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New research suggests that the financial-services sector, though ripe with instances of negligence and other malfeasance, is not yet moving aggressively to reclaim compensation from perpetrators.
David McCann, CFO.com | US
August 23, 2012
At a time when news of banking scandals is uncomfortably frequent, a new report says that last year only 17% of global banking organizations "clawed back" compensation payments previously made to employees.
The survey of financial-services institutions by the consulting firm Mercer was not expansive, with only 42 banks participating (in addition to 18 insurance companies and three other types of firms). Still, the results may suggest that regulators are not achieving the objectives of their persistent calls for banks to implement clawback policies.
Under such policies, banks can reclaim compensation to individuals responsible for financial-restatement misconduct, gross negligence, or other malfeasance — or even if companies or business units are performing poorly.
Regulators in both North America and Europe have increasingly encouraged the use of clawbacks as a means of managing employee risk-taking since the 2008 financial crisis. In the United States, the Dodd-Frank Act requires all public companies to develop and implement clawback policies. The Securities and Exchange Commission has not yet come out with regulations for carrying out that provision of the law, but at some point, every public-company executive will be potentially subject to clawbacks.
"A lot of companies have clawback policies already," says Andrew Liazos, head of the executive compensation practice at law firm McDermott Will & Emery. "But many of them allow for discretion by the board whether to claw back or allow clawbacks only when there is misconduct. But under Dodd-Frank, the lack of misconduct is not a defense."
Among Fortune 100 companies, 86.5% have publicly disclosed clawback policies, according to a recent report by Equilar, a compensation-research organization. But they may be very different from one another. "To say you have a clawback provision is one thing, but how broad and onerous it is is a different story," says Liazos.
Recent news suggests that clawbacks are often particularly warranted at financial institutions. Barclays acknowledged improper manipulation of LIBOR rates (and agreed to pay $453 million in settlements to U.S. and British authorities). More banks are expected to become ensnared in the scandal as well; Bank of America, Citigroup, and UBS have all been investigated.
In another high-profile case, JPMorgan clawed back two years worth of compensation from two traders and their boss in connection with the "London Whale" scandal that resulted in $5.8 billion in derivatives trading losses. Also, former Lloyds Banking Group CEO Eric Daniels is reportedly faced with losing 25% of his final 2011 bonus because of alleged improprieties in the sale of insurance products. And memories from a few years ago, of excessive risk-taking by banks in subprime-mortgage loans and financial instruments like collateralized debt obligations, have hardly faded.
The relatively small number of clawbacks in 2011 "doesn't signify that the sector is ignoring lessons from the financial crisis," says Vicki Elliott, human capital leader for Mercer Global Financial Services. But it does raise questions as to whether companies that have a legitimate justification for a clawback are motivated to actually go ahead with the process, she adds.
Elliott does, though, point to numerous cases where top executives have succumbed to political or public pressure by voluntarily forgoing bonus payments as a "sign of increased responsiveness in the financial sector."
More banks would likely claw back payments if they could. "Often the concept conflicts with local labor laws," Elliott says. "Also, clawbacks are relatively new, so it will take some time for them to bed down."
But perhaps the most significant reason for the scarcity of bank clawbacks is that it can be difficult from a practical standpoint to recover compensation that's already been paid. That's why a large majority (80%) of banks have introduced what Mercer calls "malus" conditions, under which companies withhold part or all of a scheduled compensation payment when malfeasance or underperformance occurs before the compensation is paid.
Elliott notes that "it will be interesting to see if, at a time when the news is dominated by major banking missteps and scandals, levels of clawback and malus increase in 2012. If they do not, it would be fair to ask whether the regulatory approach of managing risk through this kind of pay feature is working." Focusing on the manner in which banks are managing risk, measuring performance, and internal compliance may be a better path to sound risk management, she says.
The question remains whether clawbacks and malus conditions as they are currently structured will effectively help to ensure prudent risk-taking, according to Mercer. Given that performance conditions for deferral and long-term incentive payouts are often not based on risk-adjusted outcomes and primarily focus on overall company performance, there may be limited impact on individual risk-taking behavior, the consulting firm says.