How Updated DOJ Guidance On Compensation Clawbacks Intersects With The World Of Employment Law

• Jurisdiction: United States,Federal
• Law Firm: Arnold & Porter
• Subject Matter: Corporate/Commercial Law, Compliance, Corporate and Company Law, Securities
• Author: Ms Soo-Mi Rhee, Joshua Alloy and Daniel Bernstein
• Published date: 17 May 2023

Through recent updates to its guidance on corporate compliance, the US Department of Justice (DOJ) is encouraging companies to consider adopting (or updating) policies on compensation clawbacks. Actually seeking to claw back compensation from current or former employees who engaged in or oversaw wrongdoing, however, is not an easy task. In this Advisory, we discuss how compensation clawback policies may intersect and possibly conflict with the world of employment law as well as practical reality, including potential legal bases for clawing back compensation, what clawing back compensation may actually look like in practice, and potential complications.

Background on DOJ Corporate Compliance Guidance

In March 2023, DOJ's Criminal Division updated its guidance on Evaluation of Corporate Compliance Programs. One of the key changes is the emphasis on tying employee compensation systems to compliance, including through potential clawbacks of compensation paid to employees who engaged in or oversaw wrongdoing. To further encourage companies to implement such compensation systems, the Criminal Division has also launched a Pilot Program Regarding Compensation Incentives and Clawbacks. Among other features, the Pilot Program will provide companies that successfully recoup compensation from errant employees with a reduction of fine in the amount equal to any compensation successfully clawed back. In addition, even if ultimately unsuccessful, companies that, in good faith, attempt to claw back compensation from employees engaged in wrongdoing may be eligible to receive a fine reduction of up to 25% of such compensation. Thus, DOJ is strongly encouraging all companies - public and private, large and small - to consider adopting a compensation system that includes clawback policies as part of an overall approach to improving and developing a compliance program and demonstrating ethical leadership.

Law for Public Companies on Clawbacks

The idea of a compensation clawback policy is not new, at least for publicly traded companies. Since 2002, Section 304 of the Sarbanes-Oxley Act has permitted the SEC to order the clawback of any bonus, incentive pay, or stock sale profits received by a CEO or CFO, where the company has had to restate its financials as a result of misconduct. And since 2015, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Section 10D of the Securities Exchange Act) has required the SEC to direct stock exchanges and securities associations to require listed companies to adopt and comply with a written clawback policy, again focusing on incentive compensation paid and calculated based on financial statements that were later restated due to noncompliance with financial reporting requirements. After eight years, the SEC issued final rules (Rule 10D-1) in January 2023, with a scheduled effective date in November 2023.

Faithless Servant Doctrine

Some states have long recognized the common law "faithless servant" doctrine. Rooted in the law of agency and fiduciary duty, the "faithless servant" doctrine gives employers the ability to sue an employee for acts of disloyalty, and, importantly, recover compensation paid to that employee during such periods of disloyalty or faithlessness. While New York is the most well-known for recognizing the doctrine,¹ several other states - including New Jersey,² Massachusetts,³ California,⁴ Mar...