Clawbacks are gaining favor

The Baltimore Sun

CEOs are different from you and me. They get paid for failure. They get overpaid for success.

But at least corporate boards are starting to ban them from pocketing bonuses from profits that later prove to be fake.

Lockheed Martin is one of the first Maryland corporations to adopt a "clawback" policy to address such a situation. Beginning Jan. 1, the Bethesda-based defense contractor can reclaim executive pay tied to profits that are subsequently marked down because of fraud or negligence.

"This is just good corporate governance," says Lockheed spokesman Jeffrey Adams. "There was no specific triggering event, other than the periodic assessment of our policies and practices."

That -- and perhaps Lockheed's simultaneous decision to give executives a fat golden parachute plan. The clawback policy could defuse potential criticism of the severance cupcakes.

To the uninitiated, it may seem amazing that clawback clauses are necessary. Employers would snatch tainted performance bonuses from you or I so fast our fingers would burn. Senior corporate executives, however, are a special case.

In the corporate fraudfest that began with Sunbeam and Enron and seemingly hasn't stopped, phantom profits have triggered billions in bonuses.

Often the people banking the performance loot were the same guys cooking the books to produce it. Yet little of that money was ever recovered for shareholders, say corporate legal experts.

The 2002 Sarbanes-Oxley Act attempted to encourage clawbacks, but it has proven to be largely ineffective.

Courts have ruled that shareholders can't sue to recoup executive pay on their own. And the law's muddy language makes it difficult for the Securities and Exchange Commission to do it for them. That leaves it to corporations to install clawback policies or write them into executives' contracts. "It seems to be gaining momentum, although I wouldn't say it has become universal," says David Lynn, editor of thecorporatecounsel.net and former chief lawyer for the SEC's corporate finance division. "The board wants to make sure the pay is for performance and, if something goes wrong, somebody isn't unjustly enriched."

Forty-two percent of Fortune 100 companies had clawback policies in a 2007 report by Equilar, an executive-pay research firm in Redwood Shores, Calif., although that was twice the portion from the year before. Clawback clauses are far less prevalent at smaller companies, says Equilar research manager Alexander Cwirko-Godycki.

One of the first to adopt a clawback plan was Bristol-Myers Squibb, the pharmaceutical giant that turned out to have been inflating profits by shipping drugs to distributors that didn't need them. The best-known clawback occurred late last year when former UnitedHealth Group executives involved in backdating stock options agreed to pay back more than $900 million. (Backdating caused incorrect calculation of option expense, which inflated profit.)

The purest clawback plan was disclosed last year by Intel, which will seek reimbursement of excess bonus pay whether or not top executives play a role in publishing fake profits.

A third grader could see the sense in this, but apparently most corporate boards can't. If the hole in the bull's-eye turns out to be an ink blot, you return the marksmanship prize no matter who wielded the pen.

But we'll take what we can get.

Lockheed requires executives to repay compensation if it was tied to restated profits resulting from "intentional misconduct" by the executive, "gross negligence, or failure to report another's intentional misconduct or gross negligence."

Now the burden is on others to adopt the same standards. Corporate governance pros expect to see more companies roll them out this year. But most shareholders are still at risk of paying executives for results they didn't actually produce.

As clawback plans become more popular, "it becomes more and more obvious if you don't have one yourself," says Equilar's Cwirko-Godycki. In the absence of effective federal laws requiring clawbacks, let's hope the peer pressure spreads and more boards lay ground to seek clawbacks on their own.

jay.hancock@baltsun.com

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