Salz Review - Wall Street Journal

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141 Salz Review An Independent Review of Barclays’ Business Practices 11.45 If paying bonuses in shares is a first step to better aligning employee and shareholder interests, then the use of deferral is a way to improve risk sharing. Barclays has followed the industry in its increasing use of bonus deferral. Bonuses over £65,000 in financial year 2012 are subject to a graduated level of deferral and will be paid out over the following three years subject to continued service and malus. 224 100% of bonuses paid to managing directors in the investment bank have been deferred. Increased deferral enables Barclays to claw back bonuses more easily as risks crystallise. But deferring bonuses for longer periods leads to many recipients discounting their value to reflect the possibility they will not be paid. As a result, they are likely to have less impact on encouraging particular behaviours. 225 Ideally the deferral period should reflect the degree of risk in the relevant business activity, with greater and longer deferrals where there is a significant risk that the accounting basis for the award could be shown to be inaccurate. The effectiveness of deferral as a means of adjusting pay retrospectively will be greater where the consequences of individual performance can be tracked over time and malus can be applied to the awards before they vest. 11.46 There has been significant industry commentary about bonuses being subject to claw back or malus. These terms are often confused and misused. In general use, clawback requires an employee to pay back an amount already received under a cash or share incentive scheme. This is difficult to apply both legally and practically. Malus, in contrast, is used to reduce the employee’s unvested deferred cash or share incentive award. In either case (subject to the terms of the arrangements), the cause can be: because a risk crystallises as a result of which performance was inaccurately measured at award, because the employee is in breach of his employment contract, or because historic issues come to light. Although strictly different, malus and clawback are ways of seeking redress either through recovery of what has already been paid or by reducing the value of what is being held as a deferral. For this reason, we will use them interchangeably – as, so we were told, Barclays does. 226 11.47 In the FSA’s Remuneration Code, Principle 12(h) 227 requires the largest financial institutions to reduce deferred remuneration where there is evidence of employee misbehaviour or material error; where the firm or business unit suffers a material financial downturn; or where there is material failure in risk management. 11.48 Banks’ ‘accounts’ are complex and necessarily reflect a financial position at a given point of time, with judgments made as to the valuation of assets and the prudent provisioning at that point. Inevitably, these valuations and provisions will prove to be wrong to some degree. Results also include items that will seem to have little to do with employee performance, such as ‘own credit.’ In determining the size and structure of the variable compensation pool, good practice requires a bank to consider current and potential risks, the cost and quantity of capital required to 224 Code staff deferral is a minimum of 40% for bonuses less than £500,000 and 60% for bonuses of more than £500,000. 225 See for example: PricewaterhouseCoopers, “If executive pay is broken, making it more complex is not the answer”, The Psychology of Incentives Study, March 2011; http://www.pwc.co.uk/human-resourceservices/publications. 226 For informal discussion purposes; formal legal distinctions are used when required. 227 FSA, Policy Statement 10/20: Revising the Remuneration Code – Feedback on CP10/19 and final rules, 2010; www.fsa.gov.uk/pubs/policy/ps10_20.pdf.
Salz Review An Independent Review of Barclays’ Business Practices 142 support those risks, as well as the timings associated with the revenue streams on which the pool is based. Sir Win Bischoff recently observed: “We need a return to proper forward loss provisioning. People should be paid based on realised profits, not mark to market." 228 The starting point for a remuneration committee in any given year is therefore to determine the appropriate risk-adjusted profit number that should form the basis for calculating the compensation pool. 11.49 Given the difficulty of reflecting risk fully at the time of bonus awards, we consider the idea of malus to be a useful tool in compensation arrangements. Malus seems in the past to have required a material event to occur, internal investigations and public admissions of failure. This created asymmetry between the burden of proof required to award a bonus and that necessary to cancel it. It is not obvious why this should be the case where payment of the relevant bonus has been deferred. But new remuneration contracts may be required to widen the ability of banks to apply malus. We are encouraged by the firmer stance Barclays appears now to be taking on malus for the financial year 2012: clawing back £300 million of unvested deferred and longterm incentive awards, and applying malus on the basis of risk adjustments, not just for misconduct. Recommendation 23: Discretionary pay The size of the variable pool should aim to reflect, so far as practicable, the full range of risks. Significant bonuses should only be paid in the case of strong performance across all dimensions of a balanced scorecard which appropriately weights risk, values, and other non-financial elements. Barclays should aim to be transparent as to its discretionary bonus process, including how bonuses correlate with performance ratings based on the balanced scorecard. Barclays should combine bonus deferrals and malus adjustments to align reward with risk and prudent behaviour. It should apply malus consistently and systematically – while reinforcing efforts to get bonus decisions right first time. Long-term Incentives 11.50 For a group of around 200 executives, compensation has historically been structured differently from the rest of the bank. 229 In addition to a fixed annual salary and discretionary annual bonus, these executives received an annual Long-Term Incentive Plan (LTIP) award. Each year, new LTIP pools were defined, with each eligible member being given an award bounded by a target range, and subject to a predetermined maximum cap. The actual payout to employees was then linked to criteria relating to business and individual performance over a defined period – typically three years. Maximum payouts have tended to be several times larger than annual salary, ranging from an average of three times salary in the retail bank to an average of eight times salary in the investment bank. In 2011 only seven executives 228 Financial News, “Sir Win Bischoff calls for accounting reform”, 13 March 2013. 229 A much broader Group LTIP (The Performance Share Plan) applying to nearly 1500 employees was discontinued after the awards made in 2007.
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Salz Review - April 2013
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Salz Review - Wall Street Journal

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