As noted in yesterday’s NACD Director’s Daily, the Boston Globe reported that the Federal Deposit Insurance Corporation (FDIC) issued final rules on recovering cash compensation from executives and directors of financial institutions that have been liquidated by the federal government. The Dodd-Frank Act empowered the FDIC to recover compensation when a current or former senior executive or director is “substantially responsible” for the failed condition of a covered financial company. The FDIC’s final rule clarifies that an executive or director would be considered “substantially responsible” if that person failed to act “with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances.” In other words, executives and directors stand to lose their compensation from the previous two years if they are shown to be negligent in the performance of their duties.
While this new FDIC rule only applies to banking institutions, other clawback provisions in the Dodd-Frank Act will affect all public companies. The Act directs the Securities and Exchange Commission (SEC) and national listing exchanges to require companies to recover incentive-based compensation from any current or former executive if the company is required to prepare an accounting restatement due to the material noncompliance with any financial reporting requirement under the securities laws. The specifics of the rule are yet to be developed; the SEC is scheduled to release a proposed rule near the end of 2011 with final adoption in early 2012.
Both clawback provisions set a fairly low bar to recoup compensation. The FDIC will recover compensation in cases of negligence. In banking institutions on the verge of collapse, it may be a heavy burden for an executive or director to prove lack of a breach of a fiduciary obligation and exercised “prudent” business judgment. The SEC and national listing exchanges will recover compensation in the event of noncompliance with “any financial reporting requirement.” This seemingly provides many opportunities to clawback incentive compensation from an executive. Final rules from the SEC will shed more light on the practical implications of the law.
Clawbacks may have more lasting effects than simply revoking an executive’s pay. Therefore, boards must monitor the corporation’s well being and closely align executive pay with performance.