10 Geo JLPub Poly 321

Citation: 10 Geo. J.L. & Pub.
Pol'y 321 2012

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Whose Money Is It Anyway?
Why Dodd-Frank Mandatory Compensation
Clawbacks Are Bad Public Policy
SAM SHARP*
INTRODUCTION .......................................... 321
I. THE RECENT HISTORY OF EXECUTIVE COMPENSATION CLAWBACK
PROVISIONS ........................................
323
A. Company-Adopted Clawbacks Disclosed in Form DEF 14A . 323
B. Sarbanes-Oxley Section 304 ........................ 325
C. TARP Executive Compensation Provisions .............. 329
D. Dodd-Frank Section 954 ........................... 330
II. TIE DIFFERENCES AND SIMILARITIES BETWEEN SARBANES-OXLEY
SECTION 304 AND DODD-FRANK SECTION 954 ................ 331
III. WHY DODD-FRANK SECTION 954 IS MISGUIDED POLICY ........... 332
A. Section 954 Creates Incentives to Limit Performance-Based
Compensation .................................. 333
B. Section 954 Is a Solution in Search of a Problem ......... 333
C. Section 954 Creates Unfavorable Incentives for
Executives ..................................... 335
IV. RECOMMENDATIONS TO THE SECURITIES AND EXCHANGE
COMMISSION .......... ............................... 336
A. Maximize Board Discretion to Select Triggers and Determine
When to Seek Clawbacks .......................... 337
B. Clearly Define Incentive-Based Compensation ........... 339
C ONCLUSION ............................................ 341
INTRODUCTION
In the aftermath of the financial crisis, Congress passed the Dodd-Frank Wall
* J.D. candidate 2012, Georgetown University Law Center; B.A. 2009, University of Cincinnati.
2012, Sam Sharp.
HeinOnline -- 10 Geo. J.L. & Pub. Pol'y 321 2012
322 THE GEORGETOWN JOURNAL OF LAW & PUBLIC POLICY
Street Reform and Consumer Protection Act (the "Act")' on July 15, 2010.
President Obama signed the law into effect just days later on July 21.2 The bill
was a wide-ranging attempt to further regulate the American financial industry,
but several of its provisions have nothing to do with financial regulation and
affect businesses far removed from the financial sector.
3
The Act has been
criticized for its excessive scope by scholars and mainstream commentators
alike.
4
There has even been proposed legislation to repeal the Act in its
entirety.
5
Dodd-Frank's executive compensation provisions are particularly wor-
risome for corporate governance professionals, because the provisions are
revolutionary in their effect on the balance between shareholders and directors
and because the provisions apply to all SEC-regulated companies regardless of
whether those firms had anything to do with the financial crisis. Although the
statute on its face creates concern for corporate board members, there is a grave
potential for even more intrusive regulation because it is unclear how far-
reaching the Act will be until the Securities and Exchange Commission ("SEC")
completes its mandatory rulemaking.
This Note will address the executive compensation clawback provisions in
Dodd-Frank section 954, discuss their potentially devastating impact on pub-
licly traded companies, including their directors and officers, and provide
1. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat.
1376 (2010).
2. Id.
3. See, e.g., id. at 342 (ordering certain federal agencies to establish offices of Minority and
Women Inclusion); id. at 750 (ordering study of carbon markets); id. at 951 (requiring shareholder
vote on executive compensation resolutions for all publicly listed companies). Despite these widely
applicable and unrelated provisions, President Obama said in his signing statement, "unless your
business model depends on cutting corners or bilking your customers, you have nothing to fear from
this reform." Press Release, The White House Office of the Press Secretary, Remarks by the President
at Signing of Dodd-Frank Wall Street Reform and Consumer Protection Act (July 21, 2010), available
at http://www.whitehouse.gov/the-press-office/remarks-president-signing-dodd-frank-wall-street-reform-
and-consumer-protection-act.
4. See, e.g., Alan Greenspan, Op-Ed., How Dodd-Frank Fails to Meet the Test of Our Times,
FINANCIAL TIMES, Mar. 30, 2011, at 9 (warning of Dodd-Frank's "unanticipated adverse outcomes" and
"regulatory inconsistencies whose consequences cannot be readily anticipated"); Steven Bainbridge,
Dodd-Frank: Quack Federal Corporate Governance Round I, in UCLA SCHOOL OF LAW, LAW AND
ECONOMICS RESEARCH PAPER SERIES 10-12 (Oct. 10, 2010), available at http://papers.ssrn.com/sol3/
papers.cfm?abstractid= 1673575. Professor Bainbridge's title makes clear that his article is a fol-
low-up to Professor Roberta Romano's famous 2005 article criticizing Sarbanes-Oxley. See Roberta
Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 Yale L.J. 1521
(2005).
5. House Bill H.R. 87 was introduced on January 5, 2011 by Rep. Michelle Bachmann and reads in
relevant part: "The Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law
111-203) is repealed and the provisions of law amended by such Act are revived or restored as if such
Act had not been enacted." H.R. 87, 112th Cong. (1st Sess. 2011). Senate Bill S. 712 was introduced by
Senator Jim DeMint on March 30, 2011 and reads in relevant part: "The Dodd-Frank Wall Street
Reform and Consumer Protection Act (Public Law 111-203) is repealed, and the provisions of law
amended by such Act are revived or restored as if such Act had not been enacted." S. 712, 112th Cong.
(1 st Sess. 2011). As recognized by lawmakers and business groups, neither bill is likely to become law.
See, e.g., Maya Jackson Randall & Jessica Holzer, Dodd-Frank Foes Adopt New Tactics, WALL ST. J.
(Apr. 7, 2011), http://online.wsj.comarticle/SB10001424052748704013604576248982186837122.html.
[Vol. 10:321
DODD-FRANK MANDATORY COMPENSATION CLAWBACKS
recommendations to the SEC in conducting rulemaking pursuant to section 954.
As discussed below, the clawback provisions are especially deserving of scru-
tiny because, despite the provisions' high level of ambiguity, they apply to all
publicly listed companies and impose the draconian penalty of mandatory
delisting.
6
Part I discusses the recent history of clawback provisions, including
both private and government-imposed provisions. Part II analyzes the differ-
ences between the federal government's two biggest intrusions into corporate
clawback decisionmaking: Sarbanes-Oxley section 304 and Dodd-Frank section
954. Part III offers some criticisms of the clawback provisions in Dodd-Frank,
and Part IV concludes with recommendations to the SEC as it engages in
rulemaking pursuant to Dodd-Frank section 954.
I. TiH RECENT HISTORY OF EXECUTIVE COMPENSATION CLAWBACK PROVISIONS
A. Company-Adopted Clawbacks Disclosed in Form DEF 14A
In general, clawback provisions are contractual agreements between employ-
ees and an employer specifying certain conditions under which the company
can recover previously paid out compensation. Publicly traded companies have
adopted their own clawback provisions to recover compensation from execu-
tives independent of any statutory requirements. These provisions have become
much more common in recent years, and there has been substantial growth
preceding the enactment of Dodd-Frank. A recent study by Equilar, a proxy
research firm, found that approximately 73% of Fortune 100 companies had
clawback policies as of 2009, compared to 18% of those companies in 2006.
