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Image Credit: <www.lexisnexis.com

Image Credit: <www.lexisnexis.com>

First things first. Let’s define what a “Clawback” is:

From Wikipedia:

In finance economics, a clawback is when an organization (typically a financial firm) that is attempting to recover from a catastrophic shift and/or collapse (e.g., the current worldwide financial crisis) attempts to essentially “tame” its past practices by giving its most highly-paid employees bonuses in pay that can be withdrawn, or reclaimed, if the reason for the bonus is later found to be invalid.

In laymen’s terms? If one is a senior executive that’s paid a cash bonus and/or incentive compensation based on high performance that is later determined to have actually been not so high, that pay can can be “clawed back” by the company (i.e. the executive has to repay it).

This sounds intuitively fair. If one is paid a bonus based on high performance that is later determined to have been less than stellar, that compensation should be recouped by the dispensing company as it wasn’t actually earned.

Here is where (for me) things get a bit grey.

The Dodd–Frank Wall Street Reform and Consumer Protection Act has in it a provision that requires mandatory clawbacks of any excessive incentive compensation paid out to executives over the prior three years in the event of 1. You can read a great summary of the change here.financial earnings restatement. 1

The key issues for me here are that:

A. The clawbacks are mandatory.

B. The degree of board discretion here is still somewhat unclear.

I’ve been meaning to get to this topic ever since JP Morgan lost billions on a bad hedge back in 2012. There was widespread discussion of clawbacks to reclaim compensation from those most responsible for the loss. In addition to key executives directly responsible for the loss, CEO Jamie Dimon’s pay was also put on the table for clawbacks (though ultimately only his unvested LTI was reduced).

To his credit, Dimon was 100% open to his earnings being clawed back. With that said, I wonder if he should have been. The SEC hasn’t yet issued guidance on the Dodd-Frank clawback provision here, so the board had the discretion to exercise considerable judgement around clawbacks in this case (and behaved pretty reasonably).

Image Credit: <barbaradenny.com

Image Credit: <barbaradenny.com>

Regardless of what the outcome was there, however, I can’t help but think that any legislation that requires mandatory action be taken by boards / companies around clawbacks is flawed. A no fault provision simply paints too broad a brush, and the legislative intent here (which is to create a greater incentive for senior executives to more closely monitor financial statements / direct reports) doesn’t actually serve its intended purpose.

Executives like Dimon don’t purposely let errors like the 2012 hedge slip through the cracks, so a mandatory clawback provision does little (if anything) to mitigate these sorts of risks.

Ultimately, as long as the SEC continues to take a stance (via lack of additional directives or explicit grant) that boards have broad discretion around clawbacks, I don’t have a huge problem with the provision.

2. Sarbanes Oxley section 304 has similar clawback provisions to CEO and CFO compensation in the event of issuer misconduct, which I think is more than enough.I also don’t think it was needed, though. 2

As always please share your thoughts below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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