January, 2016 | Issue 1

EXECUTIVEBRIEFINGCANADA

Your executive compensation resource

CANADA’S COMPENSATIONCLAWBACK POLICIES ON THE RISE

In July 2015, the US Securities ExchangeCommission (“SEC”) released its proposalon mandatory remuneration clawbacksthat will apply to all Canadian issuerslisted on US exchanges without anyexemption. Under the SEC requirements,any compensation paid due to an errorthat triggers a material financial

re-statement can be recovered.

There is no similar requirement inCanada. We are uncertain whether theCanadian Securities Administrators(“CSA”) will follow the SEC proposedrules. We do know that proxyadvisors and institutional shareholdersin Canada are supportive of theclawback concept.

That said, 80% of S&P/TSX 60companies in Canada have

voluntarily adopted remuneration clawback policies. Between 2014 and 2015 disclosures, organizations in the energy industry showed a significant increase in adoption.

Typically, Canadian clawbackpolicies do not cover all “executives”across the organization or majorbusiness units.

The exact method of defining theamount of clawback is not formulaic.Board discretion on a case-by-casebasis seems to be common.

Going forward, could mid-sizeand smaller issuers in Canada bepressured by their shareholdersand the strong support from proxyadvisors to adopt a clawback policy?

HIGHLIGHTSClawbacks

Highlights

De�nition

Risk factors

Proposed SEC rules

Current landscape in Canada

SEC implications

Other possibilities

IS COMPENSATION A CONTRIBUTORY FACTOR FOR RISKS?

Clawback policies on the rise 2

Yes. This is especially true in the financial industry. Since 2012, the CSA disclosure rules required issuers to consider as a whole the composition of compensation committees, the role(s) of compensation advisors, and compensation frameworks in order to identify and assess any risks inherent in compensation arrangements. Boards are continuously seeking more clarity, better assessment tools and e�ective control mechanisms to address the relationship betweenrisks and compensation. The following are some of the factors that could encourage risky behaviour and inappropriate outcomes:

Governance and oversight:checks and balances are notsu�cient in the decision-makingprocess.

Ex-ante1 compensation programdesign: performance metricsand pay opportunities are notaligned properly to reflect theacceptable risk appetite of theorganization.

Ex-post2 compensation policy:the absence of any malus3

arrangements or clawback,which are e�ective toolsin dealing withunanticipatedoutcomes.

Actual implementation andpractice: the culture, businessconduct and/or administrativeprocess are not working togetherto support the desired riskmanagement standard setby the organization.

A clawback in North America is typically initiated with

either a fraud/misconduct committed by the covered

employees or after a �nancial restatement within the

look-back period. In many cases, clawback provisions

are triggered by both �nancial restatement and fraud/

misconduct. In fewer instances, clawback provisions

can apply if a former employee has breached a non-

competition agreement after leaving the organization.

In this article we will examine the ex-post defense (remuneration clawback due to erroneous information) in

the US Securities Exchange Commission (SEC) proposal and the current clawback policies in large Canadian

issuers (S&P/TSX60).

WHAT IS COMPENSATION CLAWBACK?

SEC PROPOSED RULES ON MANDATORY COMPENSATION CLAWBACK:

Clawback policies on the rise 2

not been sold, the recoverable amount is the number of shares underlying the excess stock options or SARs after applying the restated financial measure. Lastly, where the shares obtained have been sold, the recoverable amount would be the sale proceeds received with respect to the excess shares, reduced to reflect the applicable exercise price.

5. For incentive-based compen-sation based on stock price oron TSR, where the amount oferroneously awarded compensa-tion cannot be calculated directlyfrom the information in arestatement, the proposed rulespermit companies to determinethe recoverable amount byusing a reasonable estimate ofthe e�ect of the restatement onstock price or TSR.

6. The proposed rules areanticipated for implementatione�ective with the 2017 proxyseason.

Almost five years after the 2010 enactment of the Dodd-Frank Act, the SEC in July 2015 released proposed rules to implement section 954 of that legislation regarding the “recovery oferroneously awarded compensa-tion”, as highlighted below:

1. The recovery requirementwould be triggered by a restate-ment to correct an error that ismaterial to previously issuedfinancial statements. The recoveredamount (determined on apre-tax basis) of incentive-basedcompensation will be the excessportion that would have beenreceived under the restatement.As expected, this may be themost complicated portion of theproposed rules, “the devil is inthe details.”

2. The clawback policy appliesto any individual (including aformer employee) who served asan executive o�cer of the companyduring the three-year periodpreceding the date when anaccounting restatement isrequired. The term “executiveo�cer” includes the company’spresident, principal financialo�cer, position(s) in charge of aprincipal business unit, divisionor function, and any otherperson who performed similarpolicy-making functions for thecompany.

3. The proposal defines incentive- based compensation as anycompensation granted, earned orvested (all or in part) on the attain-ment of any “financial reportingmeasure.” The SEC further providesthat financial reporting measuresare any measures determined andpresented in accordance with:i. The accounting principles used

in preparing the company’sfinancial statements,

ii. Any measures derived (all orin part) from such financialinformation, and

iii. Stock price and total share- holder return (TSR).

4. For equity awards where theshares, stock options or SARs arestill held at the time of recovery,the recoverable amount is thenumber of shares, stock optionsor SARs received in excess of thenumber that should have beenreceived after applying the restatedfinancial measure. If the stockoptions or SARs have been exercised,but the underlying shares have

Clawback policies on the rise 3

No

Yes

No

Yes

FY 2014

Use of Clawback Policies (% of Organizations)

WHAT IS THE CURRENT LANDSCAPE OF CLAWBACK IN CANADA?

