By: Thomas E. Holber
This blog post will compare and contrast recent claw-backs of executive compensation in England with statutory remedies available under United States securities laws.
This February, two British financial institutions, Lloyds Banking Group and HSBC, made headlines by announcing “claw-backs” of previously awarded executive bonus compensation. A claw-back eliminates the award and returns the money to the bank. It is not known at this time how the financial institutions determined that a claw-back was appropriate in these cases. Presumably, each of the claw-backs was facilitated by employment agreement provisions.
Each of the compensation claw-backs was preceded by the financial institution’s exposure to a scandal. After the discovery of a consumer fraud scandal, Lloyds Banking Group stripped its former CEO and a number of current and former directors of a portion of 2010 deferred bonus compensation, totaling £2m in aggregate. The former CEO’s bonus award was reduced by 40 percent. Four executive directors’ bonus awards were reduced by 25 percent. Eight lower-seniority directors’ bonus awards were reduced by 5 percent. Lloyds also issued a press release, stressing that the “decision is based entirely on the principle of ‘accountability’ and in no way on culpability or wrong-doing by the individuals concerned.” HSBC was also involved in a consumer fraud scandal. The bank was fined by the FSA, Britain’s financial regulator, £10.5m and ordered to pay £29.3m in restitution for its involvement in defrauding the elderly between 2005 and 2010. The size and scope of its claw-backs are not yet known. One source indicates the claw-backs will be on a smaller scale than those of Lloyds.
Domestic security laws also provide for executive compensation claw-backs through provisions of Sarbanes-Oxley and Dodd-Frank.
Sarbanes-Oxley §304 applies to the current CEO and CFO of ’34 Act filers and liability depends on “misconduct” resulting in material noncompliance with financial reporting requirements under securities laws. Liability for misconduct may not require a showing of scienter. SEC v. Jenkins, 718 F.Supp.2d 1070 (D. Ariz. 2010) held that issuer misconduct related to the issuer could be imputed to its top executives. Damages under §304 includes all incentive compensation received for twelve months after the earlier of filing financial documents with the SEC or making such disclosures publicly. Damages can also include any profits from the sale of those securities.
Dodd-Frank §954 applies to certain “control persons,” essentially current or former executive officers of ’34 Act filers (although it is more complicated than that), and liability depends on the re-filing of financial documents due to material noncompliance with securities laws. Damages under §954 look to the three years preceding the date of the restated financial documents and are based on the excess of actual compensation over hypothetical compensation if a misstatement had not been made. §954 implementation via the SEC rulemaking process is still ongoing.
Comparing and contrasting the claw-back provisions under domestic law is constructive. Dodd-Frank §954 and Sarbanes-Oxley §304 each seem to provide for claw-backs without a necessary showing of scienter or fault. Dodd-Frank §954 reaches a broader class of executives and also covers former executives. Sarbanes-Oxley §304 encompasses up to 100 percent of incentive compensation, while Dodd-Frank §954 is not limited based on compensation type, but only encompasses hypothetical excess compensation.
Comparing and contrasting the available remedies under domestic law with the claw-backs recently announced at Lloyds Banking Group is also instructive. The claw-backs at Lloyds may have covered a class of executives even beyond those covered by Dodd-Frank §954. The compensation reduction at Lloyds was, like Sarbanes-Oxley §304, limited to bonus compensation. Finally, the claw-back was a reduction of previously awarded deferred bonus compensation, rather than a full elimination of incentive compensation as Sarbanes-Oxley §304 provides.
However, assuming the recently announced claw-back awards are a consequence of agreed-upon employment arrangements, those announcements show a better path for domestic banking institutions than relying on statutory remedies. Restricting deferred bonus compensation via contractual claw-backs can cover a broader class of executives than existing securities awards while maintaining a no-fault standard for eliminating compensation. One consequence, though, could be that banking institutions are reluctant to claw-back as much compensation from employees as statutory provisions allow.
Nevertheless, including such provisions in employment agreements is a legitimate “stick” to keep employees from pursuing the “carrot” of large compensation awards with reckless abandon.