.
Employment Laws
State wage and hour laws will create a challenge for companies seeking to implement clawback mechanisms. Employment laws in various jurisdictions outside the United States also provide protections for employees. Thus, companies interested in adopting criminal-conduct-focused clawback policies will need to take into account these laws in adjusting their compliance and compensation programs.
State wage payment laws impose varying degrees of restrictions on an employer’s ability to make withholdings from their employees’ wages and use different definitions of “wages.” For example, California law broadly defines “wages” to include all amounts for labor performed by employees of every description, including bonuses and incentive compensation (but not stock options) and prohibits an employer from collecting or receiving any part of wages previously paid (unless such clawback is required by law). Similarly, New York law tightly circumscribes the circumstances under which employers can withhold from their employees’ pay and broadly defines wages, but New York courts often conclude that discretionary bonuses are not wages.
Given the DOJ policies take the form of settlement incentives, the program is unlikely to preempt state law, and companies must carefully review applicable state wage and hour laws and draft their clawback provisions, policies and procedures in compliance therewith.
Implications for White Collar Enforcement
According to DOJ, the new initiative aims to ensure more consistent compliance and clawback practices across industries and among both private and public companies. For companies and their attorneys, the incentives presented by the DOJ, the complex compensation policies at larger companies, and limitations that may exist under state or non-U.S. employment law will present coordination challenges.
Compliance professionals and outside counsel specializing in white collar fields will need to better understand compensation policies and employment laws at the state and federal level. And companies and their counsel will need to be in a position to explain this interplay when approaching federal prosecutors in the event a company discovers potential misconduct.
The DOJ has expressed some understanding of these challenges. For example, AAG Polite stated that companies can take into account the possibility of success in efforts to recoup employee/executive compensation, and that the DOJ does not want to incentivize waste. Thus, a company may determine that risk management weighs in favor of clawback policies, but could determine that seeking clawback from an employee in a given state may not be feasible. The existence of the policy and best efforts still can be taken into account favorably by prosecutors.
Clawback compliance policies are expected to reflect an evolving new best practice for private and publicly traded companies, and companies can watch for further DOJ guidance and practical lessons from published settlements.