Clawbacks and Litigation Over Executive Compensation: Strategies to Reduce Your Risk

June 21, 2012

Brought to you by Winston & Strawn’s Executive Compensation and Employee Benefits and Litigation practice groups

Erik Lundgren Michael Melbinger Bill O'Neil Jim Smith Employee Benefits and Employee Benefits and Litigation Litigation Executive Compensation Executive Compensation Chicago New York Chicago Chicago [email protected] [email protected] [email protected] [email protected]

I. Introduction and Overview • History of Executive Compensation Litigation II. Shareholder Say on Pay • History and Impact • Strategy for Maximizing the Likelihood of a Favorable Vote III. Litigation Over Failed Shareholder Say on Pay Votes • The Cases So Far • Shareholder Say on Parachute Pay Litigation • How to Win Them

IV. The Recent Surge in Other Litigation over Executive Compensation • Code Section 162(m) Disclosures • SOX Section 304 Clawbacks • Stock Plan Approval V. Compensation Clawbacks • Litigation • Current Events • Developing a Policy

 Overview of say on pay

 Lawsuits over failed shareholder say on pay votes

 Lawsuits over shareholder say on parachute payments

 Lawsuits over 162(m) disclosure

 Lawsuits over stock plan approval disclosures

 Strategies for avoiding litigation

 Compensation clawbacks in the news

 Adopting a clawback strategy

Cases that Made Headlines Cases that Made Law Kozlowski – Tyco Sanders v. Wang Lay & Fastow – Enron Tatum v. Ameritech Belnick – Tyco In re Oracle Rigas – Adelphia In re Cendant Ebbers – WorldCom Warnaco, Gemstar/TV Guide Grasso – NYSE In re The Walt Disney Company Martha Stewart – ImClone AT&T v. Lillis Ryan v. Gifford

 Section 951 of the Dodd-Frank Act requires public companies to conduct an advisory shareholder vote on three aspects of executive compensation:

 A vote, at least once every three years, to approve compensation paid to executive officers in the prior fiscal year ("Say on Pay")

 A vote, at least once every six years, to determine how often the issuer will conduct a shareholder advisory vote on executive compensation ("Say on Pay Frequency")

 For companies soliciting votes to approve merger/acquisition transactions, a vote to approve golden parachute compensation arrangements ("Say on Golden Parachutes")

 The Act explicitly states that it is not binding on the issuer or the board and may not be construed as (i) overruling a decision by the issuer or board, (ii) creating any additional fiduciary duties for issuers or directors or (iii) implying any change to existing fiduciary duties

 The Act’s new provisions went into effect in January 2011

 Public companies were required to hold the first say-on-pay vote during the 2011 proxy season (smaller reporting companies in 2013)

 Vote is “advisory” in nature

 An up-or-down vote (to approve/disapprove the company’s executive compensation)

 Not on an executive-by-executive basis

 Not a vote on business judgment of the board in awarding compensation

 Not a vote to approve a compensation system or philosophy

 Results: the overwhelming majority of companies passed the say-on-pay vote

 2011: Approximately 40 companies failed (out of 2,686 reporting (2%))

 Almost half were sued

 2012: Almost 50 companies have failed to date

 Four companies failed for the second consecutive year

 To date, one notable lawsuit filed almost immediately after vote result

 Citigroup (failed vote on April 17; lawsuit filed in SDNY on April 19)

 Pay for Performance Disconnect

 ISS Quantitative P4P Test

 ISS Qualitative Test

 Problematic Pay Practices

 Non-Performance Based Equity

 Rigor of Performance Goals

 Benchmarking Practices

Source: Semler Brossy 2012 Say on Pay Results, June 13th

 Derivative lawsuits have been filed to date against Directors & Officers of at least 17 issuers

 No private right of action under Dodd-Frank (consistent with advisory nature of vote)

 7 have been dismissed at pleadings stage

 Most under Delaware law on demand futility grounds

 1 motion to dismiss denied (subsequently settled)

