UBS Revamping Bonus Plan, Will Try to Claw Back Previous Payments

The UK’s Times reports that Swiss bank UBS intends to change its bonus program so that current year bonuses can be largely reversed if performance in subsequent year falls or generates losses. Even more striking, the bank is considering trying recoup bonuses already paid to certain executives.

The UBS move is a worthwhile effort towards establishing greater accountability and linking pay to longer-term performance measures. However, the idea of giving a bonus that can later be almost completely reversed is such an odd construct that it suggests that the idea of basing pay on current year performance may need rethinking.

Note that the sort of ills that plague Wall Street now were almost unheard of when firms were private partnerships. There was no incentive to produce financial statements that gave an unduly rosy picture of business results; indeed, the very last thing that owner-managers would want to do is pay out compensation in excess of “true” earnings, since that would deplete their hard-earned capital. So the annual bonus worked despite the potential for abuse because the leadership was vigilant.

But now that the products and the risks have become vastly more complex, it is possible for top executives to have sufficient knowledge to make informed decisions on an annual basis? There are other ways to approach this conundrum. When Warren Buffett started his insurance operations, the executives got 15% of the profits……five years later. The risks in insurance are long-tailed (it can and does take years to know the total payout and expenses on policies written in the current year), so that structure fits the timeframe required to measure results accurately.

If UBS has to resort to boomerang bonuses, it says that it has serious doubts about its ability to determine the earnings of its units on a current basis (as refreshing as that is, I would not find that very comforting were I a shareholder). So why not attack the problem more directly with a longer-term payout structure? That is what this amount to. In fact, UBS uses a surprisingly Buffett-like five year time frame and “ring-fences” the amount that UBS reserves the right to withdraw.

And when better to implement a change like this, when jobs are scarce and former Masters of the Universe have little bargaining power?

From the Times Online:

Senior executives and traders at UBS will forfeit previously earned bonuses if they underperform, under a radical new pay system devised by the stricken Swiss bank.

Just as bonuses (Latin for “good”) are paid out for good performance, maluses (“bad”) will be meted out if the bank subsequently makes losses or if the employee misses performance targets, UBS said. The maluses could wipe out all previously agreed share bonuses and two thirds of all cash bonuses under stringent new rules designed to align the interests of executives and traders with those of shareholders.

The Swiss bank announced plans for a complete overhaul of its pay system and disclosed that it was taking legal advice to see whether it could claw back previously paid bonuses from tarnished executives. That raises the prospect of UBS demanding and, if necessary, suing Marcel Ospel, its former executive chairman, for the return of millions of dollars of bonuses that he received before UBS collapsed into losses.

Maluses will be awarded for financial losses at group or divisional level, for asset writedowns, for personal misconduct, for breaches of risk rules and for missing performance targets. A worker receiving a malus will forfeit previously awarded cash and/or share bonuses held in ringfenced accounts. Both cash and share bonuses will be held in ringfenced accounts for up to five years. Executives underperforming repeatedly could be given so many malusus that they could end up with a negative balance, UBS said….

UBS is reforming bonuses under pressure from the Swiss Federal Banking Commission. Last month the bank was rescued with a $60 billion (£40 billion) bailout package by the Swiss Government. All 2008 bonuses will be down from 2007 levels, UBS said

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  1. Anonymous

    What a lovely word : maluses. Hope it catches on and we become familiar with it. Sadly, I have my doubts.

  2. Anonymous

    It is nice to know that there are still some parts of the world where logic is still exercised.

    Maluses is a good concept that needs to be drilled into the American public consciousness. any bets on that working?

    Thanks for posting this Yves. It did brighten a fairly dismal day.

  3. john bougearel

    I just want to try this new word in a sentence.

    Can we “malus” the Secretary of the US Treasury? Afta’ all, don’t we pay him?

  4. baychev

    isn’t vesting doing exactly that? or it is designed to keep the person around like shackles? tie vesting to future performance than just to the number of years.

  5. a

    I guess I remain skeptical. It looks like one big PR campaign, with the objective of allowing large bonuses to be paid this year under the cover that reform is in the air.

    This year UBS has seen “losses at group … level”, right? So is UBS saying that it’s going to distribute maluses to all of its employees this year? Of course not! Bonuses will just be “down” from last year.

  6. eh

    The UBS move is a worthwhile effort towards establishing greater accountability…

    I’m not so sure I agree, e.g. with the part about asking for the money back. Presumably UBS had risk management structures in place; were they violated? Is there evidence of such malfeasance? Or of anything criminal? I can understand the feeling behind the move, if less so the logic. It strikes me somehow as petty, small-minded. How do they expect to recruit people to work for them with such policies in place? In the ‘past results are no guarantee of future returns’ sense. Anyway, more of what you’ve come to expect from these shallow clowns in finance.

  7. burnside

    I believe UBS undertook to separate investment banking from their wealth management division in August of this year. While I understand the reluctance of some to credit the firm’s intentions with respect to this latest announcement, there is after all some indication here that UBS is becoming a front runner in matters related to (self-) regulation and internal reforms.

    Stockholders who are unnerved by these proposals may be overlooking the evidence that the new rules are “. . .designed to align the interests of executives and traders with those of stockholders.” To me, at least, this appears to be a move intended, in part, to generate fresh infusions from the capital markets.

  8. Byrd

    I think the author’s comment about UBS’s new policy proposal as being an indication that UBS is incapable of reporting shows how little most people understand of this crisis.

    UBS and every other major financial instituition engaged in massive off balance sheet transactions and OTC markets knowing that this could one day blowup. Management knew about it and new that everyone else was doing the same thing.

    The problem is not that UBS or any other bank for that matter, “cant” assess the profitability of its current business, but the problem is that pay structure is such that the controls are not enforced since management itself also benefits in high short term payouts that can dwarf any longer term considerations.

    I think it is correct to have top manager compensation more in line with potential future losses generated in their businesses. Whether this means longer term investment periods for bonuses or clawbacks will be seen.

  9. Lune

    I agree with 'a'. This is a PR move until proven otherwise, designed to fend off govt criticism over paying out bonuses this year after receiving a $60bil bailout. Bonuses are "less" than last year? Give me a break! If your firm teetered on the edge of bankruptcy, requiring a cash infusion equivalent to >10% of your country's GDP just to keep running, there should be so many "maluses" awarded that everyone from the janitor on up should essentially be in debtor's prison right now. But no, bonuses will only be "lower" than last year.

    If they really wanted to align executive interests with shareholders, they should do what Buffett does and simply not pay out the bonus until 5 years later. Paying bonuses now with some ill-defined option of clawing them back later is an accounting contortion whose sole purpose is to allow bonuses to be paid this year while hoping / praying that conditions improve the next several years so that they can quietly discard this policy and go back to the usual beggaring of their shareholders and clients when the current public scrutiny has died down.

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