Payback Time? The SEC Launches a Second 'Clawback' Case

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"The seminal change is that the CEO [or chief financial officer] is not personally accused of any misconduct—it's the fact that now some misconduct occurred on his or her watch that's now sufficient in the SEC's mind," says Colin J. Diamond, a partner at White & Case in New York.

The use of clawbacks is likely to grow as pressure mounts to redress the difference between big executive pay packages and shareholder losses at companies whose values crumbled during the financial crisis. "It stems from the general sensitivity and public anger over the level of executive compensation and the sense that it was excessive greed that brought on the current financial crisis that's affecting everybody," says Pamela Baker, a partner at Sonnenschein Nath & Rosenthal and chair of the firm's national employee benefits and executive compensation practice group.

G-20 and Some Banks Endorse Clawbacks

Many companies already have some kind of internal clawback provision on the books. Some of the bank-reform bills working their way through Congress would expand the government's authority to demand them. Perhaps the most prominent measure was presented earlier this month by Senator Christopher Dodd (D-Conn.) as part of his proposed overhaul of the financial industry. Dodd's amendment would require publicly traded companies to recoup any incentive-based compensation, including stock options, from current or former executive officers—whether or not they committed individual wrongdoing—if erroneous data warrant an accounting restatement.

At its September meeting in Pittsburgh, the Group of Twenty, or G-20, organization of finance ministers and central bankers recommended deferring some banker bonuses and allowing clawbacks. On Nov. 10, Commerzbank joined some financial institutions, including Morgan Stanley (MS) and UBS (UBS), in reforming its bonus payment system to include clawback provisions.

But much as they satisfy an emotional need to see justice brought to the executive suite, clawbacks are not easy to implement or enforce. Such actions can be massively expensive and time-consuming. It's unlikely that any current or former employees will willingly return compensation they received—and may perceive that they earned fairly. Often the amount sought will amount to barely more than the cost of litigation, says Diamond.

Even Broader Definition of Who's Responsible?

There's a reason that Kenneth R. Feinberg, the Treasury Dept.'s special master on compensation, has focused more attention on limiting current and future executive payouts at companies that received government bailouts. Feinberg has said he is reluctant to impose widespread clawbacks, although he has the right to do so. "I'm wary of exercising that authority in too many cases," he said at a Chicago Bar Assn. meeting in September, citing the difficulty of recouping money "already paid and maybe already spent and already taxed."

"It seems easy and enticing but is actually very difficult to do," says Alan Johnson of executive compensation consulting firm Johnson Associates. Keeping the clawback provisions limited to the CEO and CFO is simple enough, he says, but hundreds of people can lose their employer's money, even in a good year. Broadening the definition of contributing to wrongdoing and those who can be deemed responsible "risks turning into a witch hunt," Johnson says. Many of his clients, including corporate and financial companies, are keeping a close eye on Congress and the SEC to see how the issue is resolved, he says.

Sonnenschein's Baker has seen an increase in calls by activist shareholders for companies to withhold pay if performance doesn't hold up. Instead of paying bonuses in full at the end of each year, she says, companies can hold on to the funds for three to five years. But that might bring further problems. "That's a long drought, and companies worry: Would you go and work for a company like that if another across the street will give you your bonus right away?"

Clawbacks are only one of the ways that the government is trying to reshape executive compensation, says Ken Raskin, head of White & Case's executive compensation, benefits, and employment law practice. Raskin argues that a one-size-fits-all solution covering all companies isn't practical. "Companies have historically had the option to tailor their clawback policies in a way that works best for them."

Deprez is a reporter for BusinessWeek.