 Ohio court, applying Ohio law

 3 settled

 Generally for significant changes to corporate governance/executive compensation practices and some monetary component

 6 remain pending

 Basic factual allegations

 Company has a “pay-for-performance” philosophy/policy

 Directors awarded increased executive compensation despite decreased shareholder returns

 Board failed to rescind compensation following a failed say-on-pay vote

 Demand was futile because the board faces a “substantial likelihood of liability”

 Claims, Generally

 Board members breached their fiduciary duties by approving excessive compensation and failing to rescind compensation notwithstanding negative shareholder vote

 Company violated Section 14(a) of the federal proxy rules by making false and misleading disclosures in its proxy solicitations stating that it followed a “pay-for-performance” philosophy

 Executives were unjustly enriched by the excessive compensation

 Company’s compensation consultant(s) aided and abetted the board’s breach of their fiduciary duties

 Say-on-pay lawsuits have been overwhelmingly unsuccessful:

 Beazer Homes (Ga. Super. Ct. Sept. 16, 2011) (Delaware law): claims for breach of fiduciary duty and unjust enrichment dismissed on demand futility grounds and for failure to state a claim

 Pico Holdings (S.D. Cal. Jan. 6, 2012) (Delaware & federal law): claim for declaratory relief dismissed for failure to state a claim (Dodd-Frank did not change state law regarding fiduciary duties or the business judgment presumption); claims for breach of fiduciary duty, gross mismanagement, contribution & indemnification, abuse of control, waste and unjust enrichment remanded (court declined to exercise supplemental jurisdiction over state law claims)

 Umpqua Bank (D. Or. Feb. 23, 2012) (Oregon law): claims for breach of fiduciary duties and unjust enrichment dismissed on demand futility grounds

 Intersil (N.D. Cal. Mar. 7, 2012) (Delaware law): claims for breach of fiduciary duties and unjust enrichment dismissed on demand futility grounds

 BioMed (D. Md. Mar. 12, 2012) (Maryland law): claims for violation of Rule 14(a), breach of fiduciary duty and unjust enrichment dismissed on demand futility grounds

 Jacobs Engineering (Cal. Super. Ct. Mar. 14, 2012) (minute entry): claims for breach of fiduciary duty dismissed on demand futility grounds and for failure to state a claim

 Monolithic Power Systems (N.D. Cal. June 13, 2012) (Delaware law): claim for breach of fiduciary duty dismissed on demand futility grounds

 Failure to Make Required Pre-Suit Demand

 Plaintiff failed to make a demand on the board or to demonstrate why a demand would have been futile

 Demand is excused if (a) a majority of the board was “interested” in the challenged decision or lacked independence, or (b) decision was not the result of valid business judgment

 Where majority of board did not receive the challenged compensation, allegations did not support claim of “interestedness”

 Allegations of “domination” of disinterested directors by recipients of challenged compensation generally rejected

 Board’s mere approval of the challenged compensation decisions insufficient to create a “substantial likelihood of liability”

 Allegations insufficient to overcome the business judgment rule

 Under Delaware law, directors have “wide discretion” in awarding executive compensation

 Vote – which was made after challenged compensation decision – did not rebut the directors’ valid business judgment

 Act specifically states that the vote is not binding and neither created nor implied any change to directors’ fiduciary duties

 Failure to State a Claim

 Generally tracking the bases for determining no substantial likelihood of liability

 Southern District of Ohio, applying Ohio law, denied motion to dismiss

 66% of shareholders voted against executive compensation

 Complaint alleged: (1) demand excused because board approved compensation and recommended that shareholders do so, and (2) directors breached their fiduciary duties because executive compensation increased from 54% to 80%, while annual shareholder return decreased 18.8%, and the approved compensation violated the company’s stated pay-for-performance policy

 Holding: these allegations were sufficient to excuse demand

 A company’s risk of litigation following a failed vote appears to depend on multiple factors:

