This post was originally issued as a Baker McKenzie client alert authored by Geoff Martin and Maria Piontkovska in our Government Enforcement Group, Sinead Kelly in our Executive Compensation Group and Benjamin Ho in our Labor & Employment Group.
On March 3, 2023, the Criminal Division of the United States Department of Justice (“DOJ”) published details of a three year Pilot Program Regarding Compensation Incentives and Clawbacks (the “Compensation Pilot Program”). The Compensation Pilot Program is effective March 15, 2023 and from that date it will be applicable to all corporate criminal matters handled by the DOJ Criminal Division. At the same time, DOJ also updated its Evaluation of Corporate Compliance Programs guidance document to reflect the criteria introduced by the Compensation Pilot Program, among other updates.
Background and Objectives of the Compensation Pilot Program
The concept of incentivizing corporate compliance by structuring compensation programs to reward compliant behaviors and punish non-compliant ones, is nothing new. For example, prior editions of the Evaluation of Corporate Compliance Programs addressed appropriate incentives for company management and executives to promote good governance and compliance, and expectations about the consistent application of discipline against employees found to be involved in misconduct.
However, in a September 2022 memo to DOJ prosecutors titled: “Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group“, Deputy Attorney General Lisa Monaco indicated that DOJ intended to go further on this particular topic. In the memo, Monaco indicated that DOJ would expect companies to design compensation structures not only to incentivize and reward good compliance practices, but also to financially penalize individual employees found to have been engaged in misconduct, including by clawing back compensation after the fact.
DOJ’s objective in this initiative is to encourage companies to redistribute some of the cost and penalties associated with individuals’ criminal conduct away from the company (and its shareholders) and onto the individuals themselves. Because misconduct is often discovered after the fact, measures that enable retroactive discipline and clawback of compensation already paid, are of particular importance to DOJ. These measures also reinforce DOJ’s continued focus on individual accountability which has been another of DOJ’s recent areas of focus in addressing corporate criminal matters.
Six months after Monaco’s memo, the Compensation Pilot Program now puts concrete DOJ policy in place to implement those objectives. At the end of the three year pilot period, DOJ will determine whether the Compensation Pilot Program will be extended or modified. If it is deemed a success, we can expect the Compensation Pilot Program to be fully adopted by DOJ.
Overview of the Requirements of the Compensation Pilot Program and its Potential Reductions in Penalties
(1) Compliance Program Requirements for Companies Resolving Corporate Criminal Matters
During the term of the Compensation Pilot Program, every corporate criminal resolution entered into by DOJ will include a requirement that the resolving company implement criteria related to compliance in its compensation and bonus systems. Subject companies will have to report to the Criminal Division annually during the term of the resolution about its implementation of such criteria.
While DOJ prosecutors are expected to tailor these criteria to each company and the facts of each case, the Compensation Pilot Program lists the following examples of potential compliance criteria that companies may be required to implement: (1) a prohibition on bonuses for employees who do not satisfy compliance performance requirements; (2) disciplinary measures for employees who violate applicable law and others who (a) had supervisory authority over the employee(s) or business area engaged in the misconduct and (b) knew of, or were willfully blind to, the misconduct; and (3) incentives for employees who demonstrate full commitment to compliance processes.
(2) Reduction in Criminal Penalties for Companies that Claw Back Compensation, or Attempt to do so
The Compensation Pilot Program further provides that Criminal Division prosecutors shall apply, in addition to any other reduction available under applicable DOJ policy, a fine reduction in an amount equivalent to any compensation that is recouped from executives during the period of the resolution. Recognizing the practical difficulties and likely timeframe of such clawbacks, the Compensation Pilot Program suggests reducing the applicable fine by amounts the company expects to be recouped during the relevant resolution period, and then providing that the company will pay the fine in full if these amounts are not actually recouped.
On the other hand, if a company’s good faith attempts to recoup compensation is unsuccessful, Criminal Division prosecutors may in their discretion apply a reduction of up to 25% of the amount of compensation the company attempted to claw back. The Compensation Pilot Program notes that such reductions may be warranted where, for instance, a company incurred significant litigation costs, or can demonstrate that it is highly likely that it will successfully recoup the compensation shortly after the end of the resolution period.
Implications Both for Companies Resolving Corporate Criminal Matters with DOJ . . . and Those That are Not
Implementing compliance-related compensation incentives and clawbacks will only be mandatory under the Compensation Pilot Program for those companies that resolve a corporate criminal matter with DOJ. Nevertheless, as has been the case with prior DOJ compliance guidance issued in the enforcement context, many companies and their compliance departments will look to the Compensation Pilot Program as an indication of DOJ’s expectations of best practice in corporate compliance.
