– Broc Romanek, CompensationStandards.com

It is worth reading this Washington Post article from yesterday to get a sense of where the Obama Administration’s pay czar – Ken Feinberg – is heading as he gears up to help set pay at seven companies by this Thursday’s deadline. Below is the text from the article:

President Obama’s compensation czar has been meeting for weeks with executives at some of the country’s largest and most troubled companies as they face a Thursday deadline to propose how much they will pay their top employees. Kenneth R. Feinberg has the unprecedented task of deciding executive compensation at seven companies that received large government bailouts. His meetings with American International Group, Citigroup, Bank of America, General Motors, Chrysler, Chrysler Financial and GMAC have been conducted in secret, with neither Feinberg nor the companies willing to say much in public. But one window into this opaque process is an account provided by people familiar with his discussions with AIG, the crippled insurer that has received tens of billions of dollars in federal rescue money.

Last month, Feinberg’s face flashed across the video screens at corporate offices in London, Paris and Wilton, Conn. Over the better part of an hour, AIG employees on both sides of the Atlantic peppered him with questions about their compensation, recalled several people familiar with the videoconference. What could happen to the bonuses they were promised? Would he try to alter their contracts? How would the company’s pay structure change?

Some of AIG’s highest earners work in these offices, which are home to its financial products division. In March, the division’s employees were paid $165 million in retention bonuses, triggering national outrage. More than $200 million more are scheduled to come due in 2010. After the public uproar this spring, the government brought in Feinberg to help it address — and defuse — one of the most politically sensitive issues it faces.

Feinberg, who has sole discretion to set compensation for the top 25 employees of each of those companies, has 60 days to make a determination after the proposals are complete. Under the administration’s initiative to curb excessive pay practices, each of the seven companies must also receive his approval for how it pays the rest of its 100 most highly compensated executives and employees. The companies must submit pay plans for these employees by Oct. 12.

With Congress and the public already exasperated by the hefty pay awarded to Wall Street bankers, Feinberg is under intense pressure to put checks on excessive pay. But if he goes too far, the companies he oversees could lose their rainmakers and other key executives to rival firms that are not subject to similar pay restrictions.

“I wish I could hum the theme song for ‘Mission: Impossible’ because I think his job is mission impossible,” said Robert Profusek, a lawyer at Jones Day who has advised major banks on compensation matters. “On the one hand, there’s this populist outrage that is fanned every other day by somebody in Washington. . . . But he can’t just go in there with a hatchet and cut everything because the good people will leave. That’s not in our best interest” as taxpayers.

The seven companies are still finalizing the pay plans due Thursday, and several possible approaches are being discussed, say people with knowledge of the deliberations. All seek to give employees an incentive to care about the long-term health of their company instead of short-term gain. They include extending the time that executives must wait before cashing in on restricted stock awards, boosting the proportion of pay that comes in the form of company stock, and adding stronger clawback provisions that allow firms under certain conditions to take back compensation they’ve already paid.

During the videoconference with AIG employees, Feinberg mostly avoided giving them detailed answers to their questions. Many of the employees left frustrated because he gave them no sense of whether he would seek to modify contracts that promise them upcoming bonuses, said people familiar with the session.

Legally, Feinberg cannot prohibit bonuses that were promised before the February passage of the stimulus bill, which included new compensation restrictions for companies receiving government rescue funds. That includes, for example, retention payments to AIG employees. He could try to renegotiate those bonuses if he thinks they’re against the public interest, according to the rules on new compensation.

He could also take these bonuses into account when evaluating an employee’s overall compensation package. For example, if a company proposes giving an executive $1 million in compensation and a $500,000 bonus later this year, Feinberg could subtract the $500,000 from the proposed pay package, in effect negating the bonus.

Even for Feinberg, who oversaw the complex process of paying compensation to victims of the Sept. 11, 2001, attacks, this latest mission is a delicate balancing act. Senior Treasury Department officials say they do not want Feinberg to set precise prescriptions for how companies compensate employees. Instead, his task is to evaluate pay according to several principles. For instance, does an employee’s compensation reward short-term, risky business behavior? Or, on the contrary, is the compensation tied to longer-term performance goals? Does it allow the company to remain competitive and recruit top talent?

Already, banks such as Goldman Sachs, which recently returned its bailout funds to the government, have set aside enough money that they could resume paying year-end bonuses on the same scale as they did before the financial crisis. That has boosted Citigroup and Bank of America’s argument that they must be free to keep their pay competitive. Further complicating Feinberg’s mission is the assortment of companies under his watch. They include banks, financing firms and automakers, and the industries traditionally pay their executives differently. For each company, he will have to assess the role individual employees play and their ability to generate revenue.

