Both the Sarbanes-Oxley Act and the Dodd-Frank Act contain compensation clawback provisions. Under the Executive Compensation Clawback Full Enforcement Act (Full Enforcement Act) introduced by Representative Barney Frank, insurance providing coverage to executives of certain financial institutions for compensation clawbacks would be prohibited.
Section 304(a) of the Sarbanes-Oxley Act provides that the chief executive officer and chief financial officer of a company must reimburse it for: (i) any bonus or other incentive-based or equity-based compensation received by that person from the company during the 12-month period following the first public issuance or filing with the SEC (whichever first occurs) of the financial document embodying the financial reporting requirement under the securities laws, which the company was in material non-compliance with due to misconduct and in connection with which the company had to prepare an accounting restatement; and (ii) any profits realized from the sale of securities of the company during that 12-month period. This clawback provision can be used by the SEC even if the chief executive officer or chief financial officer of the company is not personally charged with the underlying misconduct.
The Dodd-Frank Act expands the SEC’s clawback authority. The Dodd-Frank Act requires the SEC to issue rules directing national securities exchanges to prohibit the listing of any security of a company that does not adopt a policy providing for the recovery of any incentive-based compensation (including stock options) awarded to current or former executive officers during the three-year period prior to an accounting restatement resulting from material noncompliance of the issuer with financial reporting requirements in excess of what would have been paid to the executive officer under the accounting restatement. The Dodd-Frank Act’s clawback provisions are far more expansive than Section 304. Among other things, the Dodd-Frank Act covers not only the chief executive officer and chief financial officer, but all other executive officers, present and former, and does not require misconduct to trigger a clawback.
Section 210(s) of the Dodd-Frank Act also allows the FDIC, when acting as a receiver of a “covered financial institution,” to recover from any current or former senior executive or director substantially responsible for the failed condition of the covered financial institution any compensation received during the two-year period preceding the date the FDIC was appointed as the receiver (provided that in cases of fraud, there is no time limitation).
The Full Enforcement Act would prohibit officers, directors employees and other institution-affiliated parties of certain enumerated financial institutions from, directly or indirectly, insuring or otherwise hedging against any personal liability to repay previously earned compensation or the payment of civil monetary penalties, subject to certain exceptions (most notably, that defense costs may be insured) where the personal liability arises under any “Federal financial regulatory law” (which is defined to include most securities laws) or any rule or order promulgated by a Federal financial regulatory agency. Both the Sarbanes- Oxley Act and the Dodd-Frank Act are included in the definition of Federal financial regulatory law.
The practical impact of the Full Enforcement Act if it becomes law is unclear. First, it is unclear whether insurance covering clawbacks is widely available. Second, the Full Enforcement Act does permit insurance coverage for defense costs, which can be very significant. Third, it applies only to a limited group of financial institutions, not all public companies. Fourth, any insurance product available is unlikely to provide coverage for clawbacks that result from fraud or intentional misconduct.