BY STEVEN M. DAVIDOFF
Ina Drew and two JPMorgan Chase traders are leaving in the wake of the bank’s $2 billion trading loss, and others could follow.
The question now is whether JPMorgan will invoke its newly implemented clawback policy to penalize these executives, including forcing the return of Ms. Drew’s reported $14 million salary last year.
We are on new terrain.
Prior to the financial crisis, a clawback wasn’t really an option. Bank executives and other employees kept prior compensation, even if it turned out that they bore responsibility for their institution’s later billion-dollar losses. For example, Charles Prince, the former chief executive of Citigroup who left in the midst of the financial crisis, not only kept the hundreds of millions he was paid but also received a $68 million exit package.
Financial institutions were savagely criticized for these practices, the “heads I win, tails you lose” nature of Wall Street compensation. It was a problem that extended beyond the C-suite. Traders could pocket millions of dollars for strategies that later soured.
One of the most egregious examples was Joseph Cassano of the American International Group. The executive, who headed up the A.I.G. Financial Products, kept more than $300 million in salary and bonuses despite heading the group the led the insurer to near collapse.
When things went bad during the financial crisis, many Wall Street traders pulled the eject button, escaping with millions and leaving the wreckage behind.
In the wake of the financial crisis, the Dodd-Frank Act was supposed to change all this by implementing clawback policies. By ensuring that prior compensation could be returned to a company, employees would act in the long-term interest of the company instead of trying to make money in the short term. The clawback ensures that employees have the right incentives and can’t just run with the money.
But the clawback policy in Dodd-Frank as adopted by the Federal Deposit Insurance Corporation has been criticized as weak, since it only applies to the “too big to fail” banks and other financial institutions. The policy is triggered if the bank is put into insolvency proceedings and employees are found to have failed to apply their job with the “degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances.”
This is a legal standard and allows the employee to simply claim they made an error but acted with appropriate care. And the policy only applies to senior executives and directors, not traders. The standard is so high and the circumstances it can be used so narrow, I doubt the F.D.I.C. will ever invoke this clawback provision.
But this does not end the matter. Regulators and institutional shareholders have been at work in the market to build on these requirements. New York’s comptroller, John C. Liu, has been pushing financial institutions to adopt stronger clawback provisions, including getting Goldman Sachs to implement tougher rules. Not surprisingly, given Jamie Dimon’s prior criticism of financial reform, JPMorgan resisted most assiduously although it did eventually address some of Mr. Liu’s concerns.
Under JPMorgan’s policy adopted in 2009, JPMorgan retains “the right to reduce current year incentives to redress any prior imbalance. . . . ” In addition, prior equity compensation can be clawed back if the employee “engages in conduct that causes material financial or reputational harm to the Firm or its business activities” or “for members of the Operating Committee and Tier 1 employees, such employees improperly or with gross negligence fail to identify, raise, or assess, in a timely manner and as reasonably expected, risks and/or concerns with respect to risks material to the Firm or its business activities.”
According to Mr. Liu, JPMorgan takes the position that this clause not only applies to the business as a whole but also to various units. So it is possible that the policy could ensnare executives in the chief investment office, where the trading losses occurred.
I do not know if any of these traders or Ms. Drew is a Tier I employee, but there is a real question whether they and others have acted in a way to trigger these policies. It is even worth asking the question whether the intelligent Mr. Dimon — who admittedly has been upfront that this was “stupid” and has been a valuable chief executive for JPMorgan — has acted in a way to trigger this policy as the supervisor of these people.
JPMorgan’s shareholder meeting is on May 15. No doubt shareholders will be asking whether JPMorgan rewarded these traders with termination packages, but also about clawbacks. At a minimum, the JPMorgan board has a duty to look at this issue, find out the facts are and determine the situation warrants clawbacks. Others are likely to be scrutinizing the board to make sure there is no whitewash, since these clawbacks and compensation adjustments are seen as ensuring that Wall Street does not again profit and leave others holding bag.
We are about to see the first real test of the new post-financial crisis regime. Hopefully, Wall Street will do better this time.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.
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