The sum of all fears: the changing bonus culture in financial services

The sum of all fears: the changing bonus culture in financial servicesThe recent financial crisis has seen Gordon Brown confirm that “the days of big bonuses are over”. With a number of banks either nationalised or partly nationalised, it is clear that the government will be able to influence a number of banks’ remuneration policies.

The Financial Services Authority (FSA) is also going to have an increasing influence on banks’ remuneration policies. However, it is resisting calls to cap exorbitant city bonuses. It does appear that the FSA may require banks to prove they have sufficient capital before bonuses are paid and put pressure on banks to move away from remuneration structures which encourage excessive risk. For example, in mid October the FSA wrote to the CEOs of 28 of the largest banks it supervised, confirming that “It would appear in many cases that remuneration structures of firms may have been inconsistent with sound risk management”. In addition, the FSA set out clear guidance as to good and bad remuneration policies.

What does all of this mean for lawyers? Clearly, over the forthcoming months, banks will require advice about their current bonus structures and what other approaches can be adopted in the future.

Current bonus structures

Over recent years employees have built up an expectation, through custom and practice, that they will always be paid a “discretionary” bonus. This expectation will lead to an increase in bonus litigation because employees who are made redundant may be able to bring a breach of contact claim for the non-payment of a bonus (pro-rata or otherwise) while employees whose business areas are still performing will still expect to be paid a discretionary bonus.

In terms of employees who are made redundant, lawyers will have to consider the wording of any bonus clause/scheme and the terms of the employee’s contract of employment to ascertain whether an employee can bring a breach of contract claim for the non-payment of a bonus. If an employee has a bonus claim, it will be necessary to ensure that this is expressly covered in the severance documentation in order to avoid future litigation. If bonus litigation does arise then any such claims will generally be brought in the High Court rather than an employment tribunal unless the employee can argue that the non-payment of the bonus amounts to an unlawful deduction from wages (which is not straightforward) or the amount of the bonus claim is less than £25,000.

For those employees who remain in employment and still expect to be paid a bonus, it will be vitally important that the bank sends out a clear message (in writing) confirming how market conditions and the company performance will impact on the number and amount of bonus payments. Early, clear communication is key to ensuring that banks and managers are able to manage employees’ expectations.

Future bonus schemes

The future appears to be a move towards more detailed contractual bonus schemes which take into account long term risk. The whole issue of rewarding employees both in the short and long term and also ensuring retention of staff will become a growth area for lawyers. A pure discretionary cash bonus will probably become a thing of the past. Instead there will be pressure from the government and the FSA to ensure that part of a bonus is paid in cash and the rest is retained and paid out over a period of time subject to good and bad leaver provisions and/or is paid in the form of share options which vest over a three year period. It is also possible that some of the banks may consider the private equity model involving a combination of carried interest and a cash bonus.

Another developing area for lawyers will be the inclusion of claw back provisions in contractual bonus schemes. These provisions could allow banks to claw back a bonus paid to an employee when it transpires at a later date that they have made a high risk “toxic” investment. Lawyers will also need to provide advice on the letters sent to employees confirming the award of a bonus. Such letters will need to set out clearly why the bonus has been awarded and confirm that the terms of the bonus scheme, including any claw back provisions will apply.

It appears that the bonus culture of banks, and for that matter public companies, will have to change. The days when employees were awarded large discretionary bonuses without any consideration as to the level of risk and long term stability of both the investment and the company are behind us.

Adam Hartley is an employment, pensions and benefits partner at DLA Piper UK