Sports stars should be subject to clawbacks

September 4, 2012: 10:47 AM ET

Much has been made of Lance Armstrong's loss of future earnings. But his past earnings should be at stake too.

By Cyrus Sanati, contributor

FORTUNE -- The disgrace of legendary cyclist Lance Armstrong on allegations of doping puts yet another black eye on the world of professional sports. The jig was finally up as nearly all of Armstrong's former teammates, many of whom were also dopers, stood waiting in the wings to tell the world under oath how their friend had indeed cheated. But instead of fighting the allegations in arbitration, Mr. "Live Strong" Armstrong decided that the chips were invariably stacked against him and chose to veer out of the peloton of shame he had created.

Doping in cycling is an epidemic, but it is also pervasive across sports, especially in baseball and track and field. And why not? There seems to be very little downside to cheating: dopers are almost always identified long after they have already cashed in on their success. In a way, the situation eerily reminiscent to the, "heads, I win; tails, you lose," mentality that was so pervasive on Wall Street in the years leading up to the financial crisis.

It may be that the sports world is in need of its own version of Dodd-Frank, the financial regulatory reform bill, which aims, in part, to root out Wall Street cheats. One particular idea sports officials can learn from here is the financial claw back. In the sports world, this would translate into enforceable and damaging penalties levied on athletes, not only while competing, but also after they have walked away. And we are not just talking about going after the prize money or salaries. Everything, including money made through endorsement deals, should be up for grabs.

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It may seem like a no brainer forcing athletes caught cheating to give back the cash along with the medals they won while competing under the influence, but it's actually very rare. Not only do most disgraced athletes get to keep the multi-million dollar salaries and prizes they earned while essentially cheating, but they also keep the cash they picked up through endorsement deals, which are often incredibly lucrative.

Sometimes the product the athlete is endorsing is related to their sport, as is the case with Armstrong and his relationship with bicycle maker, Trek, or shoemaker, Nike (NKE). In those cases, people are encouraged to believe that if they work hard and have the same shoe or bicycle as Lance, they might gain an edge over other weekend warriors.  In other cases, the products they endorse have little or no relationship with the sport, like Armstrong and his team's partnership with the US Postal Service. These deals can be just as profitable, if not more, than those that promise success. From 2001 to 2004, Armstrong and his crew of alleged dopers reaped $31.9 million from the USPS, mostly for sporting the USPS logo.

Like Wall Street, if you make it big in sports -- even in one such as cycling -- companies will want to pay you. Also like Wall Street, the deals are partially performance based. For example in the USPS deal, Armstrong would receive a bonus of $1.47 million for every stage he won in the 2001 Tour d'France.  In that case, the pressure to win every stage became more than just about pride or the hope of future endorsement deals -- it became directly linked to getting paid. So at the same time traders on Wall Street were busy taking risky directional bets with other people's money to earn big bonuses, Armstrong and his team took risky bets with their health and reputation to do much the same.

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Clawbacks on Wall Street were once as rare as they were in sports but all of that is changing. Dodd-Frank now requires financial firms listed on an exchange to have some sort of clawback provision or risk being delisted. Firms like Morgan Stanley have already instituted a claw back policy while others are now falling in line. The clawback is focused on performance based compensation, e.g. bonuses, and don't target salaries. This works well on Wall Street because the bonus is where the bulk of a trader or banker's compensation lies. So far, though, clawbacks on the Street are a rarity, but more cases are expected to float to the surface thanks to Dodd-Frank.

For example, JPMorgan Chase (JPM) is expected to claw back millions from employees who were responsible for the massive $6 billion (and counting) trading loss that occurred at its chief investment office in London earlier this year. The head of that department, Ina Drew, was given $14.6 million in stock based severance pay, along with $2.6 million in pension benefits and nearly $10 million in deferred compensation when she was forced out of her position. A lot of that cash could now come back to JPMorgan shareholders thanks to clawbacks that JP Morgan Chief Executive, Jamie Dimon, told Congress this summer were "likely," to be triggered in this case.

Much has been written about Lance Armstrong's loss of future earnings, but not much has been said about the potential loss of his past earnings -- those that he made while he was at his prime and allegedly doped up. Apparently, clawback provisions in sport contracts are extremely rare. Three "super" sports agency interviewed by Fortune on this topic, who wished not to be identified given the sensitive nature of this topic, say that they have never heard of a clawback provision ever being asked for or given in any kind of marketing or player contract. One of the agents went so far to say that if a marketer asked for such a provision, he would, "take his client and walk out of the room."

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But sports contracts do have moral clauses which attempt to keep athletes in line while under contract. This gives the sports team or marketer the right to break a contract if an athlete acts up in some way, but most do not explicitly say they can take money back after the contract is up and paid. Armstrong will be a good test case here. In 2004, SCA Promotions sought to withhold paying a $5 million bonus to the cyclist after winning his sixth Tour following allegations of doping. Armstrong took SCA to court and won. But now that the US Anti-Doping Agency has stripped Armstrong of his titles, SCA is back and is looking to overturn the 2004 ruling and clawback that $5 million.

If SCA is successful in clawing back its cash, it could possibly deter other would-be dopers from thinking about cheating their way to glory. But an SCA win won't change anything in the long run unless it causes marketers and sports teams to come together and require that clawback provisions be standard in all future contracts with sports stars. Until that happens, the risk of getting caught doping won't out way the gains for an athlete, especially one near the end of his or her career. It is too early to know what if any impact that clawbacks have had on curbing risk taking on Wall Street, but if it proves successful, then companies and sport teams could help curb substance abuse and cheating by following its lead.

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