Clawbacks: Coming Soon to a Bank Near You?

By now, you've probably heard of compensation clawbacks, when financial institutions take back pay from employees who are deemed responsible for acts of negligence, or outright illegal behavior. Although JPMorgan Chase's (NYS: JPM) trading blunder earlier this year has brought the issue to the fore, clawbacks are actually much less common than the media would have us think.

Available since the crisis, but used primarily in Europe
Clawbacks took root in the financial world during the throes of the financial crisis. Swiss bank UBS (NYS: UBS) was the forerunner in this arena, instituting the system in late 2008. Since then, the bank has made use of the rule to refuse to pay 300 million francs in bonuses to bank managers when the institution suffered a 2.74 billion franc loss in 2009. The bank kept another 204 million francs of deferred compensation in 2011.

Deutsche Bank (NYS: DB) has recently toughened up its own clawback rules and is empowered to take back bonuses that employees earned at other banks. Now, recently hired miscreants could lose the shares they received from Deutsche Bank for unvested stock from prior employment if they don't toe the line. Similarly, HSBC (NYS: HBC) may take back unvested shares from its former executives whose units were involved in drug-money laundering.

Sound tough? It is, but banks have been facing pressure from regulators and investors to retrieve monies given to those who don't deliver as promised or, worse, commit crimes that put the bank in jeopardy. Despite examples like these, a new study shows that only 17% of banks worldwide made use of the system last year. But all that may change, as more banks are hit with lawsuits regarding the LIBOR-setting scandal. The question is: Will American banks jump on the bandwagon as well?

JPMorgan sets the pace
So far, only JPMorgan has pledged to claw back millions in compensation from employees involved in the London Whale trading fiasco. Of course, the bank's losses have been pegged most recently at $5.8 billion, but it's a start.

Despite Dodd-Frank regulations that require U.S. banks to promulgate and enforce clawback policies, most institutions make their own rules as to when they will be levied, and the parameters are pretty soft. For example, many require proof of misconduct, whereas Dodd-Frank has no such requirement.

Fool's take
With big banks such as JPMorgan, Bank of America (NYS: BAC) , and Citigroup -- all of which had seats on the rate-setting panel -- being questioned by regulators regarding what they knew about LIBOR, it seems only a matter of time until pressure mounts domestically to claw back pay from those involved in the scandal.

Clawbacks probably won't make much headway toward paying back funds lost, but they would deliver a very important message to those who would play fast and loose with others' money. If banks take Deutsche Bank's lead, scofflaws would certainly think twice about any funny business, since even pocketed bonus money from previous employment won't be safe if they are caught. This system might even help prevent another meltdown -- good news for investors and taxpayers alike.

It will take a while for clawback policies to take effect, and the hijinks for which the big banks are being taken to task can be scary to investors who are in for the long haul, trying to build up a comfortable cushion for retirement. That's when knowing about the 3 Stocks That Will Help You Retire Rich can really be a portfolio-saver. Read this special report -- and start building a secure retirementnest egg today.

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Fool contributorAmanda Alixowns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase, Citigroup, and Bank of America. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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