 Stock price performance

 Vast majority of lawsuits following 2011 vote (14/17) experienced poor performance in the stock price in 2010 (e.g., Dex One’s stock declined 77.77%, Hercules’ stock declined 34.6%)

 Magnitude of the increase in executive compensation

 Particularly true where the increase in comp was coupled with stock price decline – “pay for nonperformance”

 Citigroup shareholders claim increase of 1,499,999,900% (following 2009 comp of $1)

 Also relevant where stock price increased but comp increased by significantly greater amount (e.g., Stanley Black & Decker’s stock increased by 26%, but CEO comp increased by 240%)

 Composition of the executive compensation

 Cash “bonuses,” especially where stock declined, are likely to spur litigation

 Company size

 Smaller-cap companies are more vulnerable

 14/17 companies sued after 2011 vote had market caps of approximately $2 billion or less

 Where are we headed from here?

 Cincinnati Bell – the only case to allow “say-on-pay” claims to proceed past the pleadings stage – predated the seven dismissals – and decided under (limited to?) Ohio law

 Clear trend: “say-on-pay” claims not sufficiently colorable to survive a motion to dismiss

 Consistent with the language and expressed intent of the statute

 So far, only one lawsuit from the 2012 proxy season (Citi)

 But plaintiffs’ bar is enterprising and creative

 Is this the beginning of the end, or just the end of the beginning?

 What is the “next wave”?

 Provisions took effect April 25, 2011

 Effective date applies to smaller reporting companies, as well; two-year delay with respect to other say-on-pay requirements does not apply

 Previously, target companies soliciting shareholder approval of a business combination were required to briefly describe any substantial interest of an executive or director

 Under Dodd-Frank and its implementing rules and regulations, target companies must:

 Disclose “parachute payments” – broadly defined to include any compensation for named executive officers based on or related to a proposed merger or acquisition – in tabular, footnote, and narrative form (Item 402(t) of Reg S-K)

 Hold nonbinding advisory vote on the “parachute” payments, separate from the vote on the proposed transaction (Rule 14a-21(c))

 No such vote is required where parachute disclosure was made in the target’s annual meeting proxy and subject to general say-on-pay vote (whether approved or not), assuming no subsequent revisions to the parachutes

 “Parachute” payments that must be disclosed include, e.g., accelerated vesting of equity awards and pre-merger agreements of named executive officers with the would-be acquiror

 No “de minimis” exception

 Irrelevant whether the arrangements discriminate in favor of named executive officers

 Previously vested equity awards exempted

 Post-transaction agreements with the buyer exempted

 While they must be disclosed, agreements between named executive officers of target and the would-be acquiror are not subject to vote

 Pursuant to SEC implementing rules, new disclosure requirements apply not only to merger proxy statement soliciting in connection with a proposed shareholder vote, but also to the target’s Schedule 14D-9 in response to a third-party tender offer

 Bidders in third-party tender offers not required to provide information about the target’s parachute payments in Schedule TO (unless the tender offer is a Rule 13e-3 going-private transaction)

 Where parachute disclosure was made in the annual meeting proxy and subject to a say-on-pay vote, separate vote is not required in connection with the transaction

 Exception applies regardless of outcome of the annual meeting say-on-pay vote

 Exception does not apply to provisions of parachute payments that have been revised or added in connection with the proposed transaction, as to which a separate vote will be required

 Although if such changes merely reduce the amount of parachute comp, no separate vote is necessary

 Thus far, it does not appear that shareholders are withholding support as a means of protesting excessive exec comp

 Shareholders are likely to support the say on golden parachute vote when they believe the overall transaction makes sense

 However, approval of the say on golden parachute vote has seen less support than approval of the overall transaction

 ISS factors leading to an AGAINST recommendation:

 Recently adopted or materially amended agreements that include excise tax gross-up provisions (since prior annual meeting);

 Recently adopted or materially amended agreements that include modified single triggers (since prior annual meeting);

