DOJ revises Compliance Program Guidelines and presents Pilot Program for Clawbacks
In the latest series of key policy updates, the U.S. Department of Justice (DOJ) Criminal Division announced the first-ever Pilot Program on Compensation Incentives and Clawbacks (Pilot Program), issued revised evaluation criteria for corporate compliance programs, and updated a memorandum on the selection of monitors in Criminal Division matters.
The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks
At the 38th American Bar Association (ABA) National Institute on White Collar Crime, Deputy Attorney General (DAG) Lisa Monaco and Assistant Attorney General (AAG) Kenneth Polite announced the launch of a Pilot Program focused on compensation incentives and clawbacks. The Pilot Program is a three-year initiative applicable to all corporate matters handled by the Criminal Division and will come into effect this week on March 15, 2023. The program is following up on the promise made by DAG Monaco in September 2022 to provide further guidance on how to reward corporations that develop solutions to incentivize better compliance through their compensation systems, including clawback policies (see our blog post dated September 23, 2022).
The Pilot Program is reflected within the revised DOJ Guidance on Evaluation of Corporate Compliance Programs (CMS Guidance) and aims to incentivize companies to establish compensation systems that “contribute to the presence of an effective compliance program.” During her speech at the ABA, DAG Monaco stated that with its recent policy changes, the DOJ intends “to shift the burden of corporate wrongdoing away from shareholders, who frequently play no role in the misconduct, onto those directly responsible.” The DoJ’s Pilot Program on Compensation Incentives and Clawbacks consists of two elements:
1. Compliance-driven Compensation and Bonus Systems
Upon entering into a corporate resolution with the Criminal Division, the resolving company is required to implement compliance-related criteria within its compensation and bonus system and annually report its implementation progress to the DOJ during the resolution term. With regards to existing compensation systems, prosecutors may consider whether they already incentivize compliance by deferring or escrowing parts of the compensation tied to conduct inconsistent with company values and policies. In its amended CMS Guidance, the DOJ indicates the factors essential for an adequate compensation system: compensation structures shall clearly and effectively impose financial penalties for misconduct on the one hand and, on the other, provide positive incentives for improving and developing a compliance program or demonstrating ethical leadership.
During her speech, DAG Monaco specifically referred to the recent investigation and prosecution of Danske Bank from December 2022. As part of its plea agreement, the bank agreed to revise its performance review and compensation system so that “Danske executives with a failing score for compliance will also fail to secure a bonus.” It is certainly reasonable to anticipate that the Danske Bank case may be used as a model for future enforcement actions. Companies are thus well-advised to assess their (executive) compensation schemes along the lines of the following questions nowadays explicitly outlined in the amended CMS Guidance:
- Does the company have policies or procedures in place to recoup compensation that would not have been achieved but for misconduct attributable directly or indirectly to the executive or employee?
- What policies and practices does the company have in place to put employees on notice that they will not benefit from any potential fruits of misconduct?
- What role does the compliance function have in designing and awarding financial incentives at senior levels of the organization?
- What percentage of executive ethical behavior compensation is structured to encourage enduring ethical business objectives?
When evaluating the effectiveness of corporate compliance programs, U.S. prosecutors will look far beyond the mere design of incentive systems and also verify to what extent it actually works in practice. According to the CMS Guidance, U.S. prosecutors will enquire a company to provide specific examples of actions taken (e.g., promotions or awards denied, compensation recouped, or deferred compensation canceled) due to compliance and ethics considerations. Mere lip services and paper concepts will thus not serve to satisfy DoJ’s expectations here.
2. Fine Reductions
As a second novum, the DOJ’s Criminal Division promises to consider fine reductions where companies seek to regain compensation from culpable employees and those with supervisory authority over employees or business areas engaged in the misconduct. A company may only qualify for this particular fine reduction if it otherwise fully cooperated with the DOJ’s investigation and timely and appropriately remediated the misconduct, referring to the recently updated Corporate Enforcement Policy (see our blog post dated February 10, 2023). Under the Pilot Program the resolving company will have to pay the general fine at the time of resolution. However, it is subject to a reserved credit equivalent in the amount the company seeks to clawback from its culpable executives and employees during the resolution term. Notably, the company may keep any compensation successfully regained during the resolution term in addition to the reduced fine.
