Banks Toughen Pay Clawbacks Under Activist Shareholder Pressure

Regulators are still working on the final version of the Dodd-Frank Act's rules for when and how banks can claw back compensation from executives.

Some banks have decided to beat them to the punch.

Big banks like Capital One Financial (COF) and Citigroup (NYSE:C), and regional banks like Hancock Holding (HBHC) in Mississippi, have already adopted some of Dodd-Frank's tougher new standards.

Some of the stricter rules include not having to prove misconduct to implement a clawback, and exposing a larger number of executives and employees to a clawback policy.

The early adopters credit — or blame — activist shareholder groups like California State Teachers' Retirement System and the New York City Comptroller, or individual shareholders who cast dissenting votes on say-on-pay proxy ballots. Clawbacks, according to activists, give shareholders a hedge against the tendency of some executives to take excessive risk with a company's capital.

"We've seen how perverse incentives for short-term gains may encourage excessive risk-taking or questionable conduct," says John Liu, the New York City comptroller, whose office manages $127.5 billion of pension funds. "Banks often engage in such risk-taking."

JPMorgan Chase (JPM) was on the hot seat after the London Whale trading loss, and it clawed back funds from several executives involved with the scandal.

Some consultants and attorneys have counseled banks to take heed of shareholders' demands for tougher clawbacks. It's "definitely best practice" for banks to adopt a clawback policy now "because of their special risk profile and what the shareholder industry has come to expect," says Will Tysse, an employee-benefits attorney at McGuireWoods.

To be certain, clawbacks have been in place for years; the Sarbanes–Oxley Act of 2002 made the current chief executive and chief financial officer of publicly traded companies subject to clawbacks. Dodd-Frank took clawbacks several steps further, such as widening the number of executives subject to potential clawbacks and extending the clawback period to three years from one.

Additionally, the Treasury Department required all banks that participated in the Troubled Asset Relief Program to adopt clawbacks.

Regions Financial (RF) in Birmingham, Ala., is one of the banks that decided not to wait on rules pending before the Securities and Exchange Commission. The $120 billion-asset company recently adopted a policy that makes its top executives subject to clawbacks, as well as "a number of other senior officers," according to its proxy statement. Regions also made its officers subject to clawbacks even if their misconduct does not require it to restate its financials.

HomeStreet (HMST), a $2.5 billion-asset thrift in Seattle, approved a policy to claw back compensation "if it was determined that the recipient's activities exposed HomeStreet to imprudent risks," according to its proxy.

Capital One approved one of the toughest clawback policies of any company, Liu says. Going beyond Dodd-Frank's expected requirements, Capital One will publicly disclose the exact amount that it claws back from executives. Capital One spokeswoman Tatiana Stead declined to make additional comments.

Citi passed a new policy that lets the bank claw back some deferred incentive compensation "in the event of serious financial or reputational harm to Citi," it said in its proxy.

Hancock, a $19.1 billion-asset company in Gulfport, Miss., made major changes to its clawback policies this year, after almost 30% of Hancock's shareholders rejected its executive-compensation packages in a say-on-pay vote in 2012.

Hancock was one of several banks that received a large portion of "no" votes on the say-on-pay question, part of a wider trend of shareholder dissatisfaction. Hancock's compensation committee "considered this reduced level of shareholder support" when it established the new clawback policy, the company said in its proxy. After discussing the issue with its compensation consulting firm, Pearl Meyer & Partners, Hancock broadened its clawbacks to include "a bonus or other incentive compensation" paid to any executive officer in the event of a material financial restatement. Hancock did not respond to requests for additional comment.

So far, mostly large banks have approved the tougher clawback rules. McGuireWoods' Tysse predicts that regional and community banks will soon adopt their own policies soon, even before the final Dodd-Frank rules are passed.

"It's mostly the largest banks that have felt the brunt of shareholder pressure," Tysse says. "You'll start to see that filter down to midsize and smaller banks as well. They'll feel pressure to keep up with the leading edge of industry practice."

There have been some attempts by bankers to protect themselves, such as purchasing so-called clawback insurance. The SEC's final rules will address whether clawback insurance is allowed, Tysse says. Former Rep. Barney Frank, D-Mass., introduced legislation a year ago to ban clawback insurance, but it was not approved.

Some banks are holding tight until the SEC makes the rules official. TFS Financial (TFSL), the $11.1 billion-asset parent of Third Federal Savings & Loan of Cleveland, said in its proxy statement that it will approve clawbacks "once regulations under [Dodd-Frank] are finalized." Other companies that indicated in proxy statements that they will wait for final SEC guidance include SCBT Financial (SCBT), a $5.1 billion-asset company in Columbia, S.C., and the $2.64 billion-asset State Bank Financial (STBZ) of Atlanta.

Holding tight is the advice that some consultants have given to banks. "If you're not under pressure [from shareholders], don't get drowned," says John Siemann, executive vice president at AST Phoenix Advisors, which consults banks on corporate governance issues. "The status quo is fine until you have to start to make adjustments."

Judith Burns, a spokeswoman for the SEC, said the agency has not provided a timeline for when it will approve the rules. She declined further comment.

SEC Chairwoman Mary Jo White, in her confirmation hearing before the Senate Banking Committee in March, said completing the Dodd-Frank rules must be an "immediate imperative" for the agency.

"The SEC needs to get the rules right, but it also needs to get them done," White said in her testimony.

"There's no higher priority that I have than moving the SEC along, frankly, under both the Dodd-Frank Act and the JOBS Act to get those regulations out as quickly as possible," she said. "I can't give you an exact date, but I guarantee you that I'm going to be focused on that ... from day one."