 Single trigger payments that will happen immediately upon a change in control, including cash payment and such items as the acceleration of performance-based equity despite the failure to achieve performance measures;

 Single-trigger vesting of equity based on a definition of change in control that requires only shareholder approval of the transaction (rather than consummation);

 Potentially excessive severance payments;

 Recent amendments or other changes that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders;

 In the case of a substantial gross-up from pre-existing/grandfathered contract: the element that triggered the gross-up (i.e., option mega-grants at low point in stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger); or

 The company's assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. ISS would view this as problematic from a corporate governance perspective. © 2012 Winston & Strawn LLP 31 Say on Parachutes - Litigation Risks: Failed Vote

 Typical shareholder litigation challenging M&A transactions seeks to enjoin the shareholder vote on the deal and is therefore won or lost prior to the vote

 Extremely difficult for shareholders under existing law to pursue post-closing claims

 Risk posed by failed say-on-parachute vote is that plaintiffs’ lawyers will be emboldened to continue to pursue claims in a post-closing environment

 Only one failed say-on-parachute vote to date

 Advance America

 First selling company to fail say on golden parachute vote, April 20, 2012*

 No complaint filed yet

*See 8-K for voting results, available at: http://www.sec.gov/Archives/edgar/data/1299704/000110465912027029/a12-10194_18k.htm

 To include or not to include Item 402(t) disclosure in the annual meeting proxy?

 Pros

 Item 402(j) already requires a vote on parachute comp in the annual meeting proxy

 Inclusion of the parachute disclosure in the merger proxy could cause some shareholders who would otherwise support the transaction to vote “no” not just on the parachutes, but on the deal

 Low risk

 Subjecting parachute comp to a separate vote in connection with a merger transaction spotlights the issue for plaintiffs’ counsel in the inevitable shareholder litigation, providing them with a roadmap/fodder for their claims challenging the deal

 Case in Point: Encore Bancshares (NY State Supreme Court)

 Typical shareholder complaint filed in advance of shareholder vote on proposed sale transaction (and executive comp), alleging typical claims of breach of fiduciary duty and disclosure deficiencies in proxy statement

 Certain directors set to receive cash payments for restricted stock and severance in connection with the proposed sale

 Many allegations in support of plaintiffs’ claims taken directly from company’s Item 402(t) disclosure

 No decision yet

 Cons

 Including Item 402(t) disclosure in annual meeting proxy could be viewed by market – correctly or incorrectly – as a prelude to a merger

 Generally, not a signal the company will want to send

 Gratuitously highlighting parachutes could make shareholders incrementally more likely to vote “no” on say-on-pay generally

 Low risk

 Including Item 402(t) disclosure invites more scrutiny from ISS in its Say on Pay review of change in control and severance plans

 Bottom Line: Incremental litigation advantage of making 402(t) disclosure in the annual proxy does not outweigh the downsides

 Generally, compensation in excess of $1M per covered executive per year paid by a publicly held corporation is not tax-deductible.

 An exception to this general rule is “any remuneration payable solely on account of the attainment of one or more performance goals.”

 Such “performance-based awards” are only tax- deductible, however, if three main conditions are satisfied: (1) the performance goals are determined by a compensation committee of outside directors; (2) the material terms under which the remuneration to be paid, including the performance goals, are disclosed to and approved by a majority of stockholders; and (3) before payment, the compensation committee certifies that such goals were met

 When a company states that it will pay the executive compensation regardless of whether it will be tax- deductible, shareholders argue that they are coerced into voting for the plan.

 Faced with the choice of approving the plan and receiving the tax benefits or rejecting the plan and having the company pay the bonuses without the tax deduction presents the shareholder no choice at all and renders the shareholder approval requirement meaningless.

