The topic of clawback, and indeed malus, has been a bit of a strange animal to date. You know what it is when you see it, but trying to adequately describe when it is triggered and how it takes effect is a little more challenging. The Financial Reporting Council’s consultation paper on reforming the UK Corporate Governance Code did not provide the guidance on how clawback provisions should be adopted that had been hoped for (see our alert), and we are yet to see the FRC’s response since the consultation window closed in December 2013. HMRC has an appeal pending against a decision that the clawback of a signing on bonus was tax deductible (see our alert on the initial decision), and the appeal should be heard soon (although nothing as yet). However, the Bank of England and the Prudential Regulatory Authority (PRA) have issued a consultation paper which contains a proposal to extend the Remuneration Code to require all PRA-authorised firms to amend employment contracts to enable employers to clawback vested variable remuneration. This is the first major step towards requiring employers (well, PRA-authorised ones at least) to be able to claim back vested awards (clawback) as opposed to reducing unvested awards (malus).
So, how much light on the confusing world of clawback does this latest document shed?
The Remuneration Code (part of The Senior Management Arrangements, Systems and Controls 19A sourcebook of the PRA’s Handbook, which sets out the standards that banks, building societies and designated investment firms have to meet when setting pay and bonus awards for their staff) already has requirements in respect of malus. The latest proposal is to take the existing malus provisions and extend their application to enable clawback of vested variable remuneration.
So, as with malus, clawback should be permitted when:
- there is reasonable evidence of employee misbehaviour or material error;or
- the firm or the relevant business unit suffers a material downturn in its financial performance; or
- the firm or the relevant business unit suffers a material failure of risk management.
The plan is for the new rule to come into force on 1 January 2015. If adopted, the rule will require firms to negotiate the necessary amendments to employment contracts that are capable of being amended “at the earliest opportunity” from that date. The PRA suggests that the clawback provisions apply to all vested variable awards up to six years after vesting (therefore putting the maximum time period in line with the statute of limitations for contracts). The PRA also expects firms to take “all reasonable steps” to amend employment contracts to permit clawback of awards granted before 1 January 2015 but which vest after that date, again using the six year time limit.
As is the case with malus, clawback should not be limited to employees directly culpable of malfeasance. As an example, in a case involving a material failure of risk management or misconduct, the PRA expects firms to consider applying clawback to any employee who:
- could have been reasonably expected to be aware of the failure or misconduct at the time but who failed to take adequate steps to promptly identify, assess, report, escalate or address it; or
- by virtue of their role or seniority, could be deemed indirectly responsible or accountable for the failure or misconduct, including senior staff in charge of setting the firm’s culture and strategy.
The consultation paper asks for comments, particularly with respect to the proposals that the grounds for applying clawback should be as wide as the grounds for malus, and that clawback should be possible for a period of six years from vesting.
The PRA’s paper states that, as regulator, there is a possible role for it to help ensure a greater degree of coordination and consistent application across the industry and to seek to remove “first-mover” disadvantage – the situation whereby firms may lose key staff to competitors if they are the first to revise their remuneration policies in a way that is seen to be less favourable to employees than the policies of other firms are.
The closing date for responses is 13 May 2014. We may have a response from the FRC or the outcome of HMRC’s appeal by then. In the meantime, full marks to the Bank of England for addressing the issue of how to avoid first-mover disadvantage in an industry that is operating compensation and benefit structures under intense public and media scrutiny. Given that the overwhelming majority of the FTSE100 now uses either malus or clawback provisions in their remuneration structures (and the new DRR disclosures require the remuneration policy table to expressly set out whether there are any such provisions), clawback remains an area that is worth all companies, not just those subject to the PRA’s Remuneration Code, keeping a close eye on.