During their discussions, Feinberg has yet to provide executives with a clear sense of how he plans to evaluate their pay proposals. While the pay packages will become public information, the companies have been reluctant to divulge details as they negotiate with Feinberg.

Bank of America said it was “taking the steps necessary to attract and retain key talent and respond to competitive pressures” and that it was looking forward to “working cooperatively with Mr. Feinberg to ensure we comply with all applicable compensation regulations outlined by the Treasury.” Citigroup and AIG declined to comment. Gina Proia, a spokeswoman for GMAC, said the company was “working with the appropriate officials, and obviously attracting and retaining key talent is critical.”

GM spokesman Tom Wilkinson said that traditionally the pay packages at the carmaker “have not been particularly rich.” He added, “We’re very sensitive to trying to make the relationship with the government a mutually beneficial one.” Chrysler Financial, meanwhile, said it was working with Feinberg to “seek advice and input with regard to our compensation plans.” A Chrysler spokeswoman said the company did not want to discuss the package it was putting together for Feinberg.

On Thursday, Feinberg should have seven proposals on his desk, each with its own set of potential land mines. “You’ve got to allow these companies to make the money for the shareholders,” said Linda Rappaport, head of the executive compensation practice at the firm Shearman & Sterling. “And to make the money for the shareholders, they have to have the talent. And to have the talent, they have to be able to pay them competitively.”

– Broc Romanek, CompensationStandards.com

As I head out for a two-week email-free vacation (I have some blogs tee’d up to go out while I’m gone), I have to admit surprise by Judge Jed Rakoff’s decision to not approve this week’s settlement between the SEC and Bank of America over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed.

BofA had agreed to pay a $33 million fine, which I suggested recently was on the high side for a non-scienter violation. Personally, I thought the SEC was trying a new approach and acting fast – as bringing charges against individuals will take considerably longer. Take my poll below to express what you think.

According to this Reuters article, the Judge’s order states: “Despite the public importance of this case, the proposed consent judgment would leave uncertain the truth of the very serious allegations made in the complaint.” The order is linked from this “WSJ Law Blog.” Judge Rakoff will hold a hearing on the case on Monday in his US District Court, Southern District of New York.

Poll: The SEC and Bank of America Settlement

Take a moment to participate in this anonymous poll:

– Broc Romanek, CompensationStandards.com

In this podcast, Susan Wolf of Schering-Plough describes her company’s experience with using a survey to canvas shareholders about their executive pay practices, including:

– Why did the company decide to try a survey?
– What was the reaction of shareholders?
– Were there any surprises? What would you change if you did it again?

– Paul Hodgson, The Corporate Library

Below is something I recently posted on “The Corporate Library” Blog:

Heads I Win, Tails You Lose: The Banks Never Stopped Paying Bonuses

What am I talking about? Surprised that they’ve returned so soon to the bad old ways of short-term bonuses? They never even stopped.

Using powers unavailable to mere researchers, Andrew Cuomo, NYC’s Attorney General has forced the banks to fess up what they did on bonuses last year. Yes, LAST year. AS they were driving the rest of the economy down the pipe. AND as they were asking the government for money – or being forced to accept it.

No Rhyme or Reason – The ‘Heads I win, Tails You Lose’ Bank Bonus Culture (see, you don’t even have to make this up!) is a 22-page report that concludes after months of investigation:

Thus, when the banks did well, their employees were paid well. When the banks did poorly, their employees were paid well. And when the banks did very poorly, they were bailed out by taxpayers and their employees were still paid well.

The report lists banks paying out more in bonuses than they received in income (Goldman, Morgan Stanley, J.P. Morgan Chase), in some cases with half the TARP funding being paid out in bonuses. Others paid out billions in bonuses while seeing a loss (Citigroup and Merrill Lynch). Bank of America and Citigroup saw performance crippled in 2008, yet compensation expenses stayed at EXACTLY the same level as they had in 2007, one of the best bull years.

O.K. O.K. I’m sorry about all the capital letters, but really, I’m surprised this whole report isn’t printed in UPPER CASE. It’s certainly well calculated to make the blood of any shareholder (or Congressman) boil. The usual excuses for this kind of behavior are offered, in this case by Merrill Lynch executives, that employees in units that performed well should not suffer because of the huge losses engendered by other less successful units.

But somewhere along the line the overall financial health of the whole firm must be taken into account (phew, got through that sentence without any upper case at all).

Johnny and Jane’s Allowances

Let’s try and liken this to family finances to try and bring it down to the level of common sense and reality, rather than the fantasy and lunacy that reigns on Wall Street and in the other banks.

