return-of-moneyWe are in October and I am looking forward to my annual exploration of classic monster movies beginning this coming Friday. This year I decided to go back to the roots by watching the 30s and 40s classic Universal monster movies involving the king of the monsters – Frankenstein. While I have thoroughly enjoyed re-watching all the old classics again (and again) about the best my wife can say is that thankfully in only comes one month a year.

I thought about criminal history whilst reading about the clawbacks ordered by the Wells Fargo Board of Directors of $41 million from current Chief Executive Officer (CEO) John Stumpf and $19MM in unvested stock awards from the now retired former head of the consumer banking group, Carrie Tolstedt. Most people wondered why it took the Wells Fargo Board so long to administer this obvious sanction. Indeed, Gillian Tett, writing in the Financial Times (FT) in a Comment piece entitled “Clawbacks emerge as a vital weapon in finance, wrote, “In some respects this seems like too little, too late. The board only imposed this clawback after five Democrat senators wrote a letter to the bank complaining about the issue — and Mr Stumpf delivered a truly dreadful performance in a Congressional committee. It would have been far more commendable if the Wells board had acted before it was pushed.” Gretchen Morgenson, writing in the Fair Game column in the New York Times (NYT) in an article entitled “Executive Pay Clawbacks Are Gratifying, but Not Particularly Effective”, said, “But the move came almost three years after the improprieties came to light — and should serve as Exhibit A for the shortcomings in these pay recovery programs.”

Other than agreeing that the Wells Fargo Board was a day late (if not a dollar short) in requiring clawbacks, the writers very much diverged on the effect of this action they perceived on banks specifically and in the wider business market in general. Tett said this action may well be seen in the future as a “watershed moment” as it marks “the first time that a board has imposed a tangible clawback of this size, let alone against a chief executive.”

Morgenson wrote such actions have been rare and may well continue to be rare in the future. The main reason is that executive compensation “policies are written to cover only a portion of an executive’s pay.” She quoted James F. Reda, managing director of executive compensation consulting at Arthur J. Gallagher & Company, for the following ““Clawbacks extending to all types of compensation are uncommon. They typically only apply to the cash portion and only to the top executives.”” Moreover, she noted, “recoveries are generally restricted to cases in which accounting improprieties are significant enough to force a company to restate its results. Or a company will require clawbacks only if the pay was based on inaccurate financial disclosures. Wells Fargo’s policy contained both of these stipulations, neither of which applied to the account-opening scandal. Instead, the board apparently relied on a third policy” and “That policy covers actions that harm the bank’s reputation.”

Morgenson provided a couple of other reasons Boards rarely order clawbacks. The first is the Board has to find there was misconduct and then determine that the misconduct was material. She cited, “Steven A. Bank, a law professor at the University of California, Los Angeles, and an expert on executive pay, said he was unsurprised that clawbacks are so rare. One major reason, he said, is that corporate directors are typically given enormous leeway in deciding when to pursue them. Unless they are forced to do something, they probably won’t.”

As to the second “element of discretion inherent in clawback programs relates to the board’s judgment over whether any wrongdoing has a material impact on the company. This concept of materiality is famously subjective, giving directors lots of room to determine that improper activities were not in fact meaningful enough to recover pay”. She cited to George S. Georgiev, an assistant professor at Emory University Law School, who said, “The nebulous nature of materiality is a problem in these matters.”

Further, Boards are more accustomed to awarding pay and not taking it away. Finally, there is simply the question of whether the Board members were equipped to perform the job duties of Board member. Morgenson wrote, “corporate directors tend to weigh them in a narrow, rules-based way when they should instead take a broader, more common-sense view.” She quoted Frederick E. Rowe Jr., chairman of Greenbrier Partners, a money management firm in Dallas, for the following, ““directors ought to know bad behavior when they see it. It all comes down to this: Are you doing something to the customer or for the customer?” That seems a pretty simple question. Too bad the Wells Fargo board didn’t think to ask it.”

Yet changes may well be coming. Tett wrote that the Securities and Exchange Commission (SEC) has proposed new regulations which would require companies to institute policies requiring senior executives to pay back incentive compensation which was “erroneously awarded” but these regulations are still two years out from taking effect. But with Congressmen from both parties howling at Wells Fargo, it may well be this remedy is made more forceful by the SEC in response to concerns from Congress.

Tett also had the fascinating idea which should drive abject fear into the heart of any banker. It was that Deutsche Bank could raise $1.5bn of the amount it needs to settle with the US government by recouping “currently unvested compensation awarded to [its] bankers, and cancelled 2016 bonuses.” Now that might well generate enough fear into bankers’ hearts that they might actually follow the law. It might even be appropriate for this scary month of October.


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© Thomas R. Fox, 2016