7
Usually these provisions are referred to as "bad boy" provisions and specify
certain behaviors, such as leaving the company to work for a competitor, that
will trigger a compensation clawback. There is a tremendous variety among
clawback policies of different companies, and this variety allows boards of
directors flexibility in designing policies specific to the needs of their companies
while also judging the effectiveness of different plans before modifying their
own.
6. Dodd-Frank section 954 applies to any issuer listing any security on a national securities
exchange. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 954,
124 Stat. 1376, 1904 (2010). A "national securities exchange" is an exchange registered as such under
section 6 of the Securities and Exchange Act of 1934. 15 U.S.C. 78f (2010). There are currently
fifteen national securities exchanges registered under section 6(a): NYSE Amex (formerly the American
Stock Exchange), BATS Exchange, BATS Y-Exchange, NASDAQ OMX BX (formerly the Boston
Stock Exchange), C2 Options Exchange, Chicago Board Options Exchange, Chicago Stock Exchange,
EDGA Exchange, EDGX Exchange, International Securities Exchange, The NASDAQ Stock Market,
National Stock Exchange, New York Stock Exchange, NYSE Arca and NASDAQ OMX PHLX
(formerly Philadelphia Stock Exchange). Exchanges, SEC (July 26, 2011), http://www.sec.gov/divisions/
marketreg/mrexchanges.shtml.
7. Press Release, Equilar, Inc., Clawback Policies Get More Clarity in 2009 (Nov. 18, 2009),
available at http://www.equilar.com/company/press-release/press-release-2009/clawback-policies-get-
more-clarity-in-2009.html; see also Stephen Gandel, Can Financial Firms Get Executives to Give Back
Pay?, TimiE (Jan. 27, 2010), http://www.time.com/time/business/article/0,8599,1956081,00.html.
20121
It is unclear whether the mandatory clawback requirements of Dodd-Frank
will end the recent trend of privately agreed upon clawbacks as companies
instead rely on the statute as a substitute for developing their own policies.
What is clear is that there is uncertainty among major companies about whether
their current clawback policies will comply with eventual Dodd-Frank stan-
dards. For example, American Express has a typical pre-Dodd-Frank clawback
policy that recoups compensation when one of 560 covered employees engages
in "detrimental conduct" that "includes but is not limited to termination of
employment for misconduct, working for certain competitors, soliciting Com-
pany customers or employees for a period of time after termination, or disclos-
ing confidential information."
8
This is a standard "bad boy" provision that most
companies include in their compensation agreements with covered employees.
In addition to the standard "bad boy" provision, the American Express board of
directors also has the discretion to clawback:
[P]erformance-based compensation from any executive officer and certain
other members of senior management in those circumstances when: the
payment of such compensation was based on the achievement of financial
results that were subsequently the subject of a restatement; and in the Board's
view the employee engaged in fraud or misconduct that caused or partially
caused the need for the restatement, and a smaller amount would have been
paid to the employee based upon the restated financial results.
9
By combining both the "bad boy" provision and the accounting restatement as a
result of misconduct trigger, American Express has a typical pre-Dodd-Frank
clawback policy that is consistent with enforcing an executive's fiduciary duties
under state law and encompasses conduct that would be covered by the claw-
back provisions in SOX. As robust as the clawback policy appears, the current
policy would still fall short of the Dodd-Frank clawback requirements, dis-
cussed below, because of the misconduct requirement and because American
Express has not provided for a timeframe in which compensation will be subject
to recoupment. The most significant "problem" with the policy is that it gives
the board of directors the discretion to claw back compensation, whereas
Dodd-Frank may, depending on the specifics of forthcoming rules, create a
mandatory clawback. American Express itself acknowledges the uncertainty of
its clawback policy in light of the ambiguities of Dodd-Frank section 954: "In
addition, the Dodd-Frank legislation mandates regulation to add additional
clawback requirements, and the Company will take appropriate steps to imple-
ment the final requirements under this legislation."
'10
American Express is not
alone among major companies facing regulatory uncertainty even though it has
8. American Express Co., Definitive Proxy Statement in Connection with Contested Solicitations
(Form DEFCI4A) 45 (Mar. 22, 2011).
9. Id.
10. Id.
[Vol. 10:321
adopted a comprehensive clawback policy that covers both bad conduct and
accounting restatements. As of 2009, 67.5% of Fortune 100 companies' claw-
back policies included provisions containing both financial restatement and
ethical misconduct triggers."
t
B. Sarbanes-Oxley Section 304
The federal government's first attempt at mandating executive compensation
clawbacks was section 304 of SOX. Looking at the plain language of section
304 is instructive because the text leaves several questions unresolved that
Dodd-Frank section 954 has also left unanswered. Accordingly, it is also
important to look at the case law resolving section 304 ambiguities because the
same outcomes may be reached in future judicial interpretations of section
954.12 SOX section 304 (codified at 15 U.S.C. 7243) provides:
(a) Additional compensation prior to noncompliance with Commission finan-
cial reporting requirements.
If 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, the chief executive
officer and chief financial officer of the issuer shall reimburse the issuer for-
(1) any bonus or other incentive-based or equity-based compensation re-
ceived by that person from the issuer during the 12-month period following
the first public issuance or filing with the Commission (whichever first
occurs) of the financial document embodying such financial reporting require-
ment; and
(2) any profits realized from the sale of securities of the issuer during that
12-month period.
(b) Commission exemption authority
The Commission may exempt any person from the application of subsec-
tion (a) of this section, as it deems necessary and appropriate.
1 3
The SEC has established through case law that only the SEC has the power to
enforce the requirements of SOX section 304, and thus, there is no private right
11. Press Release, Equilar, Inc., Clawback Policies Get More Clarity in 2009 (November 18, 2009)
available at http://www.equilar.con/company/press-release/press-release-2009/clawback-policies-get-
more-clarity-in-2009.html.
12. One important difference between the two statutes is the fact that 304 did not impose any
rulemaking requirement on the SEC in the same way that Dodd-Frank 954 did. To the extent that the
SEC or other parties found unresolved issues in 304, they had to appeal to the judicial branch to fill in
perceived regulatory gaps. Under Dodd-Frank, the SEC has the power, which will be protected by
Chevron, in the first instance to resolve those ambiguities in its own favor without having to risk an
adverse ruling from a court. SEC rulemaking under Dodd-Frank 954 is authorized by 15 U.S.C.
78j-4(a).
13. 15 U.S.C. 7243.
2012]
of action.
14
Because Congress did not explicitly authorize a private right of
action, appellate courts interpreted section 304 by searching congressional
intent for an implied authorization of a private right of action and so far have
found no such authorization.'" Courts have pointed out that Congress did create
private rights of action in other SOX sections but not in section 304. For
example, section 306 provides that "[a]n action to recover profits in accordance
with this subsection may be instituted at law or in equity in any court of
competent jurisdiction by the issuer, or by the owner of any security of the
issuer . .,6 One problem that courts have recognized, but have not had to
resolve, is that if plaintiffs had a private right of action under section 304, then
this right would be coupled with securities fraud suits in which investors would
file suits hoping to "require" a restatement and thus trigger the clawback as the
result
of the successful
suit.