 There have been 4 reported cases that have made it to the motion to dismiss stage—2 have been dismissed in their entirety, and 2 have been granted in part and denied in part

 The theory that has gained the most traction at the motion to dismiss stage is corporate waste

 3 of the 4 courts to address this issue have been the District of Delaware (2 of 3 of these cases survived the motion to dismiss), while the fourth and most recent case was decided by the Delaware Court of Chancery

 We believe that future courts are more likely to follow the recent Chancery decision and that these actions are unlikely to be successful in the future

 Seinfeld v. O’Connor (D. Del. March 2011)

 Direct and derivative claims brought against board of Republic Services, Inc., alleging proxy statement was materially false and misleading under § 14(a) of the Exchange Act

 Motion to dismiss for lack of subject matter jurisdiction granted. Court rejects plaintiff’s claims (1) that company misstated in the proxy that compensation plan complied with § 162(m) and (2) that § 162(m) plan contained a host of technical defects

 Resnik v. Woertz (D. Del. March 2011)

 Direct and derivative claims brought against board of Archer-Daniels-Midland Company

 Motion to dismiss granted in part and denied in part

 Plaintiff’s derivative claim under § 14(a) permitted to survive, but direct claim failed to meet heightened pleading requirements of the PLSRA (no loss causation or economic injury).

 Plaintiff sufficiently pled claim because the proxy omitted the number of individuals eligible to participate in the plan.

 Plaintiff sufficiently pled materiality of misrepresentation that plan was designed to comply with § 162(m).

 Plaintiff’s derivative claims for breach of fiduciary duty, waste and unjust enrichment permitted to proceed.

 Hoch v. Alexander (D. Del. July 2011)

 Direct and derivative claims brought against board of Qualcomm alleging board breached their duty of loyalty and good faith and that the payment of non-deductible compensation constitutes waste

 Motion to dismiss granted in part and denied in part:

 Plaintiff’s direct claim could not proceed because there was “no link between the alleged misstatements in the proxy statement and any actual economic harm.”

 Plaintiff’s derivative claim could proceed—“at this stage, [plaintiff] has properly pled that a material misstatement interfered with the voting rights of shareholders and that the false proxy statement breached Defendants’ duties of loyalty and good faith and constituted waste.”

 Freedman v. Adams (Del. Ct. of Chancery, March 2012)

 Shareholder derivative claims brought against board of XTO Energy alleging breach of fiduciary duty and waste

 $40M of executive bonuses were structured in a way that was not deductible under Code Sec. 162(m)

 After lawsuit was filed, board filed and approved a 162(m) plan for cash bonuses

 Delaware Chancery Court granted motion to dismiss all claims relating to 162(m)—“This Court rejects the notion that there is a broadly applicable fiduciary duty to minimize taxes. . .”

 Know the Rules

 Include required disclosures in proxy statement when incentive plan approval is sought

 Follow the requirements of 162(m) and double-check compliance

 Know your Disclosure

 Avoid boilerplate disclosure in CD&A and proposal for plan approval

 Make sure disclosure matches the company's intentions (e.g., don't oversell with statements like: "approval of this proposal ensures that plan compensation will be tax deductible")

 Martha Stewart Living Omnimedia

 Proxy proposed to increase number of shares reserved for issuance by 4,557,272, but company already had 1,531,131 shares available

 Complaint alleges breach of fiduciary duties, as well as dissemination of a materially misleading and incomplete proxy

 Proxy failed to disclose: (i) why issuing more shares was in best interest of shareholders; (ii) how the board determined number of shares requested; (iii) potential equity value and/or cost of issuance

 Potential dilutive impact of additional shares was also not disclosed

 Martha Stewart Living Omnimedia

 Result: Parties reached settlement in principle and company filed additional proxy materials containing more information regarding potential dilutive effect of Plan

 Vote: Plan was overwhelmingly approved by shareholders at annual meeting (approximately 98% of shares in favor)

 Lesson: Include more details in proxy proposal regarding dilutive effect of Plan, such as: (i) number of shares remaining available under existing plan; (ii) what historic equity grant activity has been; (iii) expected number of future years' grants that outstanding and requested shares will cover

Section 304 imposes a limited clawback provision: If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for: (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of the issuer during that 12-month period.

