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The Politics of Wall Street Clawbacks

Photo: Stacey Newman/iStockphoto

Ina Drew, the former head of JPMorgan Chase’s chief investment office, may have to pay for the London Whale’s losses after all.

Several weeks ago, Bloomberg reported that Drew would walk away with $21.5 million in unvested stock and options as a result of being allowed to resign, rather than being fired, after her unit’s trading losses cost the bank an amount that is now estimated at $5 billion. But today, the WSJ seems fairly certain that Drew’s millions, as well as the bonuses of several other CIO traders, won’t materialize after all.

The reason is an oft-cited but frequently misunderstood Wall Street maneuver known as a clawback:

The nation’s biggest bank is expected to claw back compensation from individuals including Ina Drew, who ran the company’s Chief Investment Office, or CIO, according to people familiar with the bank’s plans […] Other members of the CIO, including Bruno Iksil, the London-based trader known as the “London whale” for his outsize bets on certain corporate credit indexes, and his bosses Achilles Macris and Javier Martin-Artajo also are expected to face clawbacks, the people said.

Here’s a very simplistic explanation of what’s going on here: If you or I screw up at our jobs, our bosses have lots of options. They can fire us, get us disinvited to the holiday party, turn us over to the police (if we did something really bad), or dock our pay for next year. What they can’t do, generally, is take back money they’ve already paid us.

Until a few years ago, those were also Wall Street’s options, more or less. Unless an employee did something so incompetent or evil that it forced a firm to restate its financials after the fact (like saying “My unit made $2 billion last quarter” when the truth was “My unit lost $2 billion at the Bellagio”), everyone’s past compensation stayed in their bank accounts, no matter how royally they screwed up.

But after the financial crisis, regulators and lawmakers decided it was a good idea to be able to penalize people who, say, ran entire firms into the ground and walked away with $315 million. They inserted a provision in Dodd-Frank that required companies to be able to “claw back” pay from executives and other employees under certain circumstances.

What are those circumstances? Well, it depends. Banks aren’t required to make their exact clawback policies public. But at JPMorgan [PDF], the claw can come out for any employee who “engages in conduct that causes material financial or reputational harm to the Firm or its business activities,” and for any executives or so-called “Tier 1 employees” who “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.”

Drew, as the ex-head of JPMorgan’s CIO, would almost certainly qualify as a Tier 1 employee who “failed to identify” the risks her unit was taking on.

Successfully penalizing her won’t be easy, though, especially if she decides to fight a clawback attempt.

The problem is, there are no real clear guidelines about clawbacks,” Alan Johnson, a well-known Wall Street compensation consultant, said in an interview on Wednesday. “Who should be impacted? Should it be her? Her traders? The senior management of the bank?”

Wall Street clawbacks are extremely, extremely rare. When high-ranking employees, like CEOs and CFOs, cause public embarrassment and/or massive losses, it is generally easier to just let them retire with severance and a promise to go away quietly than conduct a full-scale investigation that could turn up further misdeeds or cause expensive legal battles, then go through the hassle of getting board approval for a clawback. And when low-ranking employees mess up, it’s generally cheaper and easier just to fire them.

(The alternative option to clawbacks is successfully pressuring high-ranking employees, like Bob Diamond, to give up their back compensation voluntarily. But that basically only happens in Britain, for reasons that are too speculative and boring to go into here.)

With the JPMorgan fiasco, the general sense is that someone inside the bank’s CIO should pay, in an actual dollars-and-cents way, for the London Whale’s $5 billion mistake.

When any loss becomes very large and very public, there’s huge pressure,” Johnson said.

JPMorgan’s executives have apparently decided that the benefits of clawing back CIO pay, and relieving some of that pressure, outweigh the risks involved in the long and potentially messy process of singling Drew and her traders out for punishment.

Which means that no matter how hard she’s prepared to fight her former employer, Drew should probably go light on the vacation spending this summer, just in case.