Dodd-Frank Clawbacks: Implement Prior to Final Rules?

According to the SEC's Dodd-Frank rule-making schedule, proposed rules addressing clawbacks will be issued within the January-July 2012 time frame, and final rules will be adopted within the July-December 2012 time frame.  Assuming this time line remains unchanged, a current question is whether some form of clawback policy should be initiated by companies prior to the SEC's issuance of proposed/final rules.  Here are my thoughts:


As background, Dodd-Frank requires national securities exchanges to implement clawback policies (a.k.a., recoupment policies) that are more expansive than current requirements under Section 304 of SOX.  Under Dodd-Frank:

  • The clawback policy must be triggered any time the company prepares an accounting restatement resulting from "material" noncompliance with any financial reporting requirement (in contrast, Section 304 applies only when a financial restatement is "required" and is the result of "misconduct").
  • Once the clawback policy is triggered, it would apply to all incentive-based compensation paid to current and former executive officers (in contrast, Section 304 applies only to the CEO and CFO).
  • The look back period for which incentive-based compensation is subject to clawback is the three-year period preceding the date of restatement (in contrast, the look back period under Section 304 is twelve months).
  • The amount subject to the clawback is the difference between the amount paid and the amount that should have been paid under the accounting restatement.

Issue to Consider until Final Rules are Adopted

Ensuring compliance with the Dodd-Frank clawback requirements is an issue between the company and the applicable exchange (e.g., NYSE), therefore, problems could arise with executives who have contractual rights.  For example, assume a fact pattern where the executive has contractual rights to a benefit that, if paid, would jeopardize the company's listing with NYSE because such payment would violate the Dodd-Frank clawback requirements.  If this fact pattern were to arise, it would create a tug-a-war for the company (i.e., complying with the listing requirements on the one hand, and complying with the executive's contractual rights on the other hand).  However, this issue could be resolved in a simple manner if a contractual arrangement with the executive mandated compliance with the company's Dodd-Frank policy.

Resolutions for the Gap Period

The above issue will resolve itself once proposed and final rules are adopted.  Until then (i.e., the gap period), a company could take the following actions:

  • Do nothing by adopting a wait and see approach.  This may be acceptable if the executives and the board of directors have a warm relationship.  However, if a tug-a-war arises during the gap period . . . .
  • Adopt a short policy that is expected to be amended in a more robust manner once final rules are adopted.  I am in favor of this approach.
  • In conjunction with the above bullet, have executives sign a contractual arrangement under which each executive agrees (as to all then existing and future arrangements) to comply with the Dodd-Frank clawback requirements (when effective) and any clawback policy adopted by the company as such is amended from time to time.  I am in favor of this approach because it is easy and can be accomplished with a one-page document (including signature blocks!!).
  • Adopt a formal and robust clawback policy.  I am less in favor of this approach since proposed rules have not been issued.

An example of a simple policy (referenced in the above second bullet) was adopted by Tractor Supply Company around May 3, 2011, that provides:

"Tractor Supply Company shall seek to recover incentive compensation paid to any executive as required by the provisions of the [Dodd-Frank Act] or any other 'clawback' provision required by law or the listing standards of the NASDAQ Global Select Market."

That policy, if used in conjunction with one-page arrangements that contractually bind the executives, is simple, easy to implement and should protect companies during the gap period.  I am a big fan!