1 7
Under current law, the SEC enforces its section 304 power (1) by seeking a
court order requiring the CEO and CFO to repay compensation, as was the case
in Digimarc, or (2) by seeking a preliminary injunction enjoining defendants
from committing future violations of section 304 when such an injunction
would require the executive to pay back the money promptly to avoid running
afoul of the statute.
1 8
In any event, the shareholders get the same result they
could achieve if they had their own private right of action, except that under
current law, they must wait for the SEC to bring an enforcement action. This
fact underscores the point that shareholders are probably better served by the
company-adopted clawback policies, such as the American Express policy
discussed above.
19
The SEC has also established that because only it has the power to enforce
section 304, private parties cannot settle litigation by releasing CEOs and CFOs
from liability.
20
In Cohen v. Viray, the Second Circuit, at the behest of appellant-
intervenors, including the Department of Justice and the SEC, disallowed a
derivative litigation settlement in which shareholder-plaintiffs released the defen-
dant CEO and CFO from section 304 liability.
2
' The settlement was also
interesting because it attempted to indemnify the CEO and CFO from section
14. In re Digimarc Corp. Derivative Litig., 549 F.3d 1223, 1233 (9th Cir. 2008) ([W]e conclude that
section 304 does not create a private right of action.").
15. Cohen v. Viray, 622 F.3d 188, 193-94 (2d Cir. 2010) ("The statute makes no explicit provision of
a private cause of action for violations of 304. We therefore presume that Congress did not intend to
create one.") (citing Bellikoff v. Eaton Vance Corp., 481 F.3d 110, 116 (2d Cir. 2007)).
16. Digimarc, 549 F.3d at 1230 (citing 15 U.S.C. 7244(a)(2)(B) (2006)) (emphasis added).
17. See Teachers Ret. Sys. of La. v. Hunter, 477 F.3d 162, 188-89 (4th Cir. 2007).
18. See, e.g., Complaint at 43, SEC v. Spongetech Delivery Sys., Inc., No. CV 10-2031 (E.D.N.Y.
May 5, 2010), available at http://www.sec.gov/litigation/complaints/2010/comp21515.pdf.
19. See infra p. 5.
20. Cohen v. Viray, 622 F.3d 188 (2d Cir. 2010).
21. Id. Cohen was a case of first impression on the question of whether shareholders can release
CEOs and CFOs from 304 liability. As the Second Circuit said, "We have not, and indeed no court
has, yet addressed whether by private agreement parties may indemnify a CEO or CFO against liability
imposed by 304." Id. at 193.
[Vol. 10:321
304 liability in subsequent suits brought by third parties.
22
After settlement, the
United States filed objections to the settlement, principally on the grounds that
the settlement (i) limited the remedies available to the government in pending
criminal cases against the individual defendants and (ii) undermined efforts by
the SEC to hold the individual defendants liable for disgorgement under section
304.23 The SEC cited no authority for the proposition that the indemnification
agreement was against the law, and the statute itself certainly does not make
such an agreement illegal.
24
By arguing that the agreement was illegal, the SEC
took away contract authority from the shareholders and the independent mem-
bers of the board, the very parties for whose benefit section 304 was enacted.
These parties sued derivatively on behalf of the company and agreed to the
indemnification provision as part of a complex settlement agreement that,
among other things, required the defendant to purchase above market price
shares in order to provide capital to keep the company from bankruptcy.
25
The
rigid application of section 304 and the decision to void the indemnification
provision honored neither the business judgment of the directors nor the share-
holders' view of their own interests.
SOX section 304 does not require the CEO or CFO to have engaged in
misconduct in order to be subject to a clawback.
26
It is sufficient under case law
that anyone engage in misconduct in order to trigger the section 304 clawback
of the CEO's or CFO's compensation. Since the statute did not make this rule
clear, and because Dodd-Frank is silent on this issue, the SEC's litigation
activity under SOX section 304 is worth closely examining because it provides
hints as to how section 954 may be implemented and enforced.
In Securities and Exchange Commission v. McCarthy, the SEC filed a civil
complaint in 2011 against Beazer Homes' CEO Ian McCarthy to recover
millions of dollars in bonus payments and stock awards that were based on
financial results that had to be restated in 2008 as the result of an SEC
investigation and settlement.
27
The accounting suit for misconduct was a neces-
sary prerequisite for seeking the compensation clawback because of the miscon-
duct requirement in section 304 that does not appear in Dodd-Frank section
22. Id. The settlement provided that "DHB shall indemnify defendants David H. Brooks and Dawn
M. Schlegel, and each of them, against any liability under 304 of the Sarbanes-Oxley Act of 2002
incurred by them, or either of them, in any action brought by a third party under 304, and to pay to
them, and to each of them, an amount equal to any payment made by them, or either of them, to DHB
pursuant to any judgment in any such action."
23. Id. at 191.
24. Brief for Appellee at 17, Cohen v. Viray, 622 F.3d 188 (2d. Cir. 2010) (No. 08-3860-cv), 2009
WL 7481389.
25. Id. at 15.
26. See SEC v. Jenkins, 718 F. Supp. 2d 1070 (D. Ariz. 2010).
27. Robbie Wheelan & Joann S. Lublin, Beazer CEO Will Give Back Incentive Pay in Settlement,
WALL ST. J. (Mar. 4, 2011), available at http://online.wsj.com/article/SB10001424052748703300904
576178694027276166.html.
20121
954.28 In fact, the majority of the SEC's complaint against McCarthy is devoted
to outlining the accounting fraud scheme, and the clawback provision is only
mentioned in the prayer for relief.
29
McCarthy was not implicated in the
accounting fraud, and his only wrongdoing was that he did not reimburse the
company for his bonus and profits from shares of stock. As the complaint stated:
Defendant has failed to reimburse Beazer for the bonuses, incentive and
equity-based compensation or profits from his sale of Beazer stock that he
received or obtained during the statutory time periods established by
[SOX] .... By engaging in the conduct described above, Defendant violated,
and unless ordered to comply will continue to violate, [s]ection 304(a) of the
Act.
30
The SEC complaint asked the district court for an injunction ordering McCarthy
to repay the funds and to disallow any efforts on the part of Beazer or any other
person to indemnify McCarthy.
31
The complaint against McCarthy did not
allege wrongdoing on his part, but the Commission proceeded under section
304 and won a settlement awarding $6.5 million to the company and the return
of tens of thousands of shares of company stock back to Beazer Homes.
32
Although this outcome seems to support the effectiveness of section 304, since
2002 only about ten CEOs or CFOs have had compensation clawed back as the
result of an SEC action.
33
As late as 2008, six years after the passage of SOX,
the SEC had brought only two enforcement actions under section 304 despite
thousands of accounting restatements occurring during that time period.
3 4
28. 15 U.S.C. 7243; 15 U.S.C. 78-j4. In its complaint against McCarthy, the SEC made clear that
the prior suit involved misconduct that necessitated the accounting restatement, thus triggering 304.
Complaint at 2-3, SEC v. McCarthy, No. 1:1l-CV-667-CAP (N.D. Ga. Mar. 31, 2011), available at
http://www.sec.gov/litigation/complaints/201 l/comp-pr2Ol1-61.pdf.
29. Complaint at 2-3, SEC v. McCarthy, No. 1:11-CV-667-CAP (N.D. Ga. Mar. 31, 2011), available
at http://www.sec.govlitigation/complaints/201 I/comp-pr2011-61 .pdf.
