As readers of this Newsletter are likely well aware, in March 2023 Deputy Attorney General (“DAG”) Lisa Monaco while speaking at the ABA Criminal Justice Section 38th National Institute on White Collar Crime announced a Compensation Incentives and Clawbacks Pilot Program (“Pilot Program”) at the Criminal Division (“Division”). The following day, Assistant Attorney General (“AAG”) Kenneth A. Polite, Jr. of the Division, also delivered remarks at the Institute about the Pilot Program, at which point the Division published a short memorandum describing how the Program will operate. This article provides brief background on the Pilot Program before highlighting a series of important considerations for companies and those who advise them in relation to this Program.
Effective March 15, 2023, the new Pilot Program has two parts.
The first part requires that every corporate resolution entered into by the Division “shall include a requirement that the resolving company implement compliance criteria in its compensation and bonus system.” Such criteria may include (1) providing incentives to those employees who demonstrate and promote “full commitment to compliance processes;” (2) mandatory withholding of bonuses for employees who fail to meet “compliance performance requirements;” and (3) disciplinary measures for employees who violate applicable law and those who “both (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” (“Responsible Employees”). The Program gives prosecutors the discretion to “fashion[] the appropriate requirements” based on the facts of the case, but also directs them to “be mindful of, and afford due consideration to,” how the company’s existing compensation program is structured. Resolving companies will also be required to report annually to the Division about their compensation and bonus systems during the term of any resolution.
The Program’s second component permits fine reductions for certain eligible companies in instances where the company attempts to recover compensation from Responsible Employees. The amount of the corporate fine reduction is commensurate with the compensation the company successfully recoups from these Responsible Employees. To be eligible, a company must fully cooperate, timely and appropriately remediate, and demonstrate that it has implemented a program to recoup compensation from Responsible Employees. Related to the latter point, at the time of the criminal resolution, the company must have “in good faith initiated the process to recoup such compensation.”
Companies that take advantage of this Pilot Program pay a penalty equal to (a) the penalty they otherwise incurred under the resolution, less (b) the compensation they are attempting to claw back. If a company succeeds in recouping the full compensation amount, it can keep those proceeds and need not pay the government that part of the penalty. If it fails in recouping 100% of the deferred penalty amount by the end of the resolution term, the company will owe a deferred penalty equal to the portion it did not recover. However, under these latter circumstances, prosecutors have the discretion to credit companies up to 25% of the compensation they “in good faith” tried to claw back, as determined in the Division’s “sole discretion.” Considerations relevant to the that discretion may include whether a company incurred “significant litigation costs” attempting to recover the compensation, or “can demonstrate” that it is “highly likely” to recover the compensation “shortly after the end of the resolution term.”
As DAG Monaco noted when announcing the Pilot Program, DOJ “intend[s] this program to encourage companies who do not already factor compliance into compensation to retool their programs.” DOJ’s calculus also is that “these policies empower general counsels and compliance officers to make the case to company management” that proactively implementing compliance metrics and clawback components into compensation arrangements “is money well spent.” Whether this initiative will, in practice, lead to further adoption of—and then actual attempts to utilize— clawback provisions in employment and other agreements remains to be seen.
Under the Pilot Program, the most tangible advantage to having clawback arrangements in place early is that the company is positioned to take advantage of potential penalty reductions (for pursuing compensation clawbacks from Responsible Employees) should a criminal resolution with a fine component become necessary in the future. Given DOJ’s focus on employee compensation, there may also be a more general benefit to having these clawback arrangements in place to demonstrate the effectiveness of a company’s compliance program. This is especially so for companies operating in environments that present a meaningful enforcement risk.
Although meeting and exceeding DOJ expectations about leverage employee compensation to promote compliance is unquestionably a positive, there are, however, several considerations on the other side of the ledger. For example:
The Jury is Out: To be sure, DOJ certainly is encouraging—indeed, pushing—companies to link compensation to compliance, even if that means adopting clawback arrangements with employees and executives. But the Pilot Program has just been rolled out and how it will work in practice is still quite uncertain.
Meaning of “Good Faith”: The Division’s policy on the Pilot Program twice incorporates a “good faith” standard, and it remains to be seen how the Division will exercise its sole discretion to apply that standard. As a starting point, it is unclear whether “in good faith initiat[ing] the process to recoup such compensation” will necessarily mean commencing litigation. Importantly, under the Pilot Program, although litigation costs are a factor for federal prosecutors to consider when deciding whether to award a 25% credit for non-successful recoupments, litigation costs are not part of what may be deferred from the actual penalty. Thus, it is worth considering that clawback litigation has historically proven quite expensive, and in many cases its costs can exceed what the company may hope to recover.
Moral Hazards: Beyond that, if litigation is required, there is concern that given DOJ’s position on the need for companies to claw back employee compensation, companies may feel compelled to engage in “scorched earth litigation” against Responsible Employees to recoup the maximum possible amounts of total compensation. That may be true even when the cost to litigate exceeds the value of the recoupment, thereby making settlement the most prudent outcome, especially when the company factors the time, cost, resources, distraction, bad press, and internal morale issues that may accompany continued litigation.
