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Tough comp rules expected under Dodd-Frank statute

Target execs at public cos.

The U.S. Securities and Exchange Commission is poised to implement compensation rules that corporate attorneys say will make it hard for public companies to hire talented executives.

Under §954 of the Dodd-Frank Act of 2010, the SEC is required to adopt executive compensation “clawback” rules, which it has announced it will do this year.

Clawback provisions refer to the process by which a public company can take back compensation paid to executives and return that money to shareholders if it turns out that the company did not achieve the financial results initially reported.

Dodd-Frank specifically targets any such “incentive-based” compensation.

“Based on the SEC’s implementation of other provisions under Dodd-Frank, I expect the clawback provision will be far-reaching, strong and possibly aggressive,” Boston attorney Roger A. Lane said.

‘Draconian’ requirements

Attempts to recapture excess compensation from public-company leadership have been in play since the Sarbanes-Oxley Act of 2002, but Boston attorney Diana K. Lloyd said the impending Dodd-Frank requirements are “draconian.”

“The SEC wants to improve the incentive for people to do what is right, but if there is a risk of having to pay back money despite no wrongdoing, then it is going to be hard for public companies to get talent,” Lloyd said.

She emphasized that the trigger for a clawback under Dodd-Frank is “material noncompliance” with financial reporting requirements, a lesser standard than the “misconduct” required by Sarbanes-Oxley.

And while the SEC maintains discretion on whether to clawback compensation after a triggering event under Sarbanes-Oxley, Dodd-Frank requires companies to do so or be de-listed by trading exchanges.

Lloyd, co-chair of Choate, Hall & Stewart’s government enforcement and compliance practice group, also pointed to the broadening scope of Dodd-Frank: The new clawback provision applies to all current and former executive officers, not just the CEO and CFO as was the case under SOX.

Also, while the question remains whether executives can be held responsible for the material noncompliance of other corporate officers under Dodd-Frank, Lloyd said that may well happen, noting that the SEC has held executives responsible for the misconduct of other employees under Sarbanes-Oxley.

Lloyd further noted that while Sarbanes-Oxley reaches back only 12 months from the public issuance of a document that is later identified to be inaccurate, Dodd-Frank encompasses the three-year period preceding the date the company realizes a public correction must be made.


Attorneys say the implementation of Dodd-Frank’s clawback provision raises questions about how public companies should incentivize executive performance.

“The big question is will the SEC allow indemnification of corporate officers and directors to continue under Dodd-Frank, where the indemnification in effect wipes out the effect of the clawback? Or will the new clawback provision destroy this traditional indemnification regime?” asked Lane, a partner with Foley & Lardner’s securities enforcement and litigation practice.

“Corporate bylaws almost always provide indemnification for executives if they are harmed as a result of their status as executives but have done nothing wrong,” he said. “This director and officer indemnification is one of the bedrocks of corporate structure.”

But Lane predicted that indemnifying executives against a clawback is too circular to survive Dodd-Frank, and good managers could leave public companies as a result.

Lane pointed out another problem with implementation that may negate the ultimate benefits to shareholders.

“Can an act of Congress direct corporations to take property from people?” he asked. “Because that’s what this compensation is.”

Executives might be willing to amend their compensation agreements to anticipate clawbacks, he said, because that would allow the company to comply with the statute and avoid being de-listed, but former employees might demand to be paid to do so. That would come out of the bottom line and be a loss for shareholders.

To both retain talent and protect shareholders, companies should invest in good accounting to “get it right the first time” and make sure any incentive-based compensation is defined and limited to reduce exposure to the statute, Lane said.

“For example, it might be a good idea for companies to defer incentive-based compensation for more than three years so it could be forfeited without actually having to take it back from someone,” he said.

Boston attorney Daniel Adams agreed, saying “people may have already paid taxes on the money before the SEC asks them to return it, potentially in pre-tax dollars.”

Adams, a corporate partner at Goodwin Procter, predicted further unintended consequences for shareholders.

“Companies could move away from formulaic performance-based compensation based on financial metrics to avoid where the clawbacks apply, and companies have been trying to be formulaic to meet investors’ concerns,” he said.


The Dodd-Frank law, which was passed in 2010, directed the SEC to adopt rules explaining how the clawback provision of the statute would be implemented.

Those rules must direct the securities exchanges to adopt listing standards that require companies to develop and implement clawback policies meeting the SEC’s minimum requirements. If a company trading on an exchange fails to comply with those standards, the exchange must bar the company from trading its shares there.

According to the SEC website, the commission will issue Dodd-Frank clawback rules in the first half of 2012 and adopt them in the second half of the year, following a public comment period.

However, the website previously stated that the rules would be issued in 2011, and whereas some provisions of Dodd-Frank include timetables for rule adoption, the language of the statute does not provide a deadline for issuing the clawback rules.

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