This messaging is reinforced by the updated DOJ Evaluation of Corporate Compliance Programs guidance document which now includes a section on “Compensation Structures and Consequence Management” addressing compensation incentives and clawbacks. In this way, such compensation structures and clawbacks may become corporate compliance best practice even for companies not before DOJ. In addition, having these mechanisms in place would better position any company which later found itself before DOJ in connection with a corporate criminal matter. Accordingly, many companies will choose to adopt such policies proactively.
Practical Considerations for Implementing Compensation Incentives and Clawbacks into Compensation Plans
Companies seeking to amend their corporate compliance programs and compensation models to align with the Compensation Pilot Program should evaluate the ways in which their current incentive programs may be updated to encompass performance objectives tied to corporate compliance and to otherwise reward and incentivize appropriate employee behavior. Further, companies should strongly consider adopting a clawback policy or amending any existing policy to allow for the recovery of previously-paid compensation in circumstances such as those contemplated by the Compensation Pilot Program and revised Evaluation of Compliance Programs document.
A company’s right to seek a clawback pursuant to any such policy should be incorporated in employment agreements, offer letters and severance agreements, as well as in the terms of the company’s bonus, equity and incentive plans. Doing so will increase the company’s prospects of successfully pursuing a clawback of applicable compensation if required to do under a resolution with DOJ or as part of the company’s enhanced compliance program having identified employee misconduct itself. Further, it will be evidence of best efforts by the company even if the clawback is ultimately unsuccessful.
Additionally, US-listed companies currently working to prepare their clawback policy to implement the clawbacks mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (and required to be adopted shortly in 2023), should ensure that they simultaneously consider DOJ’s new guidance and brief their compensation committees, executives and other appropriate internal stakeholders about potential expansion of those clawback policies and procedures to address the requirements of the Compensation Pilot Program.
Practical Considerations for Enforcing Clawbacks
State wage and hour laws make it difficult for companies to recoup or claw back compensation from executives or employees under most scenarios. State laws impose varying degrees of restrictions on an employer’s ability to make withholdings from their employees’ wages. Under most state wage and hour laws, once a wage is earned, it belongs to the employee and generally cannot be forfeited or clawed back except where permitted or required by applicable law.
There can however, be some greater flexibility with regard to equity awards, bonuses and commissions. For instance, if receipt of equity or earning a bonus or commission is made conditional upon the occurrence of specific criteria, then employers can argue that the incentive payment was never earned and refuse to pay any remaining payment and/or demand repayment of any already paid incentive payment. If, however, an employer gets this wrong (and a clawback is deemed not permitted or required by law), this could expose the company to claims from the executive or employee.
Companies should also keep in mind that employee protections are typically greater outside of the US and so the instances where clawbacks are permissible under applicable foreign law are generally more limited than in the US. This is a particularly significant consideration for non-US companies which may nevertheless find themselves subject to the criminal jurisdiction of DOJ (for instance due to their listing of shares on a US stock exchange). For those companies, the disparities between employment laws of their home country and the expectations of DOJ may be particularly stark. In addition, many corporate criminal cases, particularly those brought under the US Foreign Corrupt Practices Act, have a strong international component, where the relevant employees may be located across a number of different jurisdictions. Ensuring consistency of treatment and equally enforcing clawbacks in those cases will be challenging.
For those companies navigating the complexities of employee management and discipline during the course of a DOJ criminal investigation, there are now additional factors to consider in deciding if, when, how, and against whom to enforce compensation clawback. On the one hand, a company faced with criminal enforcement may be incentivized to attribute blame to certain executives from which a clawback could more easily be sought in order to gain full cooperation credit from DOJ and to reduce the company’s fine. On the other hand, there also will be challenges for each of the company, its employees and DOJ itself in balancing the defense rights and interests of individual employees who may be simultaneously facing individual criminal charges. It will be interesting to see how the Compensation Pilot Program impacts and interacts with Lisa Monaco’s other recent imperative to DOJ, that prosecutors also prioritize bringing cases against those individuals found to be involved in corporate criminal conduct.
For most companies, meeting the expectations DOJ set out in the Compensation Pilot Program will require significant changes to existing compensation structures, policies and employment agreements. Even for those companies that do implement these structures ahead of time, enforcing them, either in connection with a DOJ resolution or otherwise, it is likely to be challenging, especially outside of the US.