Transcript
Dan Daly: Welcome to Executive Insights. I'm Dan Daly. Today, we're joined by a good friend, Steve Van Putten, who is a managing partner for the executive compensation firm, Pearl Meyer, here in Boston. Steve, welcome back, always nice to have you join us.
Steve Van Putten: Great to be here, Dan.
Dan: Steve, there’s been a lot of coverage in all of business media and the media in general on Wells Fargo. Let's take that directly to your area of expertise. I'd like to talk today about Wells Fargo and the clawbacks, never mind what they did wrong. Let's talk about the clawbacks because I think our viewers will be very interested on what that means today and what it means as a member of the board going forward. If you could start with just a brief history of clawbacks and then we kind of look at the ramifications of the Wells Fargo clawback thing.
Steve: Yeah, sure Dan I mean I'm discussing the implications of Wells Fargo in every board room that I'm in from a compensation standpoint. If you go back in time, it was 2010, just following Enron and WorldCom that Sarbanes Oxley got put into place, 2002. There was a clawback provision as part of that...
Dan: In the Sarbanes Oxley?
Steve: In Sarbanes Oxley, the ability to clawback compensation. It's a little bit different than what we're going to get to in terms of Dodd Frank. Back then it was only applied to the CEO and CFO. It was only in the case of executive misconduct that the board could claw back compensation.
Dan: Malfeasance?
Steve: Yeah malfeasance but there was a lot of judgment involved in defining what exactly was malfeasance. It was very limited in its application and the SEC has enforced it very weakly since that time frame. In fact, only 18 cases ever been enforced since 2011.
Dan: Not exactly too rigorous.
Steve: Right. So fast forward, Dodd Frank following the financial scandal, 2010 Dodd Frank got passed as a law. Part of that is the SEC was directed to write a clawback proposal, yes.
Dan: The writing was transferred to the SEC as responsibility, okay.
Steve: They wrote that two years ago now that they put forward proposed rules. The rules are not yet final, we'll get to that. The key elements of this and where it differs...
Dan: Right how have they changed? That would be helpful to our viewers.
Steve: Where it differs from Sarbanes Oxley is one that it applies to all executive officers and two, there's a three-year look-back period where SOX only had a one-year look-back period.
Dan: I want to jump back, all executive officers. Give me some examples, I mean before it was CFO, CEO who else might be included in that now?
Steve: Division presidents, anyone with meaningful responsibilities over a line function. That's a key aspect for the board to revisit and redefine and make sure it makes sense who your Section 16 officers are.
Dan: What is the switch that causes the restatement? Is it still malfeasance?
Steve: No this is a big, big change. It's any material restatement or noncompliance.
Dan: Okay well we'll go to our accountants and ask the definition of material.
Steve: That's going to be a key part for the board, the boards going to need to...
Dan: They should have a feel for it then.
Steve: How do you define material? That can be a little bit of a slippery slope. It's important that boards take a look at that definition of material.
Dan: Okay so quick review, the look-back period has been extended from one year to three years. It is applied to executive offices which could be a division vice president, it could be a general manager, someone running a subsidiary. Then it is no longer based, the restatement need no longer to be based on malfeasance, it's any restatement that causes it. Anything material that causes a restatement so your recommendation is talk to your accountants and have some idea of what to do.
Steve: That's number one. Two is to look at your executive pay programs to see which elements of your exec comp program could be effected. This restatement would apply to all incentive-based compensation that's linked to financial results.
Dan: That's why you're smart. Let's talk about what it applies to, that's a very good point, not base pay.
Steve: Not base pay, formula-based incentive programs that are based on financial metrics, reported or otherwise disclosed. It'd not be based on any discretionary, any operational type metrics or strategic metrics would not apply to this clawback which is interesting because the move has been a way to discretionarily cut compensation. You wonder once this rule gets implemented if companies could actually move back in some form to discretion.
Dan: You're confusing me a bit. Give me some examples of a pay program where this would apply.
Steve: Annual bonus program based on EPS, operating income, revenue growth, any traditional financial metric. If it's a subjective measure or discretionary type measure it would not apply.
Dan: Would it apply to something like defined beforehand the successful integration of an acquisition?
Steve: No.
Dan: No it would not.
Steve: Only financial metrics so that's interesting.
Dan: Only financial metrics, that is news to me. I appreciate, I'm glad you came in. I think that's going to surprise, it applies only to financial metrics that are used for incentive, not base pay.
Steve: Now go forth to equity compensation, would it apply to equity compensation? It would not apply to time-based vesting equity instruments.
Dan: That's an automatic?
Steve: That's right. So stock options that vest only based on time, restricted stock that vests only based on time would not apply to this.
Dan: I'm getting 50,000 shares this year, 50,000 shares next year and all I have to do is be alive. Now if it's performance-based...
Steve: You know many companies have moved towards performance-based equity based on relative TSR or EPS, financial metrics. Those metrics would apply in this case. Now the challenge for boards is, in the event this were to happen, is that you would have to ascribe what value of the stock price was attributed to the restatement, the effect of the restatement. That could be a very challenging outcome. It's easy to assess the impact like an EPS has on a restatement, you can define that, but what is the impact on stock price? That's more difficult. Just to clarify, these are still proposed rules but the impact of Wells Fargo is that there's now a spotlight on the SEC to move forward these proposed rules and to finalize them and get them implemented.
