A major reason that Wells Fargo and CEO John Stumpf are getting beaten up like no other bank or CEO since the financial crisis is that they’ve handled their fake-accounts scandal wrong since day one almost a month ago. As a result, they’ve been forced to play defense rather than offense ever since. An apt example is the announcement that the board would claw back $41 million of Stumpf’s pay – an impressive move, but it happened only after the Senate Banking Committee held a bipartisan hostility fest with him as the focus. So the board’s action looks insincere, as if it wouldn’t have happened without pressure from the Senate committee.
And by the way, that clawback isn’t quite what it appears to be.
The average person reading a typical headline on the story – “Wells Fargo to Claw Back $41 Million of Chief’s Pay Over Scandal” said the New York Times – might reasonably suppose that Stumpf would have to write a check for $41 million to return money he’d been paid. But in fact he hadn’t received any of the money that’s being “clawed back.” The board’s action applied only to another form of compensation, stock awards, and only to those that had not vested, meaning he could not yet turn them into money even if he had wanted to. What’s more, if the awards had not been clawed back, some of them might never have vested at all, since the number of awards that would vest over a three-year period was “subject to adjustment upward (to a maximum of 150% of the original target number granted) or downward to zero” based on the bank’s performance vs. its peers, as the company explained in an SEC filing. Stumpf is giving up money he hasn’t earned yet. It’s possible he might never have received at least some of it.
A separate angle makes unvested stock awards a still more congenial form of compensation to have clawed back, if one’s pay must be clawed back at all. The average headline-reader imagines the executive paying back money deposited previously in his or her bank account. When that happens, it’s even more painful than it sounds. The executive presumably paid income tax on that income when it was received in some previous year, so he or she kept only a fraction of the total. But when it’s clawed back, the executive must pay back the whole amount, and it’s far from certain that he or she can recover the income tax that was paid to Uncle Sam. The tax code generally prohibits this if the clawback happens in a year subsequent to when the executive received the money, which is usually the case. So in a clawback of real money, the executive may have to pay back far more, perhaps twice as much, as he or she actually received after tax.
But that’s not what happens when unvested stock awards are clawed back. In that case, the executive typically has not paid any tax on the awards (though in rare cases that are complicated to explain, he or she might have chosen to do so). So he or she need not worry about trying to recover taxes.
Make no mistake, Stumpf is losing something that is probably of great value. While his unvested stock awards were valued at $41 million on the day the board acted, that amount assumes all of the awards would actually have vested, and it varies with the stock price. Their actual value when Stumpf turned them into money could have been much less, conceivably even zero, or could have been a great deal more. No one knows.
It’s worth remembering that not all clawbacks are equal. If an executive has to give back compensation, unvested stock awards are about the best form in which to give it back.
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