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Wells Fargo scandal triggers another look at compensation clawbacks

Politicians are pressing regulators to toughen rules onexecutive compensation clawbacks in the wake of 's fake accountscandal. On Oct. 5, Democrats sent financial regulators a letter calling for mandatory clawbacks in cases of"widespread misconduct" such as the Wells Fargo case.

As Wells Fargo continues to deal with congressional andregulatory pressure from its unauthorized accounts scandal, Chairman and CEOJohn Stumpf has alreadyforfeited about $41 million in unvested equity awards, and CarrieTolstedt, former head of community banking, forfeited about $19 million inunvested awards.

All four of the largest U.S. banks by asset size haveclawback policies that include provisions regarding misconduct that could harmthe institution's reputation. But there are no automatic triggers similar towhat Democrats have advocated.

Rich Reynolds, a partner with PricewaterhouseCoopers' riskmanagement practice, said automatic triggers based on any one metric do notrepresent best practice.

"There are lots of unintended consequences that arehard to anticipate and really no one metric or approach is going to solve foreverything," he said. "That's why we do talk about balancedscorecards, and that's why we do talk about judgment."Reynolds said financial institutions need clawback policies, especially forproducts with "long tails" such as derivatives with cash flows thatstretch far into the future.

The Dodd-Frank Act, passed in 2010, required regulators towrite new rules governing executive compensation, but rulemaking onincentive-based compensation remains in progress. The SEC proposed a rule in2011 and has been reviewing comments since. In May 2016, the agency proposed arevised rule and is considering comments before potentially issuing a finalrule.

The four largest U.S. banks by asset size have been payingclose attention to their compensation policies in recent years. The policiesgenerally include provisions allowing clawbacks for activity that harms thecompany's reputation. For example, Wells Fargo's latest proxy includes"misconduct which has or might reasonably be expected to have reputationor other harm" as a potential trigger for clawing back performance-basedcompensation, such as restricted share rights and performance share awards.Although Stumpf has already experienced clawbacks in unvested compensation, thebank's policy suggests the company's board could still force the executive toreturn compensation already vested.

"The initial announcement … should be viewed as littlemore than the initial salvo from directors," said Isaac Boltansky, ananalyst with Compass Point Research & Trading. "These were just the unvestedoptions, so I do expect more."

Wells Fargo has included "reputation harm" as aclawback trigger for restricted share rights since 2012, according to a 2014filing. Mediareports of the fake accounts first surfaced years ago, but the scandal onlygained nationwide attention in September when regulators hit Wells Fargo with$185 million in fines. Since then, Congress has hammered the bank for failingto act sooner to remedy the problems, suggesting that existing clawbackpolicies have not been as effective as politicians would like.

Rehana Anait, managing director in risk management for PwC,said clawback provisions should rely on data related to reputational harm tobalance profit incentives. For example, boards of directors could look atconsumer complaints regarding a particular product, the number of operationalincidents related to a particular service or how many regulatory fines theinstitution has paid over the last five years.

"Those kinds of things can make an individual think andhave greater accountability and understanding for their own actions and whatthey should do going forward to realign with what an organization wants them todo," Anait said.