 Federal courts have uniformly rejected the notion that SOX 304 provides a private right of action for shareholders. E.g,, Cohen v. Viray, 622 F.3d 188 (2d Cir. 2010); In re Digimarc Corp. Deriv. Litig., 549 F.3d 1223 (9th Cir. 2008); Pirelli Armstrong Tire Corp. Ret. Med. Benefits Trust v. Raines, 534 F.3d 779, 793 (D.C. Cir. 2008).

 There are two reasons for this:

 Section 304 does not explicitly create a private right of action because nothing in the text of the section makes any mention of a cause of action.” In re Digimarc Corp., 549 F.3d at 1230.

 Congress did not intend to provide shareholders with an implied cause of action. Id. at 1230-33. As the Digimarc court held, “we cannot find in Congress’ silence in section 304 an intent to create a private right of action where it was not silent in creating such a right to similar equitable remedies in other sections of the same Act.” Id. at 1233 (comparing Section 304 to Section 306).

 The SEC has enforced Section 304 sparingly

 Early actions were limited to fraud in which the CEO and CFO were personally involved and which led to a restatement

 Examples include option-backdating cases involving specific allegations of wrongdoing by CEO or CFO. See, e.g., SEC v. McGuire ($468M settlement); SEC v. Schroeder; SEC v. Brooks; SEC v. Sabhlok & Pattison

 Recent actions

 More aggressive actions against CEOs and CFOs with no personal involvement in the wrongdoing that led to restatement (no-fault actions). See, e.g., SEC v. Jenkins; SEC v. O’Dell; SEC v. McCarthy

 SEC v. Jenkins (CEO of CSK) – D. Ariz., Jun. 2010

 During Jenkins’s tenure, CSK engaged in fraud leading to restatement of financials from 2002-2004, which he signed; no allegation Jenkins was involved in the fraud

 Court held that Section 304 does not require personal misconduct.

 Commissioners rejected settlement proposal in July, signaling intention to seek favorable case law

 SEC v. O’Dell (former CEO of Diebold) – D.D.C., Jun. 2010

 Similar facts as Jenkins, however, SEC also sought to recoup compensation during 12-month period after the year of restated financials

 O’Dell settled for $476,016 in cash and 115 shares of Diebold stock

 SEC v. McCarthy (CEO, Beazer Homes) – N.D. Ga., March 2011

 Similar facts to Jenkins and O’Dell

 McCarthy settled for $6.5 million in cash and 117,000 shares of stock

 In SEC v. O’Leary (CFO, Beazer Homes) – N.D. Ga., Aug. 2011

 Identical allegations to McCarthy

 O’Leary settled for $1.43M, his entire 2006 incentive compensation

 In SEC v. Baker (CEO, ArtrhoCare) – W.D. Tex., April 2012

 Action seeking reimbursement of 12 months of incentive compensation after ArthroCare’s restatement of quarterly and annual financial statements

 No allegation of personal wrongdoing

 In SEC v. Nocella (CEO, Franklin Bank) – S.D. Tex., April 2012

 Personal wrongdoing was alleged

 Section 954 of Dodd-Frank adds new Section 10D, entitled "Recovery of Erroneously Awarded Compensation Policy," to the Exchange Act.

 Requires SEC to direct the national securities exchanges to prohibit the listing of any security of an issuer that does not develop and implement a clawback policy.

 Requires companies to disclose compensation clawback policy in their proxy statement.

 Proposed Rules not yet issued.

SOX 304 Dodd-Frank 954 Misconduct requirement No misconduct requirement Only applies to CEO & CFO Applies to all current & former executive officers

One year look-back Three year look-back Enforceable by SEC only ??? (private cause of action is possible)

 Officers, directors, employees, shareholders, business competitors, agents, consultants, distributors, vendors, contractors, service providers, and customers all generally can qualify as whistleblowers.