Litigation Time Horizon: Companies should also consider how likely it is that clawback litigations will be resolved within the term of the resolution. In cases where the company is unable to recoup 100% of the compensation at issue before the resolution period expires, the company can at most hope to receive a 25% credit toward its penalty—subject to the Division’s exclusive discretion.
Inability to Pay: Also, the Pilot Program does not speak to what a company should do when the Responsible Employee from whom the company seeks to claw back compensation and bonuses is unable to return the money in question. DOJ does not speak to whether it expects the company to proceed with litigation to obtain a judgment, even in the face of a Responsible Employee’s inability to pay. In addition, the cost of litigation cuts in both directions: The same way that the costs to litigate clawbacks can be expensive for companies, they can be equally—if not more—expensive for individuals. Thus, even if a Responsible Employee ensnared in litigation could have returned (or been willing to return) some compensation to the company, prolonged litigation could actually consume that employee’s personal funds, leaving the company in a net worse position from both a cost and recovery standpoint than had the company settled early on.
Conflicts with Corporate Charters, Bylaws, and State Law: It is commonplace for most (if not, nearly all) companies to authorize advancement of fees and indemnification for its officers and other key executives in accordance with applicable state law, say, the law where the corporation is chartered. Delaware law, for example, authorizes advancement of fees and indemnification for officers and key executives in the event of “any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative” so long as that “person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.” In clawback litigations, which are actions or suits “by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was a director, officer, employee or agent of the corporation,” Delaware law states that a “corporation shall have power to indemnify [such] person” if the person “acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation[.]” But, a corporation’s option to provide indemnification evaporates—and becomes an obligation—when a “present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to [in this paragraph] or in defense of any claim, issue or matter therein[.]”
Thus, a company cooperating with DOJ while under criminal investigation might decide to pursue clawback litigation against an executive, whether to demonstrate its commitment to cooperate or to otherwise fall within the scope of the new Pilot Program. That company could even wait until it resolves its criminal case and admits liability to pursue such clawback litigation. But, a company’s admission of guilt (or responsibility) cannot be imputed to an individual. Indeed, there are plenty of examples where a company has admitted guilt (or responsibility) because of an employee’s (or group of employees’) actions, only for a jury to subsequently exonerate that/those employee(s)—or in some cases, for the DOJ to even drop charges against one or more of those employees. Thus, rather than assume clawback litigation is appropriate under all (or most) circumstances where a company resolves its criminal case short of litigation, whether by guilty plea, deferred prosecution agreement, or non-prosecution agreement, companies (and their counsel) would do well to consider carefully and objectively whether when put to the ultimate test, the evidence of any particular executive’s actions will convince a jury (or judge) of the executive’s liability. Not doing so could mean not only an unsuccessful clawback litigation, but that the company “shall” pay that executive’s “expenses (including attorneys’ fees) actually and reasonably incurred . . . in connection therewith[,]” in addition to having to bear the costs of litigation it has incurred for itself.
Cost and Ability to Implement Companywide: Companies will also face the issue of whether it is practical to implement this type of change across the organization. This is especially so for multinational companies with employees and executives located all over the world and subject to the local employment laws of various foreign countries, whether located, say, in Europe, Asia, South America, or the Middle East. Indeed, reworking employment agreements—or trying to do so after an employee has already started work—could be prohibited by the laws of a particular foreign jurisdiction. Were that so, companies could find themselves “between a rock and a hard place” in terms of trying to proactively (or reactively) please DOJ while at the same time adhering to the foreign law dictating the employment relationship between the employee and the company. Indeed, the issue is complicated all the more where employees are already working under existing employment agreements and making such changes would require renegotiating several (or many) different employment contracts all over the world.
Ability to Retain and Recruit: It is unclear what DOJ might expect a company to do if an employee refuses to agree to modify an existing employment agreement. An employee might argue that a company breaches an agreement if it unilaterally tries to change it or otherwise places enormous pressure on an employee to agree to a modification. Terminating an employee who refuses to comply may well lead to its own litigation. In the alternative, insisting on modifying an employment agreement might well cause a key employee to resign. And, if nothing else, companies also will have to consider whether requiring clawback provisions in employee contracts makes it more difficult to attract talent at key positions, especially in a competitive jobs market.
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By design, the Pilot Program certainly presents a planning opportunity for companies to consider employee compensation changes. Compliance and in-house legal professionals (and the attorneys who advise them) should take this opportunity to evaluate the feasibility and appropriateness of a clawback element to their company compensation programs. Compliance and legal stakeholders should also sensitize management to the current DOJ’s continued focus on individual accountability in the event compliance issues develop down the road. There is certainly no one-size-fits-all approach to implementing DOJ’s policy initiative in this space; indeed, solving one issue might well create a new one, especially for companies with pre-existing (and heavily negotiated) executive contracts already in place. Thus, the topic of encouraging—and, in the case of corporate criminal resolutions, requiring—companies to implement compliance criteria in their compensation and bonus systems, to and including adding potential clawback provisions in employment agreements and pursuing clawback litigation against Responsible Employees, is exceedingly complex with various moving parts that require careful consideration and analysis.
