The UK regulator has proposed rules that would enable a former employer to refuse deferred bonus payments or claw back the bonuses of former employees accused of misconduct or mismanagement. Gary Freer of law firm Bryan Cave looks at the hurdles these rules will have to clear.

In April 2016, the Bank of England Prudential Regulation Authority (PRA) will close the consultation period on its proposal for the introduction of a new rule on buy-outs of variable remuneration. This relates to what it describes as the “practice whereby firms recruiting staff buy out deferred bonus awards that have been cancelled by their previous employer”.

Its stated purpose is to strengthen the existing remuneration rules in the PRA Handbook, which apply to all PRA-regulated banks, building societies and designated investment firms (subject to its proportionality framework). The overall purpose of this part of the PRA Handbook is to discourage excessive risk-taking and short-termism and encourage more effective risk management. It already includes provisions that require the deferral of variable remuneration to allow firms to withhold deferred payments (malus) and even to claw back payments that have already vested and been paid – for a period of seven years (which can be extended to 10 years in certain circumstances).

The PRA expresses concern that the widespread practice of buy-outs undermines the effectiveness of this framework because the employees being bought out were effectively able to insulate themselves against malus or clawback. It has proposed a mechanism that will plug this perceived gap in the framework. 

The consultation paper provides no evidence that the framework has in fact been undermined in any particular case, or that employees have been significantly motivated to move firms in order to do so. In reinforcing the existing malus and clawback rules still further, it reopens concerns that the regime is making the UK financial services sector less competitive and attractive, and that the regulation of bonuses in particular has tended to drive up base pay. That cannot be clawed back, and it arguably makes regulated firms less able to reduce costs in the event of sudden downturns (and therefore less stable).

The new mechanism

The principal mechanism is to be a contract between the new employer and the employee that would provide for malus (of deferred elements) and claw back (of elements which have already been paid) by the new employer on the basis of a determination made and notified by the former employer.

The grounds on which the old employer could make this determination would have to include, as a minimum, misconduct or failure of risk management – a material downturn in its financial performance would not be enough.

The employee would have to be given a right to make representations before the old employer made this determination, and the new employer would be able to apply to the PRA for a waiver where it has “reason to believe an old employer’s decision to apply malus or clawback has been manifestly unfair or unreasonable”. The grounds “might include the apparent severity of treatment towards a former employee based on the information provided, or a pattern of determinations which suggested that the old employer was not acting fairly and reasonably towards its former employee(s)”.

Can this work?

Situations in which an employee has left an old employer for a competitor are often highly charged – and these rules would allow a bitter or mischievous ex-employer considerable scope for revenge against an ex-employee or, at the very least, an opportunity to make him or her the scapegoat for any risk management failings. The ability for the new employer to apply for a waiver will also cast the PRA as the arbiter of disputes between different regulated firms and individuals. Its decisions will probably be subject to applications to the High Court for judicial review. It is to be hoped that the PRA has thought through these (presumably unintended) consequences.

It will certainly be necessary for the PRA to make much more clear exactly what it means, in this context, by terms such as "unfair" (does it have to be ‘manifest’?) and "unreasonable" treatment. As any employment lawyer will make clear, those terms are very elastic and bear a wide range of possible interpretations.

Old and new employers would be required to share information about the background and reasons for malus and clawback, which could be highly commercially sensitive. Would the former employer really want to wash its dirty linen in front of a competitor and the regulator on any arbitration of a waiver application? Would it be worth the time, trouble and cost? If it is deterred from doing so by those considerations, then the regulatory gap, which the rules are intended to plug, would remain open after all.

Gary Freer is a partner and head of the UK employment team at law firm Bryan Cave.

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