30. Id. at 14.
31. Id. at 15.
904576178694027276166.html. Without admitting or denying the SEC's allegations, McCarthy agreed
to reimburse Beazer $6,479,281 in cash, 40,103 restricted stock units (or its equivalent), and 78,763
shares of restricted stock (or its equivalent). This reimbursement represents McCarthy's entire fiscal
year 2006 incentive bonus ($5,706,949 in cash and 40,103 in restricted stock units), $772,232 in stock
sale profits, and 78,763 shares of restricted stock granted in 2006. Steve Quinlivan, SEC Settles
Clawback Claim with Beazer Homes CEO (Mar. 3, 2011), available at http://dodd-frank.com/sec-settles-
clawback-claim-with-beazer-homes-ceo/.
0904576178694027276166.html ("Since Sarbanes-Oxley was enacted in 2002, the SEC has sought to
recover, or claw back funds from about 10 top executives, said James D.C. Barrall, head of the
executive compensation and benefits practice for law firm Latham & Watkins LLP.").
34. Rachael E. Schwartz, The Clawback Provision of Sarbanes-Oxley: An Underutilized Incentive to
Keep the Corporate House Clean, 64 Bus. LAW. 1, 2 (2008-2009).
[Vol. 10:321
C. TARP Executive Compensation Provisions
The Emergency Economic Stabilization Act of 2008 (EESA) and the Ameri-
can Recovery and Reinvestment Act of 2009 (ARRA) included the federal
government's next attempts at mandating clawback provisions on publicly
traded companies.
35
The provisions of the two Acts are contained, as amended,
in 12 U.S.C. 5221. Most relevantly, 5221(b)(3)(B) requires the Secretary of
the Treasury to require TARP recipients to adopt provisions:
[F]or the recovery by such TARP recipient of any bonus, retention award, or
incentive compensation paid to a senior executive officer and any of the next
20 most highly-compensated employees of the TARP recipient based on
statements of earnings, revenues, gains, or other criteria that are later found to
be materially inaccurate.
Before the 2009 amendments, 5221(b)(2)(B) required "a provision for the
recovery by the financial institution of any bonus or incentive compensation
paid to a senior executive officer based on statements of earnings, gains, or
other criteria that are later proven to be materially inaccurate.
37
The changes
clearly show a broadening of congressional desire to apply clawbacks in more
instances against more parties. The legislation originally applied to the top five
most highly compensated employees at a financial institution receiving TARP
funding but was later expanded to include the top five most highly compen-
sated, plus the next twenty most highly paid employees at any TARP recipient
regardless of whether that recipient is a financial institution.
38
Clearly, the TARP clawback provisions were the precursor for the Dodd-
Frank clawback provisions because the wrongdoing element from the SOX
clawback rule is not present, and the scope of the clawback encompasses parties
beyond the CEO and CFO. Furthermore, there is no time period for measuring
the compensation payouts to be clawed back. Another significant change that
shows the bridge between SOX and Dodd-Frank is that the TARP clawback
rules require the companies themselves to adopt internal clawback policies,
rather than having the statute itself provide for the clawback.
Unlike the SOX clawback provisions, there were no legal actions brought to
recoup compensation under the TARP rules. As there are no instances of
executives having compensation clawed back under 5221, the biggest impact
of the statute was to set the stage for the Dodd-Frank clawback provisions. In
fact, the first and perhaps only instance of an executive being forced to forfeit a
35. P.L. 110-343 111, 122 Stat. 3765 (EESA) (codified as amended at 12 U.S.C. 5221); P.L.
111-5 7001, 123 Stat. 115 (ARRA). The ARRA amended the compensation provisions in EESA, and
those amendments are reflected in the current 12 U.S.C. 5221.
36. 12 U.S.C. 5221(b)(2)(B) (subsequently amended).
37. 12 U.S.C. 5221.
38. The definition of "senior executive officer" under 5221 means "an individual who is 1 of the
top 5 most highly paid executives of a public company." 12 U.S.C. 5221(a)(1).
2012]
bonus because it violated TARP rules had nothing to do with accounting
restatements under 5221, and was only triggered because of a bank merger
that involved a TARP recipient with outstanding obligations.
39
The $2 million
clawed back in that instance should not have prompted cheers from government
authorities or shareholders, because the company answered the bonus clawback
by increasing the base salary of the executive by 25%.
4
0 It is entirely foresee-
able that similar rises in base pay will occur as a result of the Dodd-Frank
clawback provisions, thus defeating the purpose of the legislation by severing
the link between pay and performance.
D. Dodd-Frank Section 954
Title IX of the Dodd-Frank Act contains seven sections designed to mandate
various changes in corporate governance matters.
4
' These provisions were
endorsed by public pension funds and shareholder advisory services.
4 2
Section
954 of the Act creates a new section lOD in the Securities and Exchange Act of
1934 and adds the following language:
a. LISTING STANDARDS.-The Commission shall, by rule, direct the na-
tional securities exchanges and national securities associations to prohibit
the listing of any security of an issuer that does not comply with the
requirements of this section.
b. -The rules of the Commission under subsection (a) shall require each
issuer to develop and implement a policy providing-
(1)for disclosure of the policy of the issuer on incentive-based compensa-
tion that is based on financial information required to be reported under
the securities laws; and
(2)that, in the event that 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, the issuer will
recover from any current or former executive officer of the issuer who
39. Zachary A. Mider, Wilmington Trust Reclaimed $2 Million From CEO Foley Because of TARP
Rules, BLOOMBERG (Jan. 4, 2011), http://www.bloomberg.com/news/2011-01-04/wilmington-trust-takes-
back-2-million-from-ceo-because-of-tarp-violation.html.
40. Id.
41. P.L. 111-203 951 (say on pay), 952 (compensation committee independence), 953
(compensation disclosures), 954 (compensation clawbacks), 955 (director hedging disclosure),
956 (compensation structure reporting), 957 (broker voting).
42. Hearing before H. Committee on Financial Services, Subcommittee on Capital Markets, Insur-
ance and Government Sponsored Enterprises, 111 th Cong. (2011) (statement of Gregory Smith, COO
and General Counsel, Colorado Public Employees' Retirement Association). In answering questions
about CERA's support for clawback provisions and what improvements needed to be made in federal
law to strengthen SOX 304, Smith stated, "We don't claim to be able to identify exactly what
compensation should be able to be clawed back in every case. It-that's going to be a company-by-
company determination. And I think it's important to recognize that in none of our reforms that we
asked for legislation to set what compensation's going to be. Set a formula for what compensation's
going to be. Or set a formula for what compensation can be clawed back." 2010 WL 1599545
(F.D.C.H.).
[Vol. 10:321
received incentive-based compensation (including stock options awarded
as compensation) during the 3-year period preceding the date on which
the issuer is required to prepare an accounting restatement, based on the
erroneous data, in excess of what would have been paid to the executive
officer under the accounting
restatement.
43
Major stock exchanges currently do not have rules in place mandating specific
compensation policies such as clawbacks, so Dodd-Frank section 954 creates
entirely new obligations for listed companies.
44
Stock exchange rules reflect the
same principles as state corporate law. Both recognize that directors, not
shareholders or the federal government, are responsible for determining execu-
tive compensation.
