The Department of Justice’s newly launched compensation and clawback pilot program is certain to bring with it numerous implementation hurdles and jurisdictional challenges, but it also incentivizes companies to have in place a bulletproof clawback policy. Overcoming the legal and compliance hurdles can mean the difference between a policy that is enforceable, and one that is not.
“Every corporate resolution involving the Criminal Division will now include a requirement that the resolving company develop compliance-promoting criteria within its compensation and bonus system,” Deputy Attorney General Lisa Monaco said in remarks formally announcing the pilot program in early March.
The pilot program aims to encourage ethical behavior through the use of clawbacks. “Companies should ensure that executives and employees are personally invested in promoting compliance—and nothing grabs attention or demands personal investment like having skin in the game, through direct and tangible financial incentives,” Monaco said.
Implementation hurdles
While well-intentioned, the pilot program is potentially fraught with legal and compliance challenges for any company that finds itself in settlement talks with the Criminal Division. Josh Alloy, labor and employment counsel at Arnold Porter, said that part of the challenge for companies is the pilot program is a policy, not a law, which could make enforcing a clawback policy more difficult for companies.
One key factor for how easily enforceable a clawback policy will be will depend on whether the clawback concerns a former employee or a current employee. A second related factor will depend on whether the company is trying to claw back compensation already paid—like salary and annual bonuses—or vested or unvested shares that get paid out at some future date.
“It’s always easier to try contest paying compensation out than it is trying to get compensation back from a departed executive,” said Peter Spivack, a partner in the Litigation, Arbitration, and Employment practice at Hogan Lovells.
“With respect to current employees, the employer has a lot more leverage,” Alloy said. For example, in addition to the prospect of continued employment, a company can reduce compensation, offset against future bonuses, or effectuate forfeitures of incentive compensation or equity paid.
U.S. jurisdictional challenges
Within the United States, numerous compensation laws on both a federal and state level also create legal and compliance hurdles for clawing back compensation. At the federal level, Section 954 of the Dodd-Frank Act directs stock exchanges to establish listing standards requiring publicly listed companies to develop and implement a clawback policy providing for the recovery of, in the event of a financial restatement, erroneously awarded incentive-based compensation received by current or former executive officers. In October 2022, the Securities and Exchange Commission (SEC) adopted final implementation rules.
The SEC’s rule is not as broad as the DoJ’s pilot program, however, as it applies only to publicly traded companies and only in the event of a financial restatement, in which an executive officer received incentive compensation for a percentage of profits gained through fraudulent means.
U.S. state wage-and-hour laws must also be considered in structuring or revising a clawback policy. Spivack said a big question depends on how each state defines “wages,” because employee wages cannot legally be clawed back. California, Massachusetts, New Jersey, and New York are all examples of states with strict employee wage protections in place. Where legal uncertainty could arise is when an employer offers a bonus plan or option grants, for example, that are not clearly discretionary on the part of the employer, he said.
Foreign jurisdictional challenges
Multinational companies with operations all over the world that find themselves engaging in settlement talks with the Criminal Division could face even more jurisdictional challenges. This is because many countries outside the United States—such as France, Germany, Brazil, and China—have employment laws that restrict or altogether prohibit compensation clawbacks.
“The biggest challenge is complying with the various, different national laws that would apply to a multinational company,” Spivack said. A multinational company might have an executive in a non-U.S. country who may be treated differently than a similarly situated executive in the United States from a compensation clawback standpoint, because of what the law requires in that particular jurisdiction, he noted.
“If you’re focusing on deferred compensation, if you’re focusing on compensation contingent on future financial performance, and if you have contract clauses that allow for deferred compensation to be rescinded for bad or unlawful or contrary to policy behavior, those are the types of provisions that need to be built in, and apply across the world,” Spivack added.
In public remarks, Assistant Attorney General Kenneth Polite acknowledged many of these challenges. “We recognize the difficulties companies may face when attempting to claw back compensation,” Polite said.
That is why companies that pursue clawbacks from corporate wrongdoers in good faith, even if unsuccessfully, will still be eligible to receive a fine reduction of “up to 25 percent of the amount of compensation that has been sought,” Polite explained. The company may also keep the clawback money it recouped.
Compliance takeaways
The pilot program will be in effect for three years to allow the DoJ time to assess its effectiveness. Because the program is still in its early stages, the DoJ hasn’t provided much in the way of guidance yet.
“I think there is a bit of a waiting game right now to see if the DoJ will provide more guidance as to what exactly it might be looking for,” Alloy said. “Some companies might not feel it is necessary or prudent at this time to go beyond what Dodd-Frank or the Sarbanes-Oxley Act requires.”
Nonetheless, it is in a company’s best interest to think holistically and proactively about the structure and scope of a written clawback policy, especially one pertaining to both U.S. and non-U.S. jurisdictions. “It’s important to have a clearly drafted, well-thought out, written policy, with signed acknowledgement from the employee agreeing to it,” Alloy said.
Alloy advised carefully considering who the policy is going to cover. “Just officers? All senior employees above a certain level? All supervisory employees? All sales employees?” Another potential provision of an effective clawback policy is to tie misconduct to sales commissions.
Finding the right person or group within the company to oversee and administer the policy is also important. “With larger, publicly traded companies, we would typically advise that it be administered and overseen by a committee of the board with advice of legal counsel,” Alloy said.
“If a company has to try to enforce this provision—whether a clawback or forfeiture of equity or incentive compensation—it is probably going to lead to litigation if the amount is significant enough,” Alloy noted. Thus, consider whether to build mandatory arbitration into a clawback or forfeiture policy, and whether to include a provision requiring payment of legal fees and expenses if the company succeeds in its case, which may deter some employees from challenging a forfeiture or clawback decision, he said.
Spivack recommended having contract clauses that allow all, or part, of deferred compensation to be rescinded in the event of misconduct.
There are also non-contractual remedies available to companies. In some states, courts have recognized the “faithless servant doctrine,” which states that companies can recover compensation paid to employees who engaged in serious acts of disloyalty that caused significant harm to the company, Alloy said.
The message from the DoJ is, “‘We want you to try. We want you to do what you can. We certainly understand there is a probability that you won’t be able to achieve this,’” Spivack said. What matters, what the DoJ is focused on, is the overall good-faith effort on the part of companies.
This topic and more will be covered at ACI’s 40th International Conference On the FCPA this November In Washington DC. For More Information, please go to: www.FCPAconference.com.
