Out-Law News 3 min. read

Bank of England proposes extension of 'malus' provisions to bonus buy-outs


Banks in the UK that 'buy out' a new recruit's deferred bonuses that would have been paid by the former employer had the employee stayed with them, would be required to apply malus or claw back to such buy out awards if the former employer later establishes that it would have done so, the Bank of England has announced.

The reasons for such malus or claw back would include at least any individual misconduct or risk management failings while with the old employer, but not any down turn in the old employer's financial position, according to plans put forward by the Prudential Regulation Authority (PRA).

The proposals would extend existing remuneration rules to situations where a bank compensates a new employee when a deferred bonus that would otherwise have been due from a previous employer is forfeited. The PRA said that the practice had the potential to undermine the effectiveness of the remuneration rules in a way that enabled individuals to "effectively evade accountability for their actions".

Financial services remuneration expert Steven Cochrane of Pinsent Masons, the law firm behind Out-Law.com, said that whilst on the face of it the proposal was a "conceptually pragmatic solution" to the issue, the system could prove difficult for banks to manage in practice.

"In effect, the regulator will require that any buy-out award offered by a new employer should be subject to malus or claw back by the new employer in the event that the old employer becomes aware of historic circumstances which would have triggered malus or claw back under their relevant remuneration plan rules," he said.

"As with so many policy decisions within financial regulation, the devil will really be in the detail and the system could be fraught with difficulty. One significant practical hurdle could be the necessity for the old employer to provide the new employer with extremely sensitive information, potentially including personal data relating to third parties in addition to the employee in question. Such an exchange of information will be deeply unattractive for many commercial organisations, not least because the information is likely to be extremely sensitive and the other party may well be a direct competitor. Organisations may also have data protection concerns in relation to such information flow," he said.

The PRA's new remuneration rules came into force on 1 January 2016. They require banks and other PRA-regulated firms to apply malus or claw back to individuals' bonuses in specified circumstances, for longer than required by the underlying EU rules: for the most senior staff for up to 7 years after the award date in respect of malus, and for up to 10 years in respect of claw back. These changes expanded the existing the PRA's Remuneration Code, which already required the reduction or recovery of bonuses in certain circumstances for an appropriate period, for which the minimum lengths of time were shorter.

The buy-out proposals follow an information-gathering exercise by the PRA, during which it ruled out banning the practice entirely. Instead, it has proposed that the employment contract between the individual and the new employer be amended so that malus or clawback can be applied if the old employer later establishes that the individual was guilty of misconduct or risk management failings while in its employment. The new employer would be able to apply to the PRA for a waiver if it believed that the old employer's decision was "manifestly unfair or unreasonable".

The PRA is consulting on its proposed changes until 13 April 2016. Once in force, the new rules would apply to all 'material risk-takers' at PRA-regulated banks, building societies and designated investment firms. Smaller, less risky firms would, however, be exempt in line with the PRA's existing proportionate approach to regulation.

Share plans and incentives expert Suzannah Crookes of Pinsent Masons said that the outcome of the consultation would be of relevance to companies beyond those in the financial services sector.

"There is concern over buy-out awards in other sectors, in terms of the possibility of perceived 'rewards for failure' rather than the regulation of risk and financial stability," she said.

"The operation of malus by a new employer by reference to historic circumstances under the old employment may create practical difficulties, but it could potentially address at least some of the concerns. It will be interesting to see whether public companies in other sectors may consider the feasibility of this, and whether investors will raise the issue, if it becomes established practice in financial services," she said.

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