45
For example, the Nasdaq compensation committee rules
are "intended to provide flexibility for a Company to choose an appropriate
board structure and to reduce resource burdens, while ensuring Independent
Director control of compensation decisions.
4 6
Some of that flexibility and
control is seriously jeopardized by Dodd-Frank section 954.
II. THE DIFFERENCES AND SIMILARITIES BETWEEN SARBANES-OXLEY SECTION 304
AND DODD-FRANK SECTION 954
The three primary differences between SOX section 304 and Dodd-Frank
section 954 are (1) section 304 only applies to the CEO and CFO whereas
section 954 applies to all current and former executive officers, (2) section 304
requires material noncompliance as a result of misconduct by the issuer whereas
section 954 requires only material noncompliance without a showing of miscon-
duct, and (3) section 304 applies to compensation paid out during the twelve
months preceding the restatement whereas section 954 provides for a much
longer three-year look-back.
47
In all three areas of divergence, section 954
43. 15 U.S.C. 78j-4.
44. The NYSE Listed Company Manual requires companies to have a compensation committee
composed entirely of independent directors, but nowhere does the manual describe the scope or
mandate the substance of compensation decisions made by that committee. NYSE Listed Company
Manual 303A.05. Nasdaq rules also require a compensation committee comprised entirely of
independent directors, but there are no requirements as to what policies those committees must adopt
and enforce. Nasdaq Rule 5605(d).
45. DEL. CODE ANN. tit. 8, 141(h) (2011) ("Unless otherwise restricted by the certificate of
incorporation or bylaws, the board of directors shall have the authority to fix the compensation of
directors,"), 122(5) (The corporation, under the direction of the board of directors, is empowered to
"[a]ppoint such officers and agents as the business of the corporation requires and to pay or otherwise
provide for them suitable compensation."); MODEL Bus. CORP. ACT 8.01 (2007) ("[A]II corporate
powers shall be exercised by or under the authority of the board of directors"), 3.02(11) (Corporation
has power to appoint employees and "fix their compensation"), 6.24 Official Comment ("The creation
of incentive compensation plans for directors, officers, agents, and employees is basically a matter of
business judgment.").
46. Nasdaq IM-5605-6 (Mar. 12, 2009).
47. The look-back period establishes which funds can be clawed back; it is not a statute of
limitations. Courts have decided that SOX section 304 is a statutory "penalty" and thus is subject to a
2012]
clearly intrudes more on board discretion.
4 8
The level of intrusiveness is made
even greater by the fact that the SEC is also empowered by section 954(a) to
engage in rulemaking and to direct the stock exchanges to impose new listing
standards on publicly traded companies.
4 9
SOX section 304 did not provide for
SEC rulemaking, which meant that when the Commission wanted to change
policy or enforcement tactics, it had to seek judicial sanction through litigation.
No such barriers to policy innovation exist under section 954, and the SEC can
be as aggressively direct or unclear as it pleases since ultimately the exchanges,
not the Commission, pass the final rules. Added to this cloud of confusion is the
fact that the SEC does not plan to issue its section 954 rules until well after a
year of the Act's passage.
5
III. WHY DODD-FRANK SECTION 954 Is MISGUIDED POLICY
As discussed above, company-adopted clawback policies are increasingly
common and can be valuable tools for corporate governance. This section does
not argue that clawbacks themselves are undesirable, but that one-size-fits-all
clawback policies can be harmful to corporations and their shareholders. This
belief is based on three hopefully uncontroversial assumptions. First, all things
being equal, it is more efficient for companies to seek capital in the public
market than in the private market. Second, all things being equal, executive
compensation should be based on performance, not paid out in fixed sums.
Third, important company decisions on sensitive matters such as compensation
should be made by the board of directors, not by outside, disinterested parties
such as the federal government. In light of these assumptions, Dodd-Frank
section 954 is misguided policy because it gives private companies an advan-
tage in hiring executives over public companies whose compensation payouts
will be subject to clawbacks due to factors that the executive cannot control.
Dodd-Frank section 954 creates a strong incentive for executives to seek higher
base pay to compensate them for the uncertainty of their incentive-based
compensation and thus weakens the link between performance and pay. Finally,
the rulemaking pursuant to section 954 may strip boards of directors of their
business judgment discretion to decide when and against whom a clawback
five-year statute of limitations under 28 U.S.C. 2462. S.E.C. v. Microtune, Inc., 783 F. Supp. 2d 867,
887 (N.D. Tex. 2011).
48. There are some members of the academic and legal communities who do not think section 954
goes far enough in strengthening the clawback provisions in SOX section 304. See, e.g., Scott
Harshbarger & Goutam U. Jois, Looking Back and Looking Forward: Sarbanes-Oxley and the Future
of Corporate Governance, 40 AKRON L. REV. 1, 29 (2007) (calling for a private right of action for
clawbacks, punitive damages for claims against executives, and application of clawbacks in all cases in
which any securities law is violated, not just financial reporting laws).
49. Pub. L. No. 111-203, 954(a). SOX section 304 permitted the SEC to exempt, by rule, any
issuer from section 304's requirements, but the SEC has not engaged in any rulemaking pursuant to that
section.
50. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act-Upcoming
Activity, available at http://www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml.
[Vol. 10:321
serves the interests of the company and the shareholders, taking into consider-
ation a multitude of factors that government authorities would not consider.
A. Section 954 Creates Incentives to Limit Performance-Based Compensation
Because Dodd-Frank section 954 places incentive-based compensation for
executive officers at risk of clawback regardless of whether those officers
participated in any wrongdoing, such officers are likely to demand some form of
protection from the increased risk and uncertainty surrounding their pay. One
response would be to demand higher base compensation, which would not be
subject to clawback under section 954. The amount of base pay awarded would
be somewhat constrained by the tax deductibility cap in 162(m) of the Internal
Revenue Code, which limits the amount of deductible compensation at
$1,000,000 but exempts performance-based pay from the cap.
5
' One way to
avoid section 954 and the tax consequences of 162(m) would be for execu-
tives to have performance-based pay determined by metrics not covered by
section 954. By its own language, section 954 only triggers clawbacks when
"financial information" subject to SEC reporting requirements needs to be
restated.
52
By way of illustration, suppose a senior executive of McDonald's
demands that his bonus payments be tied to the number of Big Macs sold in
emerging markets. This data need not be disclosed under SEC reporting require-
ments and thus would not trigger a clawback no matter how inaccurate the
internal reporting of such numbers may be. A similar result could occur if bonus
payments were tied to largely subjective factors, such as increases in customer
satisfaction surveys. These examples illustrate both the limited reach of Dodd-
Frank section 954 and the strong incentives that it creates for directors to seek
performance-based pay on metrics that lack transparency to shareholders.
53
In
sum, the less effective the bonus requirements are, the greater the protection
they offer from SEC-imposed mandatory clawbacks. This state of affairs hardly
seems an improvement over existing law.
B. Section 954 Is a Solution in Search of a Problem
Under state contract law, unearned compensation has been successfully clawed
back from executives by shareholders who have brought suits alleging unjust
51. 26 U.S.C. 162(m)(4)(C)(i-iii). It is worth noting that there have been calls in academia to apply
the 162(m) cap to performance based pay as well in order to force boards to limit the size of CEO
compensation. Charles M. Yablon, Bonus Questions: Executive Compensation in the Era of Pay for
Performance, 75 N.D. L. REV. 271, 303 (1999). If Professor Yablon's proposal were adopted, there
would be little reason for a CEO to seek anything other than fixed pay in return for his services, and
therefore the link between pay and performance would be severed.
