Departing employees who leave, whether voluntarily or otherwise, may claim they earned a bonus and that the employer’s failure to pay it on their termination constituted a breach of contract or even a violation of wage payment laws. Recently issued SEC regulations and announcements from the U.S. Department of Justice with regard to bonus policies have imposed new obligations on employers, and new areas of liability.
By Philip Berkowitz | March 8, 2023
Bonuses, and an employee’s right to receive them, have always been ripe for litigation brought by former and sometimes current employees. In particular, departing employees who leave (whether voluntarily or otherwise) may claim they earned a bonus and that the employer’s failure to pay it on their termination constituted a breach of contractor even a violation of wage payment laws.
They may bring such a claim even in the face of policies providing that the bonus is discretionary, or that the employee must be employed on the date of payment and not under notice of termination to be eligible, or other policies or practices that ostensibly limit the employer’s obligation to pay.
Recently issued SEC regulations and announcements from the U.S. Department of Justice with regard to bonus policies, however, impose new obligations on employers, and new areas of liability.
First, the SEC has issued regulations making clear that employers must put in place policies that provide for mandatory clawbacks of bonuses where the individual receiving the bonus has engaged in conduct, whether knowingly or not, that requires that the employer restate its earnings.
Second, the Department of Justice has stated that employers who commit crimes will get reduced sentences if they have in place policies that mandate clawbacks of bonuses the employer paid to employees who commit crimes.
Section 10D of the Securities Exchange Act (added by the Dodd-Frank Wall Street Reform and Consumer Protection Act) requires the SEC to direct national securities exchanges and associations listing securities to establish listing standards that require every issuer to develop and implement a clawback policy.
The intent is to require that incentive-based compensation be recouped where the compensation paid was based on any misstated financial reporting.
On Nov. 28, 2022, more than seven years after the SEC initially proposed rules, the SEC’s final rule implementing the clawback provisions of Section 10D was published in the Federal Register. The final rule was effective Jan. 27, 2023, 60days after publication in the Federal Register. The exchanges have until April 27, 2023 to file their proposed new listing standards (containing the clawback requirements). These new standards must become effective no later than Nov. 28, 2023, one year following the date of publication of the final rule.
Listed companies will have 60 days from the effective date of the exchanges’ new listing standards to adopt a compliant clawback policy.
Affected employers will be required to adopt a clawback policy that provides for the recovery of incentive-based compensation erroneously received during “the three-year period preceding the date on which the issuer is required to prepare an accounting restatement.” In other words, employers must have a policy that provides for the recovery of erroneous payments to current and former executive officers. This clawback policy is not contingent on the officer’s misconduct or knowledge of the erroneous financial accounting.
Under this policy, the term “received” will have a particular meaning. Specifically, the final rule provides that incentive compensation is deemed received when the financial reporting measure is attained, even if the payment occurs at a later date. The term “incentive compensation” refers to “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure,” which may include both generally accepted accounting principles (GAAP) and non-GAAP financial measures.
If compensation is not attained based on achievement of a financial reporting measure, it is not subject to the clawback policy. For example, discretionary bonuses or awards based solely on continued employment or individual performance would not be covered.
Employers subject to this final rule are not permitted to indemnify any affected officers for their required repayment of excess incentive compensation.
An employer-issuer’s clawback policy will be triggered on the first to occur of the date the company’s board of directors, committee and/or management concludes (or reasonably should have concluded) that an accounting restatement is required, or the date a regulator, court or other legally authorized entity directs the company to restate previously issued financial statements.
While employers subject to the final rule may have some discretion, they cannot settle for anything less than a full recovery, subject to certain exceptions, and recovery must be promptly made. A delay of more than 180 days would potentially require the issuer to publicly disclose the name of any current and former named executive officer from whom a balance is outstanding.
Exceptions from Recovery
As noted, lack of knowledge or misconduct will not exempt erroneous payments from recovery. However, employers have some relief from clawing back erroneously-paid incentive compensation if:
1. the direct expense of paying a third party to assist with enforcing the clawback policy would exceed the recoverable amount, and the employer-issuer has first made reasonable attempts to recover the sums that have been made and submitted documentation of such attempts to the listing exchange;
2. recovery would violate the law, and the employer-issuer has provided an opinion of counsel supporting such
conclusion to the listing exchange; or
3. recovery would cause a tax-qualified retirement plan to fail to meet applicable requirements of the Internal Revenue Code.
What About Wage Payment Laws?
The SEC regulations pay scant attention to potential state wage-payment laws that purport to preclude employers from taking deductions from wages that are not confined to very limited categories that are deemed to be for the benefit of employees, or from imposing agreements that seek to mimic such deductions.
However, New York’s labor law, which restricts such wage deductions, makes clear that a deduction may be permitted if made “in accordance with any law, rule or regulation issued by any governmental agency.” (12 NYCRR Section 195-2.1(a))
To prepare for the eventual new listing standards to be released, employers affected by the final rule can consider the following steps to prepare for the implementation of the new clawback requirements:
• Review existing policies to evaluate whether changes may be required, such as to the applicable period for recovery, the applicability of the policy to former employees, the definition of certain terms under the policy, such as “received” and “incentive compensation,” or any indemnification, insurance, or attorneys’ fees provisions;
• Review and evaluate current compensation plans to identify potential amendments to make sure future awards are subject to a compliant clawback policy; and
• Review executive officer determinations (or make a decision about whether individuals other than executive officers will also be subject to the clawback policy, even if not required by the final rule).
An additional incentive for employers to impose clawbacks on employees behaving badly came in the form of an announcement on March 2, 2023, from Deputy Attorney General Lisa Monaco.
At a meeting of the ABA National Institute on White Collar Crime, Monaco announced that employers who have been found to have committed crimes will get reduced fines from the US Justice Department if they act to claw back compensation paid to executives and employees responsible for misconduct.
She described this policy as an innovative approach to compliance, designed to drive compliance-promoting behavior. The goal of the policy, she said, is to “to shift the burden of corporate malfeasance away from uninvolved shareholders onto those more directly responsible.”
She said that, in order to have executives “put skin in the game,” the DOJ would mandate “direct and tangible financial incentives.”
Every DOJ Criminal Division settlement will now, she explained, include a requirement that the resolving company develop compliance-promoting criteria within its compensation and bonus system. This will not be limited to bonus policies, however—the DOJ may even require employers to revise performance reviews to include “criteria related to compliance,” such that employees who fail in compliance will also fail to secure a bonus.
The DOJ will also provide a credit to fines equaling the amount of compensation the company is attempting to clawback from culpable executives and employees. The company, in turn, will be able to keep the clawback money it succeeds in recovering.
What’s the upshot? Employers need to put in place policies that permit the employer to retrieve compensation from bad leavers.
And, going further, employers in regulated industries should condition payment of bonuses on employees affirmatively representing that they have not engaged in misconduct, and that they are unaware of any employee having engaged in misconduct, or alternatively affirming that they have reported any misconduct of which they are aware.
We can anticipate that these policies will inevitably lead to compensation related claims from employees—but this must be weighed against the risk that a failure to implement these policies will draw the ire of regulators, and perhaps worse, that when an employee does engage in misconduct that amounts to criminal activity, the employer will be in a much worse position when trying to negotiate a resolution with prosecutors.
Philip Berkowitz is a shareholder at Littler Mendelson. Warren Fusfeld, also a shareholder and Chelsea Smialek, an associate at the firm, assisted in the preparation of this article.
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Reprinted with permission from the March 8, 2023 edition of the New York Law Journal©
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