Key Points

  • In January 2016, the PRA proposed new rules to regulate the practice of bonus buy- outs.
  • The new rules would apply to material risk-takers at PRA-regulated banks, building societies and designated investment firms.
  • The rules are intended to ensure that staff who leave an employer, and whose previous bonus entitlement is "bought out" by the new employer, can have their bought-out bonus adjusted or clawed back by their new employer based on their performance at their former employer.
  • The rules would involve an amendment to the Remuneration Part of the PRA Rulebook, including the insertion of a new Rule 15A.
  • The consultation will close on 13 April 2016. 

Proposed rules on bonus buy-outs

On 13 January 2016, the UK's Prudential Regulation Authority ("PRA") proposed new rules regulating the practice of firms "buying out" new staff by offering awards equivalent to the deferred bonuses forfeited on leaving their previous employer.1

The PRA proposes that the rules should form a new Rule 15A in the Remuneration Part of the PRA Rulebook.

The PRA's consultation on the proposed rules will close on 13 April 2016.

Background

At present, senior staff in banks, building societies and large investment firms faced with the prospect of future disciplinary action by their existing employer may choose to move to a new employer and have their bonus awards bought out. If the staff member is later found to have acted improperly at their former employer, there is currently no mechanism for the bonus award made by the new employer to be adjusted or for amounts paid out under it to be clawed back.

This effectively permits rogue employees to "wipe the slate clean".

The PRA's proposed new rules are intended to deal with these concerns. This reinforces the effectiveness of the "malus" and "clawback" regimes.

Malus. According to the principle of "malus", firms are permitted to reduce deferred bonuses in the event of poor performance. In other words, provided that the bonus has not yet been paid or vested, then the firm may readjust the amount of the bonus award to be paid at a later date.

Clawback. Firms may "claw back" bonuses that have already been paid or vested for a period of seven years from the date of the award. This period may be extended to a total of 10 years from the date of the award if there is an outstanding investigation that may lead to the application of clawback. 

The proposed rules form part of the continuing reform of remuneration practices in the financial sector following the financial crisis of 2007-8.

In 2013, the final report of the Parliamentary Commission on Banking Standards ("PCBS") recommended that the regulatory authorities should consider proposals to reform the practice of bonus buy-outs.2

This was discussed in a joint consultation paper issued by the PRA and FCA in July 2014.3 The regulators outlined four possible approaches to the problem:

  1. banning bonus buy-outs altogether;
  2. requiring the old employer to maintain bonus awards for their former employees;
  3. allowing the old employer to adjust the value of bought-out awards; or
  4. relying on the rules on clawback to claw back any amounts paid to staff prior to leaving.

The PRA and FCA stated in a later policy statement that they would consider whether detailed proposals were needed in relation to option 3. The other options were generally considered to be impractical or inadequate.4

Application

The proposed rules would apply to all "material risk takers" at PRA-regulated banks, building societies and designated investment firms.5 

However, in keeping with the principle of proportionality, the new rules would not apply to firms falling within Level 3 of the proportionality framework.6

The proposals relate only to PRA-regulated firms. The FCA has stated that it wishes to maintain consistency in the rules for firms that are regulated by the FCA only. However, it will review the feedback to the PRA's consultation paper and will consider whether to introduce similar rules in respect of solo-regulated firms.

The proposals

The rules would require a new employer, prior to providing a bonus buy-out, to identify:

  • the amount of unvested remuneration that could be bought out;
  • the previous employer(s) involved; and
  • the duration of any retention, deferral, performance and clawback arrangements applying to the remuneration amount(s).

The new employer would be required to enter into a contractual arrangement with the employee to allow the new employer to reduce and/or claw back the bought- out bonus, where appropriate. This arrangement would then be notified to the previous employer(s) of the new staff member.

If a previous employer identifies any relevant misconduct by its former employee, it must make a determination of the reduction or repayment amount that it would have required if the employee had not left. The old employer would then be required to notify the new employer, which would either:

  • adjust the amount payable under a deferred award; or
  • claw back sums already paid to the staff member.

The grounds for malus or clawback would be, as a minimum:

  • employee misbehaviour or material error; and/or
  • failures of risk management.

The PRA has stated that a material downturn in the financial performance of the old employer should not be regarded as sufficient grounds to adjust a deferred bonus, as the PRA regards this as too open to misuse by the old employer.

It is proposed that the new rules would be made by amendments to the Remuneration Part of the PRA rulebook and specifically by inserting a new Rule 15A.

Responsibilities of the old employer

Under the proposed rules, the old employer would be subject to particular obligations in exercising their powers.  They must:

  • act fairly and reasonably in making the determination;
  • act consistently in relation to current and former employees and previous or concurrent cases of malus or clawback;
  • provide former employees with the details of and reasons for any proposed malus or clawback;
  • allow former employees to make representations as to why any determination should not be made; and
  • report cases of malus or clawback against bought-out awards to the PRA at least on an annual basis.

The PRA has proposed that the former employee will have a private right of action for damages under section 138D of the Financial Services and Markets Act 2000 in the event of a failure by their former employer to comply with the rule.

Responsibilities of the new employer

The new employer would be expected to act on receiving a notification of a determination in respect of a staff member by the old employer.

In the event that a new employer is required to claw back an award that has already been paid, the new employer would act as a claimant in a contractual claim against its employee, supported by the old employer's notification.

Alternatively, new employers may apply for a waiver where they believe that the old employer's decision is manifestly unfair or unreasonable. Grounds for a waiver could include the severity of the old employer's treatment of the staff member, or a pattern of determinations that suggested that the old employer was not acting fairly and reasonably towards its former employees.