CLAWBACKS LIKELY TO BECOME BIGGER ISSUE
Wells Fargo case might be just the beginning as more companies seek payback for misconduct
In seeking to defuse the firestorm over its sham accounts, Wells Fargo & Co.’s board turned to an old, but obscure gambit — getting its top leader to pay up. It’s a measure we could see companies take more often.
John Stumpf, the bank’s chairman and CEO, will forfeit about $41 million of unvested stock awards and forgo his salary while the company investigates its retail banking sales practices after hundreds of thousands of sham accounts allegedly were opened by employees to meet sales targets. Carrie Tolstedt, Wells Fargo’s former head of community banking, will forgo her unvested equity stock awards, valued at $19 million, and will not receive retirement benefits worth millions more. Neither Tolstedt nor Stumpf will receive 2016 bonuses.
For decades, federal regulators have been empowered to pursue the reimbursement of executive pay in a practice often called “clawing back” when an individual violates securities laws. But the power was rarely used because successful clawbacks would have required a conviction or at least a credible threat of one.
But companies will likely be driven to think more about clawbacks in coming months. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 calls for strengthening clawback rules. And the Securities and Exchange Commission is currently receiving public comments for new rules. If implemented by the SEC later this year, as expected, the new rules would allow the agency to force clawbacks in more cases beyond those involving deliberate fraud. Restated earnings stemming from negligence could trigger clawbacks.
The legal firepower to take back compensation in cases of misconduct has been increasing. The Sarbanes- Oxley Act in 2002, which reformed corporate accounting practices, widened regulators’ scope to pursue clawbacks. The law empowered the Securities and Exchange Commission to mandate top executives reimburse portions of their pay if their company restates financial statements due to fraudulent misconduct.
The change drove many companies to establish their own internal guidelines about clawbacks. But
Even before these more recent developments, the legal firepower to take back compensation in cases of misconduct has been increasing.
“policies are written in such a way that they’re unlikely to be actually used,” says Jesse Fried, professor of law at Harvard Law School.
As of 2013, about 60% of the companies in the S&P Composite 1500 Index — and 80% of S&P 500 — had clawback provisions, says Ilona Babenko, professor of finance at Arizona State University. “Banking and financial services companies are more likely to have it,” she says.
But with board directors generally reluctant to punish their own executives, few companies have exercised their provisions, Babanko says. In her research, she concluded that, in monitoring the period between 2001 to 2013, 272 companies with clawback provisions had restated earnings. She found clawbacks were triggered in “less than 10 cases,” she says.
Some notable clawback cases include agrochemical manufacturer Monsanto this year, UnitedHealth Group in 2007, CSK Auto in 2011 and J.P. Morgan in 2012.
Wells Fargo’s clawback provisions are more comprehensive than the parameters required by existing rules. Stumpf and Tolstedt are not criminally accused of fraud. “The issue is that there are some executives who are alleged to not have done their job well. That’s a step well beyond the clawback provisons most companies would allow for,” says Wayne Guay, accounting professor at the University of Pennsylvania.
“Companies are worried about setting bad precedence of punishing people before all facts come out. It may make them very well risk averse. The boards need to move very slowly and carefully.”