52. 15 U.S.C. 78j-4.
53. Even if the company is obligated under SEC reporting rules to disclose the metrics in their
Compensation Discussion and Analysis section, the number of Big Macs sold would still probably not
qualify as "financial data" and would not be subject to reporting requirements.
2012]
enrichment.
54
In a leading case that was litigated in Delaware and Alabama, a
CEO was forced to pay back $47 million in bonus compensation after the
company's financials had to be restated.
55
The compensation was clawed back
even though the CEO did not participate in, and was not responsible for, any of
the criminal activities that resulted in the falsification of the financial state-
ments, had paid taxes on the income, made substantial charitable contributions
based on that income, and "otherwise incurred expenses that he cannot now
retrieve.
' 56
Similar unjust enrichment suits are commonly filed and perform the
exact same function as section 954, except that the parties need not wait for the
SEC to bring an enforcement proceeding.
57
In fact, waiting for the SEC to bring
clawback litigation has been a recognized problem under federal executive
compensation law.
58
Following the outcome of Cohen v. Viray, discussed above,
which denied a private right of action under SOX section 304, entire law review
articles were devoted to explaining why there was no cause for concern since
shareholders already had the right to equitable clawbacks under state law.
59
Federal intervention into this area of law is undesirable because it both strikes
at the balance of power between shareholders, employees, and directors that
state law seeks to protect, and it frustrates the states' own attempts to design
regimes that recover erroneously paid compensation when shareholders decide
to challenge those payments. As the Supreme Court has stated, "No principle of
corporation law and practice is more firmly established than a State's authority
to regulate domestic corporations.",
60
The practical effect of section 954 is that it
gives the SEC the power to demand clawbacks in situations where neither
shareholders nor the board would independently seek them and in situations
where state law might not allow them. It is hard to see who is being protected
54. See, e.g., Scrushy v. Tucker, 955 So. 2d 988 (Ala. 2006) (finding unjust enrichment when bonus
payments were paid out in an amount inflated by a "vast accounting fraud").
55. Id.
56. Id. at 1010, 1012.
57. Donald Langevoort, On Leaving Corporate Executives 'Naked, Homeless and Without Wheels':
Corporate Fraud, Equitable Remedies, and the Debate over Entity Versus Individual Liability, 42 WAKE
FOREST L. REV. 627, 644 (2007) ("The unjust enrichment approach seems so easy and straight forward
that we might predict that these kinds of cases should become commonplace against executives after
companies with which they are associated get caught up in a scandal. Indeed these cases are common,
and ongoing litigation now regularly cites these cases (Healthsouth and Scrushy) in efforts to recoup.").
58. Even SEC commissioners have disagreed about when and how to require enforcement staff to
pursue compensation clawbacks under SOX section 304. Kara Scannell, Clawbacks Divide SEC:
Aguilar Pushes Harder Line for Executives at Accused Firms, WALL ST. J. (Aug. 7, 2010), http://
online.wsj.com/article/SB 10001424052748703988304575413671786664134.html. The commissioners
have split along party lines in cases such as Jenkins in which the SEC imposes the clawbacks on CEOs
or CFOs who did not participate in wrongdoing with Republican commissioners opposing the claw-
backs, Democratic commissioners favoring them, and independent Mary Shapiro voting with the
Democrats. Jesse Westbrook, SEC Rift on When to Claw Back Bonus May Leave Policy in Limbo,
BLOOMBERG (Aug. 6, 2010), http://www.bloomberg.com/news/2010-08-06/u-s-regulators-said-to-debate-
when-it-s-appropriate-to-claw-back-bonuses.html.
59. See, e.g., Manning Gilbert Warren Ill, Equitable Clawback: An Essay on Restoring Executive
Compensation, 12 U. PA. J. Bus. L. 1135 (2009-2010); Langevoort, supra note 57.
60. CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 89 (1987).
[Vol. 10:321
by such an intrusion into the internal affairs of the corporation. As one execu-
tive compensation professional has noted, "History is littered with examples of
governments' failure to regulate pay in a way that achieves sensible out-
comes."
6 1
As discussed above, the clear trend is for companies to include clawback
provisions either directly in executive officer contracts or in executive compen-
sation policies that apply to those officers. These provisions are well grounded
in contract law and would be enforceable in court.
6 2
These provisions represent
a "bottom up" approach to reform with "incremental changes in individual
contracts, which then generate a body of law surrounding clawback provisions,
their substance, their interpretation, and their enforcement.,
63
Dodd-Frank sec-
tion 954 interrupts this process by mandating policies, the details of which will
be decided either by the stock exchanges or the SEC itself rather than by the
parties to the actual contracts. It is not sound corporate governance policy to
continually allow the federal government or its designees to decide the rights
and powers of shareholders and directors. This is especially true in situations, as
in the case of compensation clawbacks, in which state law already provides
methods for reaching the policy outcome the federal government deems desir-
able.
C. Section 954 Creates Unfavorable Incentives for Executives
Federal compensation clawbacks are intended to prevent securities fraud and
disclosure misstatements by putting officers on notice that such conduct will
have individual financial costs. As the court in Jenkins said, SOX section 304
"provides an incentive for CEOs and CFOs to be rigorous in their creation and
certification of internal controls by requiring that they reimburse additional
compensation received during periods of corporate non-compliance regardless
of whether or not they were aware of the misconduct giving rise to the misstated
61. Brian D. Dunn, 2009: A Year to Forget? Are There Lessons to be Learned?, in HOT IssuEs IN
EXECUTIVE COMPENSATION 2010, 314 (Practicing Law Inst., 2010) ("Simplistic regulations transfer the
direction of creative energy from growing the business to finding ways to work around wrong-minded
regulations. The bottom line is that we do not want the government as a partner in the design of pay
plans."). Mr. Dunn is the CEO of Global Compensation for Aon Consulting Worldwide.
62. Miriam A. Cherry & Jarrod Wong, Clawbacks: Prospective Contract Measures In an Era of
Excessive Executive Compensation and Ponzi Schemes, 94 MINN. L. REV. 1, 39 (2009). Cherry and
Wong note that these contract provisions are sound in contract law whether they are triggered by
misconduct (the requirement under SOX section 304) or a material misstatement of financial data (the
requirement under Dodd-Frank section 954). These contract provisions are very favorable to sharehold-
ers because if shareholders bring derivative actions under contract law to recover compensation
payments, the pleading burdens on them are much less stringent than under tort law where a fraud
claim would require a showing of scienter, which is often difficult to plead with particularity and prove
at trial. Id. at 40, n. 226. Cherry and Wong are strong proponents of mandated clawback provisions, a
position that has not gone unchallenged. Michael C. Macchiarola, In the Shadow of the Omnipresent
Claw: In Response to Professors Cherry & Wong, 95 MINN. L. REV. Headnotes 1 (2010).
63. Cherry & Wong, supra note 62, at 43.
20121
financials."
