Efforts in Congress to toughen restrictions on executive compensation likely would upend pay practices all across the financial services industry.
On July 31, the House passed the Corporate and Financial Institution Compensation Fairness Act on a 237-185 vote. The bill, which likely will be taken up by the Senate in the fall, would give shareholders of public companies annual, non-binding advisory votes on executive pay and “golden parachute” severance packages.
The legislation also contains a key provision that would allow regulators to prohibit payment practices at financial services companies which would encourage officers or employees to take risks that threatened the safety and soundness of those companies.
“They'll look much more closely at the incentive compensation arrangements that the institutions have in place,” said David Lynn, a partner in the Washington office of San Francisco-based law firm Morrison & Foerster LLP.
Mr. Lynn, who is co-chairman of the firm's public-companies practice, is former chief counsel of the Securities and Exchange Commission's Division of Corporation Finance.
Most likely, regulators will adhere to principles set forth in June by Treasury Secretary Timothy Geithner aimed at encouraging financial services companies to align incentive-based pay with long-term value, Mr. Lynn predicted.
“The financial crisis had many significant causes, but executive compensation practices were a contributing factor,” Mr. Geithner said at that time.
SHORT-TERM RESULTS
Indeed, regulators likely would target curtailing payments based on short-term results, said Alan Levine, a partner in the executive compensation and employee benefits practice of Morrison Cohen LLP, a New York law firm.
Other potential targets are guaranteed bonuses, which are paid regardless of how a company performs, and so-called uncapped bonuses, which are usually based on a firm's revenue, said Patrick McGurn, special counsel in the Rockville, Md., office of New York-based shareholder advisory firm RiskMetrics Group Inc., which specializes in risk management and corporate governance.
“All of those are fairly routine compensation practices in portions of the financial services industry,” Mr. McGurn said. “They encourage excessive risk-taking.”
Basically, “any large award that doesn't provide a downside as well as an upside” is likely to come under attack, said Richard Ferlauto, director of corporate governance and pension investment at the American Federation of State, County and Municipal Employees in Washington.
Payments based on highly leveraged investments also are subject to more regulation, said Kenneth Werner, a partner in New York law firm Richards Kibbe & Orbe LLP who advises clients on executive employment issues.
“Leverage works both ways: When things are going up, it in-creases your return. When things are going down, it increase your risk,” Mr. Werner said.
Companies might be pushed by regulators to structure compensation plans so that payments go down as leverage increases in an investment, he said.
While it is not clear that the sign-on bonuses that brokers often receive when they are recruited by brokerage firms would be targeted, such bonuses could receive attention from regulators. “They'll be closely scrutinized, but not prohibited,” Mr. McGurn predicted.
STIFLING INNOVATION?
A report issued July 30 by New York Attorney General Andrew Cuomo found that almost 5,000 employees at nine top banks that received aid under the Troubled Asset Relief Program got bonuses of more than $1 million.
The report has fueled calls for limits on Wall Street pay practices.
At the very least, the scrutiny on compensation and its effect on risk-taking will make financial services firms much more cautious about the incentives that they offer top executives.
“It's going to stifle innovation,” said Deborah Lifshey, managing director of Pearl Meyer & Partners LLC, an executive compensation consulting firm in New York.
Although the administration didn't include in its regulatory reform plan the House bill's provision targeting pay practices at financial services companies, Congress has already set a precedent for curbing compensation at TARP recipients in the Emergency Economic Stabilization Act, enacted in November.
E-mail Sara Hansard at [email protected].