This applies to cases where a bonus was paid to an executive “on the apparent achievement of performance metrics in a particular year, and it later becomes clear that the metrics were not achieved”, and also in cases of “material earnings restatement or other company-specific change that significantly reduces shareholder value.”

are not limited to: clawbacks, holdbacks, stock ownership requirements, deferred compen-

sation practices, etc.”; and

Canadian Coalition for GoodGovernance (“CCGG”) clearlystates that “the company shouldensure it has a specific rightto require the return of thebonus and to cancel unvestedcompensation awards”.

While there is no law or regulatory requirement on clawback policies in Canada, voluntary use of such arrangements is increasing. Proxy advisors and institutional investors favour clawbacks, as noted below:

Institutional ShareholderServices (“ISS”) supports the“existence of measures thatdiscourage excessive risktaking which include, but

FY 2015

S&P /TSX60

Financial Material

20%

80%

CEO80%

CFO78%

VP40%

Energy

20%

80%

10%

90%

36%

64%

S&P /TSX60

Financial Material

32%

68%

Energy

53%

47%

10%

90%

50%

50%

[1] How popular are clawbacks? Our research indicates that 80% of S&P/TSX 60 organizations had voluntary

clawback polices in place as disclosed in 2015, compared to 68% a year ago. The energy industry has shown a

signi�cant increase in prevalence, while the �nancial industry has a high usage of clawbacks over the years.

From the voluntary clawback policies disclosed, the covered employees vary between organizations, with the

CEO included in the majority of cases and Vice Presidents included in fewer cases. This re�ects that the claw-

back policies do not universally cover all “executive o�cers” across the organization or major business units.

Clawback policies on the rise 4

Use of Clawback Policies (% of Executives)

Foreign Private Issuers (i.e. Canadian companies that are dual or cross-listed in US stock exchanges) will not be exempted from the proposed mandatory clawback rules. Going forward,

will the CSA adopt the same or similar SEC rules? Even without such rules in Canada, the majority of large Canadian issuers have already voluntarily adopted some form of clawback policy. Mid-size

and smaller issuers could be further pressed by their shareholders, with the support of proxy advisors to adopt a clawback policy.

WHAT ARE THE IMPLICATIONS OF THE SEC PROPOSED RULES IN CANADA?

80%

86%

100%88%

33%

33%

84%

12 months

Not stated

36 months

24 months

Look-back Period (% of Organizations)

Financial

11%

23%Material

Financial Material

14%

S&P /TSX60

63%

Energy

8%17%

10%

8%10%

Yes

No

Board Discretion to Determine Clawback Amount (% of Organizations)

20%

S&P /TSX60

12%

88%

Energy

12%

[2] How long is the look-back period? Look-back period is de�ned as the length of time in which the

organization can recoup compensation awarded to the covered employees. In most cases, the length of

the look-back period is not stated, with only one-third of organizations explicitly de�ning the clawback

period. When stated, 12 to 36 months tends to be the norm.

[3] What compensation elements are included in clawbacks? More than 60% of the S&P/TSX60 organizations

have speci�ed the incentives subject to clawback. Elements of incentive compensation typically include paid

bonuses, stock options, restricted share units, performance share units, as well as other forms of long-term

incentives.

[4] How is the amount of clawback determined? In most organizations that have a clawback provision, it is

common that the board evaluates each case individually to determine the clawback amount.

Clawback policies on the rise 5

As a result of clawback policies, will companies consider addition-al compensation opportunities to o�set the “downside” of clawback? Governance propo-nents will likely disagree with this approach which implicitly inflates the compensation oppor-tunity for a probable but material error. It is highly unlikely that boards will support the idea of using a higher compensation to “ensure” no wrongdoing!

Will organizations consider additional holding periods to the vested payouts of incentives? Recouping the vested amount

is likely “easier” than recouping the paid amount (especially with the after-tax issues). This is a complex question and it depends on many moving variables such as di�erent time risk horizons for the enterprise and business units, the company’s human capital priorities, business cycle of the issuer, local tax rules on deferred compensation, and varying needs for di�erent employee groups. We anticipate that there will be no single approach.

How do boards determine the amount of clawbacks? We have learned that Canadian issuers

typically use board discretion and consider situational factors in determining the amount. Nevertheless, generally acceptable principles or guidelines would be ideal to ensure fairness. The SEC has proposed that the recoverable incentive amount be deter-mined by using a reasonable estimate of the e�ect of the restatement on stock price or TSR. Without doubt, the estimate of the “true” stock price/TSR if those errors were not made could be a very challenging task!

WHAT ARE OTHER POSSIBILITIES?

Authors:Wiclif Ma | wiclif.ma@haygroup.com | T +1.416.815.6377

Derek Hirae | derek.hirae@haygroup.com | T +1.416.815.6375

Footnotes:1 Ex-ante: refers to those arrangements based on projections before the material event actually occurs (“before-hand”).2 Ex-post: refers to those arrangements in which adjustment will be made after the material event actually occurred (“after-the-fact”).3 Malus arrangements: typically refers to annual bonuses that are deferred (not immediately vest) and can be reduced or cancelled retroactively in the case of poor performance or losses in future years.

Clawback policies on the rise 5

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