64
While this policy makes sense for CEOs and CFOs with direct
access to financial data being generated by their company and who have control
over those who are responsible for such data, other executives are covered by
Dodd-Frank section 954. These executives include some who do not have
access and control sufficient to encourage compliance, thus subjecting their
compensation to clawbacks has no deterrent effect on accounting misstate-
ments.
In fact, the mandatory clawbacks actually create an incentive for employees
not to report potential accounting errors. For example, under the SOX clawback
regime, an executive who discovered accounting problems faced no personal
repercussions for reporting those discrepancies. Under Dodd-Frank section 954,
however, that executive would expose his own compensation to clawback by
reporting the potential accounting problem. This is another example of how
section 954 creates incentives that undermine the very policy goals purportedly
advanced by the legislation.
IV. RECOMMENDATIONS TO THE SECURITIES AND EXCHANGE COMMISSION
The SEC has already begun the process of rulemaking under the other
corporate governance provisions of Dodd-Frank. Considering these proposed
rules is helpful in predicting the final form of the rules created under section
954 since the congressional language authorizing the rulemaking is so similar.
65
To the extent there are still questions to be answered, this Part makes recommen-
dations to the SEC on what the rules should accomplish.
The text of Dodd-Frank section 952 begins in a fashion similar to section
954: "The Commission shall, by rule, direct the national securities exchanges
and national securities associations to prohibit the listing of any equity security
of an issuer .. . that does not comply with the requirements of this subsec-
tion.
' ' 66
Section 952, like section 954, deals with executive compensation and
Congress's order that the SEC direct the national securities exchanges to engage
in rulemaking consistent with Congress's directives. In formulating its rules
under section 952, the SEC took into account similar provisions of SOX, which
it will presumably also do when formulating rules under section 954.67 Even
though section 952 and section 954 both require the stock exchanges to delist
companies that violate these new sections, a crucial difference lies in section
64. SEC v. Jenkins, 718 F. Supp. 2d 1070,1077 (D. Ariz. 2010).
65. The SEC issued its proposed rule under section 952 of Dodd-Frank on March 30, 2011. See
Proposed Rule, Listing Standards for Compensation Committees, available at http://sec.gov/rules/
proposed/2011/33-9199.pdf. Dodd-Frank section 952 creates a new section IOC to the Securities and
Exchange Act of 1934. Section 954 of Dodd-Frank creates the subsequent section 1 OD.
66. P.L. 111-203, 952(a). Section 954 begins, "The Commission shall, by rule, direct the national
securities exchanges and national securities associations to prohibit the listing of any security of an
issuer that does not comply with the requirements of this section." 15 U.S.C. 78j-4.
67. See Proposed Rule, Listing Standards for Compensation Committees 14, available at http://sec.gov/
rules/proposed/2011/33-9199.pdf.
[Vol. 10:321
952's language requiring a cure period. Section 952 reads, "The rules of the
Commission ... shall provide for appropriate procedures for an issuer to have a
reasonable opportunity to cure any defects that would be the basis for the
prohibition (delisting) before the imposition of such prohibition.,
68
No such
cure language exists under section 954, which raises the question of whether the
clawbacks are mandatory under that section, or whether only the creation of
clawback policies is mandatory.
69
The following recommendations address
these types of ambiguities existing in the statute and propose various solutions.
A. Maximize Board Discretion to Select Triggers and Determine When to Seek
Clawbacks
Because the language in section 954 is so vague, the SEC will have ample
freedom to clarify the scope of the clawback provisions and the amount of
board discretion. The SEC's freedom is underscored by the lack of legislative
history regarding section 954.70 The SEC should exercise its freedom to maxi-
mize board discretion in designing and enforcing executive compensation claw-
backs.
In recent years, the largest publicly traded companies have adopted clawback
policies to ensure that compensation does in fact correspond to actual perfor-
mance.
71
Because of the ambiguities and open-endedness in the statutory
language, it is unclear whether these policies will satisfy section 954. The SEC
should take these existing policies into account when designing its rules in order
to minimize the potential disruptions in executive compensation policies and
give deference to privately imposed policies that presumably provide the most
effective policy for the company that enacted them.
Existing clawback policies empower boards to recover compensation paid to
executives in the event of accounting restatements but not all of these policies
comply with all the provisions set forth in section 954. For example, Procter &
Gamble reported in its 2010 DEF 14A filing,
The [compensation] Committee adopted the Senior Executive Officer Recoup-
ment Policy that permits the Company to recoup or "claw back" ... pay-
ments made to executives in the event of a significant restatement of financial
results for any reason. This authority is in addition to the Committee's
authority under [earlier plans] to suspend or terminate any outstanding stock
68. 15 U.S.C. 78j-3(f)(2).
69. Even though no cure language exists in the statute, the major exchanges already have certain
procedures in place that give companies an opportunity to challenge any action to delist their securities.
See, e.g., NYSE Listed Company Manual 801-05; Nasdaq Equity Rules 5800 Series; NYSE AMEX
LLC Company Guide Section 1009 and Part 12.
70. The clawback provisions that were passed in the final Dodd-Frank bill were only included in
previous Senate drafts of the legislation, not in House drafts. There is no mention of clawbacks in
Senate hearings on the Dodd-Frank bill.
71. See, e.g., American Express, Inc., Definitive Proxy Statement (Form Def 14A), 45 (Mar. 22,
2011).
2012]
option if the Committee determines that the participant violated certain plan
provisions. Moreover, the 2009 Plan has a clawback provision that allows the
Company to recover certain proceeds from option exercises or delivery of
shares if the participant violates certain plan provisions.
7 2
Procter & Gamble's recoupment policy also covers former executives and thus
would comply with section 954 in that respect.
7 3
The policy does give the board
discretion to claw back compensation from officers in the event of accounting
restatements, even when those officers did not engage in any misconduct and
thus the policy is in compliance with the new no-fault clawback standard in
section 954 that did not exist in SOX section 304.
v4
By using the word
"permits" though, the policy makes clear that the board has discretion as to
when to seek recovery of paid compensation. The SEC should not pass a rule
that would require companies like Procter & Gamble to recover compensation
in situations in which the board decided it was not in the company's best
interest to do so. The fact that the board is empowered to seek such clawbacks
is enough to satisfy the statutory language in section 954 and the SEC need not
go further.
General Electric is another example of a company that has empowered its
board of directors to recover compensation paid to directors erroneously. GE's
policy gives its board extensive discretionary power to decide how best to
recoup unearned compensation:
If the Board determines that an executive officer has engaged in conduct
detrimental to the company, the Board may take a range of actions to remedy
the misconduct, prevent its recurrence, and impose such discipline as would
be appropriate. Discipline would vary depending on the facts and circum-
stances, and may include, without limit ... (3) if the conduct resulted in a
material inaccuracy in the company's financial statements or performance
metrics which affect the executive officer's compensation, seeking reimburse-
ment of any portion of performance-based or incentive compensation paid or
awarded to the executive that is greater than would have been paid or awarded
if calculated based on the accurate financial statements or performance met-
rics; provided that if the board determines that an executive engaged in
fraudulent misconduct, it will seek such reimbursement.