 Certain individuals cannot receive bounties as whistleblowers:

 Persons who provide information obtained through communications protected by the attorney-client privilege, in connection with the legal representation, the required independent public accountant's engagement, or through a company's legal, compliance, audit, supervisory, or governance functions;

 Persons who obtained the provided information in a manner that violates federal or state criminal law;

 Persons with legal, compliance, audit, supervisory, or governance responsibilities to whom information about potential misconduct was communicated with the expectation that they would take appropriate steps to respond (unless the company does not disclose the information to the SEC in a timely manner or proceeds in bad faith);

 Persons who provide information that was obtained from those who would otherwise be excluded under any of the foregoing limitations.

 Instead of requiring whistleblowers to report violations or concerns under the company's internal policy first, in order to be eligible to receive a bounty, the SEC's final rules provide "incentives" for whistleblowers to use the company’s internal reporting program.

 Note that 334 whistleblower "tips" were filed with the SEC in the 31 business days between August 12, 2011, the effective date of the final whistleblower rules (the first date the SEC Office of the Whistleblower started keeping track), and September 30, 2011, the end of the SEC's fiscal year.

 More than 10 tips per day

 SEC received whistleblower submissions from individuals in 37 states, as well as from several foreign countries, including China (10) and the UK (9).

 In May, the subject of compensation clawbacks burst onto the front pages and lead stories at newspapers and TV stations all over the country, as a result of JPMorgan Chase’s difficulties, and the subject of compensation clawbacks suddenly got a whole lot more interesting. Compensation clawback provisions have a long history and were developing nicely as a best practice for compensation committees before Dodd-Frank Act Section 954 made them the law of the land (pending the issuance of final rules by the SEC and stock exchanges).

 The unfortunate recent publicity brought to light three more issues within the already crowded orbit of compensation clawback issues. First, Congress, the media, and the strike suit lawyers clearly understand companies’ potential to seek a compensation clawback from malefactors and others – and they are watching. Second, Congress and the media are unlikely to be shy about demanding that an affected company seek to clawback compensation. Finally, the strike suit lawyers are virtually certain to file a lawsuit demanding that the affected company seek to clawback compensation – or alleging that it failed to clawback enough compensation.

 Among the many other difficult legal and practical issues raised by a compensation clawback policy are the following:

 Documentation and drafting requirements,

 Legal enforceability issues under state and foreign law,

 Establishing procedures for applying the clawback policy,

 The accounting consequences of a clawback to the company,

 Problematic real-life scenarios for the board and the employees,

 The continued applicability of Sarbanes Oxley Act clawback provisions,

 What forms of incentive compensation should be affected by the clawback,

 The availability of D&O insurance and indemnification for clawback targets,

 Deciding which employees the compensation clawback policy should cover,

 The impact of the Dodd-Frank whistleblower bounties on future restatements and clawbacks,

 The tax consequences of a clawback to the employee and the company (Code Sections 1341 and 409A),

 Possible unintended consequences from the Dodd-Frank clawback provisions and their implementation,

 The use of “holdbacks” and deferrals to implement and enforce a clawback policy (see also, Dodd-Frank Act Section 956),

 The types of shareholder and employee litigation that are certain to result from a compensation clawback – or the lack of one, and

 Balancing the interests of the employees and the company in designing a clawback policy, including protecting employees against an unjust clawback (complete with examples of unjust potential clawback scenarios).

 When the SEC proposes rules under the compensation clawback provisions of Dodd-Frank Section 954, we will examine those rules in detail – as well as the open issues that are sure to remain under the rules.

 Assess current recoupment policy, if any, versus Dodd-Frank requirement

 Incorporate policy (even as a "place saver") into any new plan documents, award agreements, and employment agreements

 Consider early adoption of Dodd-Frank-compliant policy, recognizing that some change may be necessary, pending final rules and guidance