SEC's pay rules may mimic TARP's

Compensation for brokers and firm executives would be subject to claw-backs if deemed excessive

Nov 14, 2010 @ 12:01 am

By Bruce Kelly

Look for the SEC to rely on stringent TARP guidelines when it proposes new rules on broker pay and broker-dealer executive compensation in April.

As first reported on, the Securities and Exchange Commission will likely follow the strict limits included in the Troubled Asset Relief Program, according to attorneys and compensation consultants. TARP included a ban on golden parachutes for a bank's top five executives.

TARP limits were temporary, however, and were lifted once a bank had paid back the borrowed funds.

On its website, in a section labeled “market oversight,” the SEC states that it will “adopt rules [jointly with others] regarding disclosure of, and prohibitions of certain, executive compensation structures and arrangements.”

The framers of TARP were worried about the alignment of a bank's compensation structures and whether those were in the best interests of the financial institution and the public at large, said Andrew Oringer, a partner at Ropes & Gray LLP who focuses on compensation issues.

“Now, with Dodd-Frank, the issue is pushed back to center stage somewhat,” he said. “As the deadline comes closer, financial institutions will have to turn their attention to what this means.”

New SEC rules could include provisions for recoupment or claw-back of excessive executive pay, as well as limits on incentive pay that would be triggered by actions deemed inappropriate for clients, said Steven Hall, managing director of Steven Hall & Partners LLC. He said that he isn't doing work for any large broker-dealers on the impending SEC pay rules.

In a June memorandum to clients, Ropes & Gray said that bank holding companies, broker-dealers and investment advisers must disclose to appropriate federal regulators by April 21 “the structure of all incentive-based compensation arrangements that they offer.”

The SEC's goal is to determine whether the compensation structure provides an executive officer or employee with “excessive compensation or benefits, or could lead to a material financial loss to the institution,” the memo said.

Also by that date, federal regulators are to “prescribe regulations that prohibit any type of incentive-based payment arrangements, or any feature of such arrangements, that the regulators determine encourage inappropriate risks by the institutions by providing” an executive or employee “with excessive compensation or benefits, or that could lead to a material financial loss to the institution,” the memo stated. “No reporting of actual compensation will be required.”

An SEC spokesman declined to comment.

SEC Chairman Mary Schapiro discussed broker pay last Monday during her speech at the Securities Industry Financial Markets Association's annual meeting in New York. She said that the SEC is writing rules about broker compensation, focusing particularly on pay that rewards risk taking.

One focus of Ms. Schapiro's remarks was the large bonuses that represemtatives receive when leaving one firm and joining another. Upfront bonuses and compensation that encourage risk taking “are things that absolutely have to change,” she said.

Ms. Schapiro said that the SEC intends to write rules that require “compensation programs that incentivize the right kinds of behavior.”

“Clearly, what's unnecessary are compensation programs that compensate and incentivize short-term risk at the expense of ... the long-term franchise from the viewpoint of investors,” she said.

Ms. Schapiro also criticized pay schemes that produce “higher levels of compensation for higher levels of turnover in the portfolio,” citing churning practices, in which a broker receives larger payouts for increasing the trading activity in a client's portfolio.

In August 2009, Ms. Schapiro sent a letter to chief executives at broker-dealers encouraging them to be “particularly vigilant” in monitoring the sales practices and related compensation of brokers and advisers.

In the wake of the passage of the Dodd-Frank regulatory reform act, the SEC has a broad mandate to rewrite financial service industry rules. But Ms. Schapiro has recently taken aim at upfront bonuses that large wirehouses and regional broker-dealers routinely pay to woo brokers from competing firms.

As firms scrambled to pick up brokers last year after seismic shifts on Wall Street, some broker-dealers began offering top advisers pay packages that ex-ceeded 300% of one year's fees and commissions. Much of the bonus is linked to the broker's performance after joining the new firm.

That caught Ms. Schapiro's attention and prompted her August 2009 “open letter” to broker-dealer chief executives.

“Certain forms of potential compensation may carry with them enhanced risks to customers,” she wrote. “Some types of enhanced compensation practices may lead registered representatives to believe that they must sell securities at a sufficiently high level to justify special arrangements that they have been given. Those pressures may in turn create incentives to engage in conduct that may violate obligations to investors.”

The retail-brokerage industry has no single standard of disclosure regarding such bonuses, said Kent Christian, senior managing director and president of the financial services group at Wells Fargo Advisors LLC. Some firms have “fairly general” rules concerning disclosure to clients about upfront bonuses, he said.

Most advisers, would typically discuss any bonus along with the rationale for changing firms with clients, Mr. Christian said.

E-mail Bruce Kelly at


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