A year ago, we looked at RSA, which at that time said that there were three situations in which it would seek to reclaim pay: for employee misconduct; if a share award was wrongly calculated; or if the results that triggered the award had been materially misstated. Sounds good? Well, it clearly wasn't enough, because in its latest annual report, it came up with three more: concerns about the employee's capability or performance; damages to RSA's reputation, and "deterioration in the financial health of the Company leading to severe financial constraint". And, just in case they've missed anything, they now throw in: "any other situation that the Remuneration Committee may reasonably determine".
This sort of clause makes senior executives twitchy. They're expected to take risks knowing that later on, with the benefit of hindsight, a risk can appear reckless even though it seemed perfectly acceptable when it was taken. Pinning pay to such errors involves formally apportioning detailed blame and, since this can sour working relationships, clawback is likely to remain a last resort.
Tangled legacies
You don't have to look far to see how clawback can turn into a wrangle. Take Tesco. We now know that its past results were buoyed by sharp practices, including accounting errors and unreasonable squeezes of suppliers. Some of these irregularities would arguably tick RSA's boxes, but are the grounds strong enough for pay to be clawed back from Tesco's executives?
In fact, Tesco buttresses its people against much comeback. Its last report says that it might merely scale back share awards if "results are materially misstated or the participant has contributed to serious reputational damage of the Company or one of its business units or his conduct has amounted to serious misconduct, fraud or misstatement". So its executives are safe - they'll get some awards anyway and once they've been paid they can't be taken away.
Tesco only has "malus" (reducing or forfeiting awards that haven't yet been paid out); GlaxoSmithKline can apply "clawback" (getting back a bonus that's already been paid). Its conditions are reasonably stringent, but they only go back three years, which seems odd when you think how long it can take for unwanted side-effects of drugs to emerge and for court cases to drag on. Better not mention Paxil and Avandia.
And don't mention tax either - for bonuses are taxed when they're paid; claw them back later and it's still not clear whether that tax will be refunded.
Tying down banks
Clawback is a backstop and somewhat cumbersome, so it's not surprising that it's hardly been used. JPMorgan is a rare exception. It clawed back trader bonuses after its multibillion "London Whale" trading losses in 2012.
It's more practical to dock awards before they're paid, so some fund managers, like Fidelity, have been pressing for all companies to impose a period of at least five years before senior executives can sell shares they've acquired from share awards. That buys more time for problems to emerge and for malus clauses to bite. But for senior executives, this makes less sense, for the further pay gets pushed into the future, the less meaningful it becomes to them.
Bank regulators have gone further. From 2015, banks must tie up shares awarded to their material risk-takers and their highest paid for at least seven years. A bit of a blow to the Treasury this - and to political parties thinking of higher taxes on bonuses. The rake-off on high bonuses is already over 60 per cent (45 per cent income tax, 2 per cent national insurance and 13.8 per cent employers' national insurance liability), but tax only applies when people receive their deferred pay or can sell their shares. So tying up awards pushes back tax revenues for years.
Regulators say the point of these stricter controls is to make people more cautious and match their pay to the long-term wellbeing of the bank. That way, they hope that banks will be made safer.
The new game plan
But in the midst of this is a paradox that nobody seems to have an answer for: how to prevent senior executives freeing themselves of clawback by jumping ship?
When they're headhunted, they're normally 'bought out': outstanding share awards are forfeited and the new company awards its own shares with similar terms and conditions. Since the old company's outstanding awards will now pay nothing, there's nothing to be clawed back. The new company can always apply its own clawback conditions, of course, but they'll be for the future. In other words, the slate is wiped clean and the dials re-set.
Since this means that executives could be better off by moving from company to company rather than staying where they are, the irony of clawback is that it could encourage the very short-termism that it's supposed to be countering.
What's to be done about the clawback paradox?
Remuneration consultants and lawyers have explored four suggestions to help clawback stick when executives jump ship, but there are no easy solutions:
1. Expect the new company to apply clawback conditions relating to the old company? This wouldn't be practical; the new company wouldn't be aware of any internal investigation going on in the old company and would be in no position to argue the rights and wrongs with the executive.
2. How about banning buyouts?
a. But then if the old company forfeited the award, the new company would have to compensate through some other means, such as a higher salary (a buyout by any other name). Otherwise, executives would be better off financially staying with the old company and so would probably refuse to move.
It wouldn't be a solution anyway - if the past awards were forfeited, there'd be no bonus to claw back so the executive would have been released from being held financially accountable for taking risks in the past.
b. Insist that the awards in the old company are not forfeited. They'd be retained with the original conditions (including malus or clawback), even if the executive leaves.
Companies object that this would add to costs because it would prevent them from getting their money back when executives resign. It would also hamper the delicate negotiations needed when a senior executive is eased out. And when they recruit, executives might arrive with substantial share stakes in competitors, a baggage that could be a conflict of interest.
3. Expect the regulator to step in and make the employee pay back funds if the former employer would have had grounds for clawback. Clawback, though, is essentially a refund of something that shouldn't have been paid; this suggestion makes it more like a fine. And that makes it even more likely to be challenged in the courts, so good luck with that one too.
