The UK and US have announced new clawback requirements, expanding uncertainty for executives on whether earned bonuses and long term incentives will remain theirs to keep.
Following a number of scandals that shook confidence in the financial sector, the UK’s Prudential Regulation Authority and Financial Conduct Authority finalised new rules in June that require the implementation of long deferral and clawback periods.
Depending on the role, deferral of variable remuneration will extend to up to seven years after the end of the performance period, with clawback to apply until seven years after the award for material risk takers and another three after that for senior managers where a firm or regulatory authorities have commenced inquiries into material failures.
Organisations are required to “make all reasonable efforts” to recover some or all vested variable remuneration where:
- there is reasonable evidence of employee misbehaviour or material error, or
- the firm or relevant business unit suffers a material failure of risk management,
taking into consideration the proximity of the employee to the failure of risk-management in question and the employee’s level of responsibility.
The new rules apply to banks, building societies, and certain investment firms for performance periods beginning on or after 1 January 2016.
The US Securities and Exchange Commission has proposed a law that would mandate listed companies to clawback remuneration from executives following an accounting restatement due to material error. No fault is required on the part of the executive for the remuneration to be reclaimed.
Incentive-based remuneration received by executives in the three financial years prior to the statement would be affected, with the portion to be reclaimed being the remuneration that would not have been received given the restatement. Incentive-based remuneration is defined as variable remuneration that is granted, earned or vested based wholly or in part on any financial reporting measure, including share price and total shareholder return measures.
Companies have discretion regarding the method of recovering remuneration. They must, however, disclose how much remuneration was subject to recovery, whether amounts remain outstanding and the names of executives the company decided not to clawback remuneration from and why it made that decision (they have discretion not to clawback remuneration when it would be impractical, for example when it would cost more than they would retrieve).
This proposed rule is now subject to comment.
It had appeared that the ASX Corporate Governance Council would make the introduction and disclosure of clawback policies and their implementation a recommendation in the most recent version of its Principles and Recommendations, but the recommendation was removed from the final document, leaving only the suggestion that companies disclose a summary of their policies around malus or clawback in the event of serious misconduct or financial misstatement. (While malus involves the company retaining bonuses that have not yet vested to the executive, clawback involves a return of bonuses that have already been paid to the executive.)
Despite the lack of a formal rule, many Australian companies have introduced malus or clawback policies.