75
GE's policy satisfies parts of section 954 since it uses the same clawback
measurement standard, the difference between compensation actually paid and
compensation that should have been paid based on the restated financials, as
72. Procter & Gamble, Definitive Proxy Statement (DEF 14A) (Aug. 27, 2010).
73. See Procter & Gamble, Quarterly Report (Form 8-K) ex. 99 (Dec. 15, 2006); 15 U.S.C.
78j-4(b).
74. See 15 U.S.C. 7243.
75. General Electric, Definitive Proxy Statement (DEF 14A) (Mar. 5, 2010).
[Vol. 10:321
does Dodd-Frank section 954.76 The policy uses the same discretionary and
enabling language as does P&G's but fails to specify that the policy covers
former executive officers. The policies of both P&G and GE also fail section
954 because they do not provide for the same three-year look-back specified in
the statute. Both the look-back shortcoming and the former executive shortcom-
ing can be easily remedied to come into compliance with section 954, and the
SEC should specify a clear timeframe in which companies should become
compliant with the new exchange rules.
Wal-Mart's executive compensation clawback is a good example of how
companies have been innovative in designating what types of conduct will
trigger a clawback. Wal-Mart's policy states,
Our cash incentive plan provides that, in order to be eligible to receive an
incentive payment, the participant must have complied with our policies,
including our Statement of Ethics, at all times. It further provides that if the
[compensation committee] determines, within twelve months following the
payment of an incentive award, that prior to the payment of the award, a
participant has violated any of our policies or otherwise committed acts
detrimental to the best interests of our company, the recipient must repay the
incentive award upon demand. Similarly, our 2005 Stock Incentive Plan
provides that if the [compensation committee] determines that an Associate
has committed any act detrimental to the best interests of our company, he or
she will forfeit all unexercised options and unvested Shares of restricted stock
and performance shares.
77
By requiring its executive officers to comply with its Statement of Ethics,
Wal-Mart has selected a trigger that goes above and beyond the SOX section
304 trigger and that mandates that officers rigorously monitor their own con-
duct. Innovative triggers such as Wal-Mart's support the proposition that the
SEC should initiate rules that give maximum freedom to corporations in
deciding what events will constitute grounds for recovery of compensation. To
ensure that clawback policies have some teeth, the SEC should adopt rules
specifying a trigger at least as rigorous as provided in SOX section 304, while
still allowing companies to go above that standard when they determine that
their goals and objectives are best met by imposing more rigorous standards of
conduct on their executives.
B. Clearly Define Incentive-Based Compensation
Section 954 requires that only "incentive-based compensation" be recouped
by companies. Therefore, determining what specific forms of compensation fall
into that category will be crucial both for the design of compensation plans
76. See 15 U.S.C. 78j-4(b).
77. Wal-Mart, Definitive Proxy Statement (DEF 14A) (Apr. 19, 2010).
2012]
going forward and for the enforcement of section 954.78 The statute does not
define this term other than to expressly include stock options.
79
The easiest and
most regulatory-consistent way of defining "incentive-based compensation"
would be to borrow the definition from Regulation S-K, Item 402(a)(6)(iii),
which defines an "incentive plan" as "any plan providing compensation in-
tended to serve as incentive for performance to occur over a specified period,
whether such performance is measured by reference to financial performance of
the registrant or an affiliate, the registrant's stock price, or any other perfor-
mance measure."
80
That definition should be applied when determining what
compensation is subject to clawback, except that incentive-based compensation
must be based on "financial information" under section 954, so that compensa-
tion whose amount is determined by references to metrics such as market share
or customer satisfaction levels would not be subject to clawback.
The most important consequence of using this definition would be to exclude
discretionary bonuses from being subject to clawback. Since those bonuses are
already discretionary and may not be directly tied to financial information,
subjecting them to the Dodd-Frank clawback rules would be an impermissible
broadening of the statute. Such discretionary bonuses appear in column D of the
Summary Compensation Table required to be disclosed under Regulation S-K,
Item 402(c)(2)(iv) and not under the incentive-based columns.
81
Using the
Summary Compensation Table as a guide for clawback purposes, only compen-
sation in the "non-equity incentive plan compensation" column should be
subject to clawback since that column includes "the dollar value of all earnings
for services performed during the fiscal year pursuant to awards under non-
equity incentive plans as defined in paragraph (a)(6)(iii) of this Item, and all
earnings on any outstanding awards.
82
To capture equity awards, rulemaking
under section 954 should also reference compensation disclosed on the "Grants
of Plan-Based Awards" table in the "Estimated Future Payouts Under Equity
Incentive Plan Awards."
8 3
That column discloses "the number of shares of
stock, or the number of shares underlying options to be paid out or vested upon
satisfaction of the conditions in question under equity incentive plan awards
granted in the fiscal year ....
84
Using these two reference points in the
Executive Compensation Discussion and Analysis section simplifies and mini-
mizes the cost of compliance with section 954 by referencing data that issuers
already provide and already use as a basis for compensation. The information
disclosed in those two columns certainly meets the definition of "incentive-
78. 15 U.S.C. 78j-4(b)(2) (1934).
79. Id.
80. Regulation S-K, Item 402(a)(6)(iii).
81. Id. at 402(c)(2)(iv).
82. Id. at 402(c)(2)(vii)
83. Id. at 402(d)(1).
84. Id. at 402(d)(2)(iv).
[Vol. 10:321
based compensation," and the SEC should seek to shoehorn other forms of
compensation into that definition.
CONCLUSION
There is no doubt that Dodd-Frank section 954 will have serious conse-
quences on compensation payouts and compensation committee decisionmak-
ing. Even as the number of accounting restatements has decreased in recent
years, if Dodd-Frank section 954 were in place in 2009, executive officers at up
to 674 companies would have been subject to the clawback provisions.
85
These
provisions certainly serve a useful purpose, and private parties should be
applauded for enacting them as part of their efforts to keep management
accountable and properly incentivized. The benefits of clawbacks aside, any
policy that is worthwhile when privately agreed upon loses some of its value if
it is mandated by a governing authority, because worthwhile bargaining does
not take place between the private parties such that the policy can be sure to
meet the individual needs and circumstances of specific companies. Because the
needs of individual companies vary based on size, growth potential, shareholder
number and sophistication, and any number of the myriad other factors, top-
down, one-size fits all corporate governance policies should be avoided when-
ever possible in favor of internal governance. In situations like compensation
clawbacks, where Congress has found a need for action but has not detailed the
specifics of any policy, the regulations enacted by administrative agencies
should be as deferential as possible to the business judgment of the parties
tasked with actually enacting the policies, and flexibility should always be
protected such that companies can truly act in the best interests of their
shareholders without fear of government reprisal. There will be situations in the
post-Dodd-Frank future in which the temporal, opportunity, financial, and em-
ployee relations costs of a compensation clawback will outweigh the amount of
potential recovery. In those situations, it makes business and practical sense for
the board of directors to have the final say on whether to claw back compensa-
tion because the company and its shareholders have actual interests at stake,
whereas the government has none.
85. Audit Analytics, 2009 Financial Restatements: A Nine Year Comparison, 1 (Feb. 2010), avail-
able at http://www.complianceweek.com/s/documents/AARestatements20lO.pdf. In 2009, the aggre-
gate dollar value of net income restatements for Amex, Nasdaq, or NYSE listed companies was
$1,072,908,261, which is a large pool of revenue on which to base incentive compensation. Id. at 14.
2012]

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