In my last entry, I said Dodd-Frank does not mandate “clawbacks,” and that “holdbacks” are a far more efficient and effective way to ensure that your company has a recoupment policy in place that can both comply with Dodd-Frank and diffuse systemic risk.
Clawbacks are a post-payout approach that attempts to recoup unearned income after an earnings restatement. Clawbacks do not necessarily work in favor of shareholder interests; when the corporation seeks to recoup an executive’s unearned compensation, it may well come up empty, for legal reasons or because the executive may have spent the bonus and isn’t able to repay it.
Holdbacks are pre-payout payment recovery mechanisms that require the executive’s incentive compensation award to be mandatorily credited to a deferred compensation account and to be subject to forfeiture/adjustment during a pre-specified vesting period. If the public company restates its earnings during this period, the portion of the unearned incentive compensation award that is determined to be “unearned” due to the restatement can simply be rendered null and void, as the credit to the executive’s account is a mere bookkeeping entry. Thus, holdbacks are far more efficient, and they are less likely to trigger expensive lawsuits. In my opinion, they also can be designed to satisfy the mandated requirements of Dodd-Frank.
It’s not just me claiming that holdbacks encourage improved governance, an alignment of executive behavior with long-term shareholder interests and a reduction of excessive risk taking; it’s also:
- The Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation which last summer issued their Interagency Guidance on Sound Incentive Compensation Policies. The guidance stated, in part: “Incentive compensation arrangements for senior executives at LBOs [large banking organizations] are likely to be better balanced if they involve deferral of a substantial portion of the executive’s incentive compensation over a multi-year period…”
- The Conference Board Inc.’s Task Force on Executive Compensation which stated, “If appropriate, incentive plans may incorporate some form of bonus banking, deferred bonuses, longer-term performance periods, or other tools to more closely align payouts with such risks and better ensure measurement of true performance. … In appropriate circumstances, all or a portion of a bonus payout can be held back in a bonus account and paid out in the future…”
- A scholarly work in the area of systemic risk and executive compensation entitled, Working Paper: Regulation of Executive Compensation in Financial Services, drafted by the Squam Lake Working Group on Financial Regulation. It asserts that the structure of an executive’s incentive compensation arrangement has more effect on systemic risk than the amount of the executive’s compensation, and says in part, “…This deferred compensation reduces management’s incentive to pursue risky strategies that might result in government bailouts. … Because taxpayer losses trigger executive losses, holdbacks better align the personal incentives of managers with the fiscal and systemic goals of taxpayers.”
- An op-ed piece by Robert J. Shiller appearing in the New York Times describing the Squam Lake Working Group’s published report under the title, “Help Prevent a Sequel. Delay Some Pay.”
For footnotes and additional information on these items, read the comments of Robert W. Kaufman, Esq., Clark Consulting’s VP-Legal and Technical Resource Group, submitted to the Commissioner of the Securities and Exchange Commission. Mr. Kaufman’s comments are available on the SEC’s website at: http://www.sec.gov/comments/df-title-ix/executive-compensation/executivecompensation-22.pdf
Michael Goldstein is senior vice president and national director for strategic development for Clark Consulting, a leading provider of nonqualified deferred compensation plans as well as the informal funding solutions for those plans.
Michael Goldstein is a registered representative of and securities products and services are offered through Clark Securities, Inc. DBA CCFS, Inc. in Texas, 2100 Ross Avenue, Suite 2200, Dallas, Texas 75201-7906, Ph: 800.999.3125, member FINRA and SIPC. Clark Consulting and Clark Securities, Inc. are affiliated entities.
This blog is for informational purposes only; it is not intended as an offer or solicitation for the purchase or sale of any financial instrument and is not intended as advice on legal, tax, accounting or investment matters.