Firms adopt clawback rules to stem risk

Jeremy Hobson Feb 3, 2010

Firms adopt clawback rules to stem risk

Jeremy Hobson Feb 3, 2010


Kai Ryssdal: AIG was back in the news today. And as is usually the case, it was not a flattering story about the insurance company that got $180 billion from taxpayers. We learned today AIG is going to pay out another $100 million in bonuses. This morning Treasury Secretary Tim Geithner called the payments an outrageous failure of policy. And so he pointed out a new policy that the Obama administration is proposing to get the money back — the new bank fee that’s in the president’s budget plan.

Some financial institutions are taking matters into their own hands, though, with bonus clawbacks. From New York, Marketplace’s Jeremy Hobson explains.

JEREMY HOBSON: A clawback is just like it sounds.

CHARLES ELSON: I paid you for doing something for me, you didn’t do it in the right way. I want my money back.

That’s Charles Elson, who directs the Weinberg Center for Corporate Governance at the University of Delaware. He says in theory a firm pays an employee after a good year of service. Here’s how it might go:

BOSS: And this ones for you Jimmy. You made us a lot of money on that telecom deal!

JIMMY: Thanks, Mr. Buckwinder.

But then, a year or two later, it turns out the telecom deal was a dud. In the long term, it goes sour.

BOSS: Jimmmmmmyyyyy…

JIMMY: Yes, ma’am, Mrs. Buckwinder?

BOSS: You better stop construction on that swimming pool. I’m taking your bonus back.

JIMMY: But, ma’am! We already ordered the raft with the margarita holders!

BOSS: Sorry, too late.

That’s how it would work, in theory. To try to ensure that employees are not taking excessive risk in the short term at the expense of the long-term health of the company or the economy as a whole.

But Charles Elson says it’s not that simple in practice.

ELSON: Legally, once the money has gone to someone, it’s really hard to get it back because a lot of times when you pay money out, it’s the result of a contract, and usually contracts are really, really hard to get out of.

And he says:

ELSON: Practically speaking, once you pay someone that money, typically they spend it. And it’s hard to get it back from them. You could get a judgment against them, but whether you’re actually going to get the money back is another story because the money may have been long gone.

Up until recently clawbacks were only used in the case of fraud or other illegal activity.

Alan Johnson says using clawbacks to get money back from trades that go bad could be incredibly difficult because of the sheer number of trades that go bad at large firms. Johnson is a managing director of Johnson Associates, a compensation consultancy.

ALAN JOHNSON: Large firms reorganize all the time, people change jobs, positions get hedged and so forth. So to go back and say two or three years later that that was a bad trade, it’s almost impossible.

That’s not stopping the big banks from trying. Some Bank of America employees are opening pay packages now that for the first time include clawback provisions on deferred pay.

JPMorgan and Morgan Stanley are doing likewise. And at Goldman Sachs and Citigroup, some top earners will be subject to clawbacks going forward. All of this may sound great to lawmakers in Washington. But Alan Johnson says banks should be careful what they promise.

JOHNSON: Because I tell clients that in the future, there will be a year where you lose money, and the regulator, the politicians will expect a list of witches that you’ve hunted down. And you better have a long list and if you don’t have a list, you’re in big trouble. Because you promised to go witch-hunting and where are the witches? I don’t know how you run a firm then.

Charles Elson says if banks really want to make sure their employees are thinking in the long term, they should pay them over the long term. Then no clawback would be necessary.

ELSON: The idea would be pay these bonuses in stock that hasn’t vested, create a longer vesting period such that if there was any monkey business in the award of the stock, the stock can be taken away before it actually walks out the door, if you will.

But of course, for the vast majority of Wall Street employees getting paid only in stock is not an option. Even bankers need some cash to live in New York. And as one told me, unless every bank, brokerage and hedge fund followed the same rules, many employees would just go work for the competition.

In New York, I’m Jeremy Hobson for Marketplace.

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