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Shearman & Sterling LLP Compensation, Compliance Incentives and Clawbacks – DOJ Pilot Program and the SEC Clawback Rule | 36 In this article, we review DOJ's and SEC's approaches to clawbacks of incentive-based compensation as an accountability tool, explore what public companies are doing today with respect to clawback policies, misconduct clawback triggers and compliance- promoting incentives, and describe how companies should consider adopting compensation programs that incentivize a "culture of compliance." In this article, we will describe how the DOJ and SEC are focused on using incentive-based compensation as an accountability tool, explore what public companies are doing today with respect to misconduct clawback triggers and compliance-promoting incentives, and describe how companies should consider availing themselves of the benefits of the Compensation Pilot Program, should the need arise. CURRENT REGULATORY AND ENFORCEMENT LANDSCAPE The ability to claw back incentive compensation is not a new area of focus. Since the enactment of the Dodd-Frank Act in 2009 and the SEC's proposed rules implementing Section 954 of the Dodd-Frank Act in 2015, the SEC has been focused on the importance of clawback policies as a tool to recoup compensation erroneously paid to so-called "covered individuals." 4 DOJ goes a step further than the SEC by actually rewarding companies for seeking to claw back incentive compensation paid to employees who have engaged in wrongdoing connected to certain conduct by reducing fines. There may also be additional incentive compensation regulations on the horizon: the SEC's Spring 2023 Regulatory Agenda indicates that the SEC intends to reopen the comment period on a 2011 proposed rule under Section 956 of the Dodd-Frank Act that would prohibit incentive-based compensation arrangements for individuals identified as risk takers at certain qualifying financial institutions. Further, it is not just DOJ and SEC that are pressing for individual accountability. In a recent Delaware stockholder derivative suit against McDonald's former Chief People Officer, the Delaware Chancery Court found him personally responsible for breaching his oversight duties by "consciously ignoring" warning signs pointing to pervasive misconduct. 5 WHAT ARE COMPANIES DOING TODAY? To understand how public companies are linking compliance with incentive compensation, we surveyed executive compensation disclosure and equity plans of the Top 100 Companies. Proxy disclosure filed by the Top 100 Companies with respect to the 2022 fiscal year reflected that 22 of the Top 100 Companies state in their Compensation Discussion and Analysis disclosures that compliance is one of the performance metrics in an annual bonus or long-term incentive plan in which a company's named executive officers are eligible to participate. Compliance metrics were most frequently included in the short- and/or long- term incentive programs of companies in the financial services and manufacturing industries. For companies in the financial services sector, the compliance metric most often included in incentive compensation plans relates to establishing and maintaining risk controls related to compliance with applicable financial regulations. Conversely, companies in the manufacturing sector that included compliance metrics in their incentive compensation plan typically focused on compliance with safety regulations. Individual performance metrics related to compliance are mainly with respect to compensation of the Chief Compliance Officer or the Chief Legal Officer. In the Top 100 Companies, 18 expressly include compliance or compliance-related metrics in the menu of performance metrics from which a Compensation Committee or plan administrator may use to design performance-based equity awards under their equity plans. Other plans are designed to allow plan administrators discretion to choose any performance-based metric, rather than choose from a finite list. Clawback policies are more prevalent among public companies, although the types of clawback policy triggers are not standardized. Many public companies have voluntarily adopted compensation- related clawback policies in the event of a financial restatement. Proxy disclosure filed by the Top 100 Companies with respect to the 2022 fiscal year reflected that 93 of the Top 100 Companies have a clawback policy that would require compensation to be recouped in the event of a financial restatement. Of those, 49 require fraud or misconduct related to the financial restatement, whereas 44 do not; 82 of the Top 100 Companies have a clawback policy that authorizes recoupment in the event of individual fraud or misconduct without a financial restatement. 4 The final SEC clawback rule defines "covered individuals" as "executive officers" under Section 16 of the Securities Exchange Act of 1934. 5 See In re McDonald's Corp. Shareholder Derivative Litig., 289 A.3d 343, 349 (Del. Ch. 2023); see also "Executive Departures – Is Your Disclosure Adequate?" on page 30 of the Survey.