In 2015, the SEC proposed rules implementing Dodd-Frank’s requirement that all listed companies adopt and administer a compensation clawback policy. Under the statute, these policies must require, in the event of an accounting restatement, the recoupment of all incentive-based compensation that would not have been paid but for the error giving rise to the restatement. Although the SEC has yet to finalize rules implementing this provision, many companies have voluntarily adopted their own policies in response to investor and regulator expectations. In certain industries, such as the financial industry, it is common for companies to adopt policies that go beyond what is required by Dodd-Frank. Many voluntary clawback policies apply in misconduct absent a restatement. However, the majority of voluntary policies provide the board or compensation committee with discretion as to whether to recoup compensation in any situation. For example, according to Shearman & Sterling LLP’s 15th Annual Survey of the Top 100 U.S. Companies, 70 of the 90 companies that maintain clawback policies retain the discretion as to whether to seek enforcement.

Companies deciding whether to recoup compensation already earned and paid must consider the time and expense of potential litigation (especially when the subject employee has left the company), as well as Section 409A of the tax code, which limits the use of nonqualified deferred compensation to offset current obligations. Further, companies must consider the effect of the adoption and application of a robust clawback policy on recruitment efforts. As a result, it is rare for companies to actually exercise their rights under voluntary recoupment policies. 

Regardless of the practical reasons for resisting a clawback, the failure to recoup compensation may lead investors to question a board’s dedication to corporate governance principles. The board of at least one company, United Continental, is facing a shareholder suit alleging a breach of fiduciary duties for failure to recoup compensation previously received by the CEO following his departure in the wake of a bribery scandal. In addition, in their initial complaint, the plaintiffs demanded that United Continental amend its clawback policy to provide the board with the “discretion to recoup [employee] compensation whenever the board determines misconduct, willful or otherwise, has occurred.” In moving to dismiss the case, United Continental has argued that the proposed changes to the clawback policy are inconsistent with industry practice and would put them at a disadvantage when trying to recruit top talent. 

In light of the difficulty of recouping compensation, companies should consider what we refer to as the quasi-clawback, or the forfeiture of amounts that have not yet been earned, or have been earned but not yet paid. The following are ways in which companies can implement quasi-clawback features in their compensation programs:

• Forfeiture of unvested incentive based compensation. Compensation committees should consider retaining the discretion to reduce or eliminate target amounts of unearned incentive compensation upon uncovering behavior by an employee warranting such reduction or elimination. 
• Deferred payment of earned incentive-based compensation. Once performance-based compensation has been earned (i.e., the targets have been achieved), consider delaying payment for a period of time to ensure there was no inappropriate risk-taking in earning the compensation. Upon discovery, the compensation can be forfeited without the need for a clawback.
• Forfeiture of nonqualified deferred compensation. Although Section 409A of the tax code prohibits the use of nonqualified deferred compensation to offset current obligations, forcing a forfeiture of otherwise vested but deferred compensation can be utilized as a form of punishment for so-called “bad actors.” This type of provision may be the most troubling from a recruitment standpoint as it places a portion of retirement savings at risk.

Compensation committees are faced with the difficult task of ensuring their incentive compensation programs do not reward inappropriate risk-taking. While the adoption of recoupment provisions is a favored preventive measure, it can be impractical to actually enforce a clawback. As a result, forfeiture provisions, or quasi-clawbacks, should be considered to supplement formal clawback policies.