Executive pay clawback clauses have become more common following the financial crisis of 2008 since they allow companies to recover incentive pay from executives in the event of misconduct, fraud, scandal, poor performance, or a drop in company profits.
Clawbacks Under Sarbanes-Oxley and Dodd-Frank
The Sarbanes-Oxley Act of 2002 mandated an executive compensation clawback rule that covered CEOs and CFOs, but did not apply to other high level executives. That rule specified that executives would have to return incentive pay to the company if their misconduct resulted in a restatement of the company’s financial results.
The Dodd-Frank Act of 2010 expanded the use of executive clawbacks. Even though 11 years have passed and the SEC has still not issued final rules on clawbacks under Dodd-Frank, many employers have added them to their executive compensation packages. Unlike Sarbanes-Oxley, the Dodd-Frank executive clawback rules specify that executive misconduct is not a prerequisite for a clawback, and that both current and former executives are subject to a three-year time limit from the date of a material accounting restatement to return incentive pay to the company.
Tax Complications
Highly paid company executives often have individual tax rates that can be as high as 40-50%, and the tax laws regarding the treatment of repaid compensation are complex once an executive has reported the compensation as part of their taxable income in a previous year. Under IRC Section 1341, individuals can receive a deduction or tax credit for repaid compensation, but only under certain circumstances.
Company Risks
Applying a clawback provision can be challenging for companies. For example, in October 2020, Goldman Sachs announced that it would utilize clawbacks to recover $174 million from current and former executives based on its $2.9 billion settlement of claims arising from the 1Malaysia Development Berhad bribery scandal in 2015. While Goldman has been able to recover some funds from current executives, those that left the firm have yet to return any money.
In addition to the difficulty in recovering incentive payments, companies that decide to sue former executives may be required to advance the necessary legal fees to pay for a former executive’s defense since the lawsuit would have arisen from their work as executive officers of the company.
While employers may hope they never have to use them, having clawback policies in place allows companies to take appropriate action in certain circumstances. You don’t want to be the company whose executives misbehave, draw a huge amount of negative press, and then walk away with their golden parachute intact. Clawback provisions are another way to incentivize executives while ensuring their behavior never strays beyond your company’s core values.
HBL has experience in all areas of benefits and employment law, offering a comprehensive solution to all your business benefits and HR/employment legal compliance needs. We help ensure you are in compliance with the complex requirements of ERISA and the IRS code, as well as those laws that impact you and your employees. Together, we reduce your exposure to potential legal or financial penalties. Learn more by calling 678-439-6236.
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