During his speech, AAG Polite acknowledged the difficulties that companies might face when attempting to clawback compensation. These difficulties might especially occur in cases where a company tries to clawback compensation from employees outside the U.S. AGG Polite noted that companies should assess the potential cost to shareholders and the prospect of success of clawback litigation, given any applicable (local) laws, and weigh it against the value of recoupment. In this context, if a company’s good faith attempt to reclaim compensation turns out unsuccessful, prosecutors still shall have the discretion to award a reduction of up to 25% of the compensation amount attempted to clawback. According to the Pilot Program, such nevertheless-reductions may be warranted where a company would incur high litigation costs to the detriment of shareholders or would likely recoup the compensation shortly after the end of the resolution term. What the DOJ will consider as “good faith” efforts to recoup compensation remains unclear and should be followed closely over the three-year pilot period.
The DOJ’s new Guidance on Ephemeral Messaging
In addition to the new Pilot Program, AAG Polite announced more significant changes to the CMS Guidance concerning a corporation’s approachto using personal devices and various communications platforms enabling ephemeral messaging. The new guidance sets out expectations for companies to manage the use of third-party messaging services and personal devices and highlights the effect of this implementation when evaluating a company’s compliance program. The new guideline responds to the continued shift from the former use of email communications to other messengers (such as Whatsapp or Snapchat), making general data storage and access more difficult. According to the revised CMS Guidance, DOJ expects companies to adapt to these new “realities of modern life and update their policies and practices accordingly.” At the ABB, AAG Polite stated that policies governing third-party messaging services “should be tailored to the corporation’s risk profile and specific business needs and ensure that […] business-related electronic data and communications can be preserved and accessed.” In light of these policy changes, organizations are advised to review and, if necessary, adjust their policies governing the use of third-party messaging applications considering their specific risk profile. Companies should ensure that appropriate communications are stored and can be accessed by the authorities in the case of a crisis considering applicable privacy and local laws legally permissible.
Thus, companies must review and, if necessary, revise their communication and data repository policies and practices and ensure proper training, advice, and controls are used to ensure process adherence in practice. A negative response to the prosecutor’s requests for respective messaging data/information will undoubtedly hurt the assessment of the company’s cooperation efforts.
Revised Monitor Selection Guidance for the Criminal Division Focusing on Transparency and Diversity
Lastly, AAG Polite announced a revised memo on the selection of monitors in criminal cases that builds on the “Benczkowski Memorandum” and emphasizes the topic of diversity, equality, and inclusion. The revised memorandum aims to provide more transparency on how the DoJ selects monitors in criminal matters. It also articulates and clarifies the conflict of interest obligations associated with serving as an appointed monitor or as part of a monitor team. In this context, the DoJ extended the “cooling-off” period from two to three years.
Conclusion
The new Pilot Program introduces compliance-based compensation and bonus schemes as additional metrics for evaluating the effectiveness of corporate compliance programs. Overall, this is a consistent continuation of DoJ’s visible focus on corporate culture (see our blog post dated November, 11 2021). The fact that a compensation system’s type and design significantly impact a company’s corporate culture is not new. What is new, however, is the clarity with which the DoJ is now calling on companies to use this lever proactively to promote and facilitate a culture of ethics, integrity, and compliance. And not only by withholding or reclaiming variable compensation components in the event of misconduct but also by granting special recognition and rewards to those that actively shape compliance culture through their outstanding support or visible role modeling.
In the context of ESG, the discussion about appropriate compensation components and key performance indicators has also gained momentum in Germany. In the search for a system for sustainable remuneration of board members and senior executives, functioning compliance clawback clauses become indispensable. However, by requiring sustainable leadership compensation as a prerequisite for an effective compliance program, the DoJ has set high expectations that many international companies have yet to meet.
We are happy to share our many years of experience dealing with U.S. law enforcement agencies and their expectations regarding compliance management systems with you. We regularly support companies in the initial introduction, ongoing review, and further development of their compliance governance and organizations, their compliance programs, and the associated internal control systems.
Please do not hesitate to contact us.