Dan: Because the media is going to keep, I personally think, cause Wells Fargo is a story that's got legs for a month or two.
Steve: Absolutely, the vast majority of companies do have clawbacks now but they're actually a little bit more aligned with Sarbanes Oxley in that there has to be executive misconduct in order to trigger the clawback. The new rules, Dodd Frank, go a lot further than that. Companies need to take a fresh look at their clawback policy, revisit it in light of Wells Fargo and everything that's going on.
Dan: I want to come back to that, that's important. I want to end on that note. Let's go back and you've been at this game a fairly long time. Wells Fargo is not an attractive story and watching the president in front of the Senate and the House is not attractive. Do you think that that focus is going to get the attention on clawbacks, the attention from shareholders, other stakeholders, your proxy firms, some of your money men? Is this going to become an issue—clawbacks—an issue that's discussed more robustly?
Steve: Absolutely. Boards are concerned about exposure from the media, from the public, from investors, institutional investors, but also potential litigation. That's where this could extend into is more potential litigation. We're already seeing some of that right now. Now one thing to keep in mind Dan, is that the rules for clawbacks for financial institutions are a little bit different than regular publicly traded...
Dan: Give me one example of how they're different.
Steve: One example would be for regular publicly traded companies there's a three-year look-back, for financial institutions it's a seven-year look-back.
Dan: If you're on the board of a financial institution, you better go back and look at that clawback policy even more carefully.
Steve: Right because it applies to seven years’ worth of compensation.
Dan: Your opinion that this Wells Fargo thing, which is going to be around for a while, is going to impact just companies in general relative to their clawback policy in terms of how is it designed and when it’s implemented and how serious. This is being a game changer. The idea of, “Our company has a clawback policy, we're all set.”
Steve: You can no longer keep clawback policies on auto pilot. You have to take an active current look at it right now, who it applies to, what would be the impact on current compensation arrangements and how you will need to modify it once Dodd Frank gets put into final rules. We expect, it is an election year, so things tend to slow down.
Dan: You took the words right out my, I hate it when you do that Steve, election year, the impact.
Steve: It should've come out this fall but given the fact that it's an election year, we actually don't expect it until early 2017. The effective date would be 2018 at the earliest in terms of requirements. That does not give you protection to just let it run on auto pilot as I said. You need to take a fresh look at it right now to make sure it's going to be in compliance.
Dan: We'll see what litigation, derivative lawsuits, and shareholders bring against the Wells Fargo too.
Steve: That's a whole other aspect of it.
Dan: Yeah that...
Steve: We're already seeing some of that.
Dan: It isn't just the regulatory agencies whether they're banking or the SEC. It's also going to be some shareholders are going to step in there.
Steve: Also the institutional shareholder advisory firms, ISS and Glass Lewis, they evaluate the robustness of your clawback policy and they will comment on that as part of their annual say on...
Dan: Got it, got it. Let's close with step back for a second, this has been very, very helpful and confusing to me but it won't be to our viewers. Step back, free advice, you're talking broadly to a group of directors and CEOs and COOs, what is your macro advice on this thing?
Steve: First of all, revisit the design of your incentive compensation program. Make sure, the whole purpose of putting in place clawbacks is not to create undue incentives that create undue risk that could cause material harm to the organization.
Dan: Look at your policy.
Steve: Not just the clawback policy, the design of your program...
Dan: That might lead to a clawback.
Steve: That's right. So make sure fundamentally at the start that your programs make sense, that they're not going to create undue risk. Second most important is to take a look at your actual clawback policy.
Dan: Look at your compensation policy. What does it accomplish and what risk is related to your compensation policy?
Steve: Right because keep in mind Wells Fargo, underlying this was an incentive to generate new accounts to hit sales targets that did not make sense.
Dan: Bingo, came around and caught you.
Steve: Cause and effect, look at some of the causes.
Dan: Don't just, the board today should not just look at the clawback policy. They should look at the compensation policy and how that relates or doesn't relate to clawback. You have two targets you’ve got to look at. Don't have an incentive policy that is liable to lead to malfeasance or incompetent management or something like Wells Fargo.
Steve: Any restatement due to attributable circumstances.
Dan: Is there anything in your compensation plan that would lead to a restatement?
Steve: Stress test your incentive programs. That's number one, that's most important. Then second is to revisit your clawback policy to make sure that it makes sense given the nature of...
Dan: Two tasks for the board brought about by Wells Fargo. Go back to the compensation program. Does it take you in any risk situation which could lead to clawbacks and look at your clawback policy. You have two assignments.
Steve: When you look at the clawback policy, re look at your definition of Section 16 officers and who would be covered under this program.
Dan: Why do I care about that?
Steve: You want to make sure that those that are covered are those that actually could contribute to the risk of the organization and to cause...
Dan: You probably going one step further, you probably want to explain to these people that are potentially involved that this is the new game and you have to be aware of the impact of a compensation program and be aware of what your people are doing.
Steve: Exactly, actually yeah, be involved. Be aware of the organization, what's going on, what your incentive programs actually do.
Dan: Nothing is automatic. Steve, absolutely terrific, lot of time on Wells Fargo but I think it's relevant because it brought us and thank you very much for closing on the recommendations to the board. I think that's very helpful for any board of any size. Steve, thanks so much. We'll be back in a minute.
