After a short break following my retirement from Winston and Strawn and the practice of law, I’m back in the thick of things, writing for CCR Corp and exploring positions on boards of directors. I was planning to take off a bit more time, but Monday’s article in The Wall Street Journal, Clawbacks Are Hard, So Companies Try Postponing Pay, highlighted by fellow blogger Liz Dunshee’s post Next-Gen “Clawbacks”: Mandatory Deferrals, brought me back early to contribute my thoughts.
Many folks are probably not aware of just how close corporate America was to having compensation holdbacks required by law. Dodd-Frank Act Section 956, Enhanced Disclosure and Reporting of Compensation Arrangements, required “the appropriate Federal regulators” to prescribe regulations or guidelines to require each covered financial institution to disclose the structures of all incentive-based compensation arrangements they offer “sufficient to determine whether the compensation structure”—(A) provides an executive officer, employee, director, or principal shareholder of the covered financial institution with excessive compensation; or (B) could lead to material financial loss to the financial institution.” Eight financial regulators combined to issue proposed rules under Section 956 in 2011, which languished after extensive pushback by commenters. Six financial regulators then combined to issue re-proposed rules in 2016, which again led to extensive pushback by commenters (this blogger was part of a small team that meet with representatives of the federal agencies in Washington), but appeared to be destined publication as final, with some modification, until the unexpected results of the 2016 election.
Prior to 2017, I blogged several times on the proposed rules including Forfeitures and Clawbacks Under the New Proposed Rules for Incentive Compensation for Financial Institutions, which provided examples of how the proposed rules would apply (using the new definitions of “Awarded,” “Vested” (or “Vesting”), and “Deferral Period” from the proposed rules).
Assume that a covered Institution grants 10,000 performance shares to a “Senior Executive” on January 1, 2018, with a 3-year Performance Period ending December 31, 2020. Also assume that the performance targets were achieved. On December 31, 2020, the end of the three-year performance period, the 10,000 shares would be deemed “Awarded” to the Executive. Under the proposed rules, what compensation professionals think of as the vesting date, now would be deemed the “Award Date.” The “Vesting Date” would not occur until the end of a mandatory “Deferral Period.”
On December 31, 2020, the 10,000 shares are deemed “Awarded” and a mandatory Deferral Period would begin. 4,000 shares would be distributed to the Senior Executive on or after December 31, 2020 and 6,000 shares (60%) of the Senior Executive’s Awarded shares would be subject to a mandatory Deferral Period of 2 years. Generally, these shares will not be Vested until the end of the Deferral Period. During the Deferral Period, the shares could vest annually on a pro rata basis. Therefore, on December 31, 2021, 3,000 shares could be Vested and distributed to the Senior Executive and on December 31, 2022, the remaining 3,000 shares would be Vested and distributed.
For incentive compensation with a performance period of less than three years, the mandatory Deferral Period would be even longer. Assume that a Senior Executive was paid $800,000 base salary and entitled to annual bonus of 100% of base salary for 2020. Assume that the performance goals are achieved and on December 31, 2020 (the end of the one-year Performance Period), the Executive earns an $800,000 cash bonus. Shortly after December 31, 2020, $320,000 would be paid out to the Senior Executive and a mandatory Deferral Period would begin for the $480,000 (60%) of the Awarded bonus amount. That $480,000 could be paid out in a single lump sum after December 31, 2022 at “Vesting,” or could be Vested and paid out in 4 annual installments of $120,000 after each of December 31, 2021, 2022, 2023, and 2024
And in each example, the cash payout or shares would remain subject to a Clawback for 7 years after Vesting and distribution (i) until December 31, 2027, for the first 4,000 shares and until December 31, 2029, for the last 3,000 shares and (ii) until December 31, 2025, for the first $320,000 cash payout, and December 31, 2029, for the last $120,000 payout.
If these rules were to be finalized, they would only apply to larger financial institutions. However, experienced readers will recall that proposals like this often lead to new “best practices” or even new legal requirements under a future Congress. We are now seeing the former. Stay tuned for developments on the latter.
-Mike Melbinger, CompensationStandards.com February 10, 2021
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