Bankers could sue if FSA action leads to slashed bonuses

The head of financial regulator the Financial Services Authority (FSA) has said that it could penalise banks that pay bonuses for behaviour it thinks is excessive risk taking.

But Bob Mecrate-Butcher, an employment law specialist with Pinsent Masons, the law firm behind OUT-LAW.COM, said that City workers could mount a legal challenge to bonus cuts.

"There is a significant expectation built up over many years that bankers will receive a yearly bonus," he said. "It is likely that if investment banks sought to pay no bonuses, or to reduce them beyond the level justified by reduced financial performance, they would be subject to legal challenge."

Though banks treat bonuses as discretionary, there are still legal limits on how severely they can chop bonuses or for what reasons.

In a High Court case in 2000 the judge ruled that "even a simple discretion whether to award a bonus must not be exercised capriciously” and an employer should not exercise its discretion in an “irrational or perverse way", meaning a way in which “no reasonable employer would have exercised its discretion”.

FSA chairman Lord Adair Turner told the BBC this week that it would seek to take action against banks whose large bonuses encouraged employees to behave too riskily.

"If we think they are in danger of encouraging people through that bonus structure to take risky actions which appear to look good at the time, but which create toxic assets for the future, then we have the power to say if you want to do that, you've got to hold a bit more capital because we think you're a more risky institution," he said.

Mecreate-Butcher said, though, that banks would face a productivity problem if they cut bonuses after the turmoil in the financial markets of the last 10 days.

"If the financial rewards previously offered by banks were no longer available, it is unlikely that investment bankers would be prepared to sacrifice their private and family lives to the same extent as currently," he said.

Some of the biggest names in world banking have collapsed, been taken over or been baled out with public funds in recent days as the availability of money on the world's financial markets has almost evaporated.

Those financial catastrophes will also affect how the remaining banks can pay bonuses, said Mecreate-Butcher.

"Banks looking to significantly increase portions of annual rewards payable in deferred form, such as stock options or similar, may well find a reluctance from bankers to accept them after the collapse of Lehman Brothers, where several employees lost significant sums in relation to stock holdings along with their jobs," he said.