Imagine your company has gone through a Foreign Corrupt Practices Act (FCPA) investigation. As you near the end of the investigative phase and move into the enforcement phase, you tell the government that you have terminated the culpable employees or rather in reality you allowed them to ‘resign to pursue other opportunities.’ As a part of the acceptance of the culpable employees resignation, you allow them to keep a multi-million bonus and severance package. When the government asks you why Human Resources (HR), the Board of Directors or even senior management allowed this to occur, you tell the government, that if the company sought clawbacks for bribery and corruption, it would harm the company’s recruitment of top notch talent going forward.
Sound far-fetched or even like fiction? Apparently not, from our friends of noted good corporate government and ethics at United Airlines (UA), as reported by Gretchen Morgenson in a piece in her New York Times (NYT) Fair Game column, entitled “How Badly Must a C.E.O. Behave Before His Pay Is Clawed Back?”. In the continued sordid tale of bribery and corruption here in the United States involving UA, its former Chief Executive Officer (CEO), Jeff Smisek and David Samson, the then chairman of the Port Authority of New York and New Jersey. As Morgenson reported, “Mr. Samson, whose position gave him great sway over Newark Airport, wanted access to convenient flights to his second home. He had threatened to bar United from building a crucial hangar on-site if it did not start flying to Columbia. Mr. Smisek approved the restoration of the route “outside of United’s normal processes,” federal investigators said. The same day, the Port Authority approved the airline’s hangar project.” In legal parlance, that is known as a Quid Pro Quo.
UA received a Non-Prosecution Agreement (NPA) from criminal prosecution from the Department of Justice (DOJ) and paid a fine of $2.25MM to the government. As one of the conditions of the NPA was that UA “separated” itself from certain employees who engaged in the corrupt behavior, including former CEO Smisek. However, in what can only be termed a ‘soft landing’, Morgenson reported “What might otherwise have been a hard landing for these managers was cushioned significantly by their severance packages. Mr. Smisek received a separation payment of almost $5 million and restricted stock and other awards. The package totaled $28.6 million”.
The company also received a civil fine of $2.4MM from the Securities and Exchange Commission (SEC) for internal controls violations. Most interestingly the SEC invoked the internal controls provisions of the FCPA, in this case of domestic bribery and corruption. This use of the FCPA by the SEC was certainly novel but it put all US entities on notice that the SEC could use FCPA’s Accounting Provisions, including internal controls and books and records, in domestic corruption matters.
One of the company’s shareholders, “the City of Tamarac, Fla., Firefighters Pension Trust Fund” was fed up enough and filed a notice of claim against UA, “In a litigation demand, it requested that the company’s board claw back the severance pay given to the executives who took part in the bribery scandal. By doing so, United’s board would correct its breach of fiduciary duty and prevent “the unjust enrichment” of company executives.”
The response of UA was beyond priceless, as Morgenson noted, “In a letter to the pension fund, a lawyer for United explained that it would harm the company to give the board “unfettered discretion to recoup compensation” in cases involving wrongdoing. “Where such discretion is out of step with industry norms,” the letter said, it would “make it difficult for United to recruit and retain top talent, particularly at the senior management level.” [emphasis supplied]
Yes, a company which had admitted to engaging in FCPA violations just said that it could not seek a clawback from the guilty executives because it would hurt recruiting. Now imagine if this argument was presented to the DOJ during the negotiations over the NPA. What would its response have been? Something along the lines of “so you want to recruit top talent who is prone to or engages in bribery and corruption, particularly at the senior management level?”
Morgenson had previously discussed clawbacks in reviewing the Wells Fargo Board of Directors in a piece entitled “Executive Pay Clawbacks Are Gratifying, but Not Particularly Effective”. In that article, she noted there are other reasons Boards rarely order clawbacks. The first is the Board has to find there was misconduct and then determine that the misconduct was material. She cited, “Steven A. Bank, a law professor at the University of California, Los Angeles, and an expert on executive pay”, who said “he was unsurprised that clawbacks are so rare. One major reason, he said, is that corporate directors are typically given enormous leeway in deciding when to pursue them. Unless they are forced to do something, they probably won’t.”
A second reason is the “element of discretion inherent in clawback programs relates to the board’s judgment over whether any wrongdoing has a material impact on the company. This concept of materiality is famously subjective, giving directors lots of room to determine that improper activities were not in fact meaningful enough to recover pay”. She cited to George S. Georgiev, an assistant professor at Emory University Law School, who said, “The nebulous nature of materiality is a problem in these matters.”
Finally, Boards are more accustomed to awarding pay and not taking it away. Finally, there is simply the question of whether the Board members were equipped to perform the job duties of a Board member. Morgenson wrote, “corporate directors tend to weigh them in a narrow, rules-based way when they should instead take a broader, more common-sense view.” She quoted Frederick E. Rowe Jr., chairman of Greenbrier Partners, a money management firm in Dallas, for the following, ““directors ought to know bad behavior when they see it. It all comes down to this: Are you doing something to the customer or for the customer?” That seems a pretty simple question. Too bad the Wells Fargo board didn’t think to ask it.”
But these reasons are based on the scale of the conduct and size of the penalty. It is not some attempt to claim that following the law would hurt our recruiting efforts. At UA, not only does tone start at the top but it permeates down the entire organization.
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