Mom and Dad bring in a good pay packet each week. Johnny and Jane have their list of chores and get their allowances for doing them each week. Let’s see food and lodging as base salary and allowances as bonuses. But then Dad loses his job, has to stay home, and takes over Johnny and Jane’s chores during the week, when they are at school. The dishwasher continues to get stacked, the laundry done, the lawn mowed, the trash put out. Johnny and Jane aren’t doing the chores any more, and the family income is halved so their allowances are cancelled. Fair enough. But then Dad starts going out looking for other work and has to attend interviews, he’s away most of the time, or at home writing applications, working on his resume. Johnny and Jane have to take up the chores again. But do they get their allowances back?

Yeah.

When Dad gets another job.

That’s how real people live.

Let’s push it a step further. There are bills to pay, right? Like debt, like “dividends to shareholders”, what is Mom going to do? Tell the utility company that she can’t afford to pay the electricity bill because Johnny and Jane need their allowances? Tell the bank that she can’t pay the mortgage because Johnny and Jane need their allowances or they’ll GO AND DO THE NEIGHBOR’S CHORES INSTEAD AND GET PAID BY THEM!? That’s a sure fire way to get your house repossessed.

And what if they had mortgage insurance? That’s like Treasury money, yes? But she used it to pay Johnny and Jane their allowances rather than using it to pay the mortgage? Someone’s going to get mad.

If they haven’t already.

– Broc Romanek, CompensationStandards.com

We’re very excited to announce that Corp Fin Deputy Director Shelley Parratt has joined our All-Star cast and will serve as the keynote for our “4th Annual Proxy Disclosure Conference.”

Now that Congress is moving on say-on-pay (and other compensation-changing initiatives), you need to register now to attend our popular conferences and get prepared for a wild proxy season. Remember that the “4th Annual Proxy Disclosure Conference” is paired with the “6th Annual Executive Compensation Conference” – so you automatically get to attend both Conferences for the price of one. They will be held November 9-10th in San Francisco and via Live Nationwide Video Webcast. Here is the agenda for the Conferences. Register now.

SEC Settles Charges that BofA Failed to Disclose Merrill Lynch Bonus Payments

As noted in this press release, yesterday, the SEC settled charges that Bank of America misled investors about the bonuses paid to Merrill Lynch executives at the time of its acquisition of the firm. Bank of America agreed to settle the SEC’s charges and pay a penalty of $33 million. Here is the SEC’s complaint – and here is the litigation release.

The SEC alleges that in the joint merger proxy statement, Bank of America stated that Merrill had agreed that it would not pay year-end performance bonuses or other discretionary compensation to its executives prior to the closing of the merger without Bank of America’s consent. In fact, Bank of America had already contractually authorized Merrill to pay up to $5.8 billion in discretionary bonuses to Merrill executives for 2008.

Note that New York Attorney General Cuomo announced that his investigation was continuing – so this saga may not be over…

On Friday, the House passed H.R. 3269 “Corporate and Financial Institution Compensation Fairness Act of 2009,” which is Rep. Barney Frank’s latest version of a say-on-pay bill, mostly along partisan politics lines by a vote of 237-185. This follows the marked-up version of the bill that the House Financial Services Committee passed on Tuesday. There are notable differences between what the House passed and the language that the Obama Administration (through the Treasury Department) recommended in June.

Two years ago, the House passed a different say-on-pay bill by a vote of 269 to 134 (afterwards, then-Sen. Obama floated the same bill in the Senate but it never went anywhere). The Senate is not expected to consider similar legislation until sometime after the August recess – and it’s expected that there will be a tougher battle in the Senate over the bill’s terms.

Here is a final version of the bill. And here is the House Financial Service Committee’s marked-up version of the bill (with the only reported major change being the clawback reversal noted below) – and here is that Committee’s report.

Below are key provisions of the bill’s three major components, with commentary gleaned from a variety of sources:

1. Say-on-Pay: Section 2

– Likely Not Applicable to ’10 Proxy Season – Effective date for this Section is six months after SEC adopts rules implementing this Section; and the SEC is directed to adopt rules within six months of enactment of the bill into law. The upshot is that say-on-pay is not likely to be applied to the ’10 proxy season, but perhaps could be effective later in 2010. Treasury’s recommendation was to adopt something before the ’10 proxy season.

– FPIs Excepted – No Triennial Alternative – Requires annual non-binding vote on disclosure of executive compensation arrangements and “golden parachutes”; mark-up clarified that neither applies to foreign private issuers. Note that the idea of a triennial vote (ie. Carpenters Union’s alternative) was considered during the mark-up but defeated.

– SEC Might Exempt Small Businesses – Gives authority to the SEC to exempt certain types of companies from say-on-pay; SEC might use this to exempt smaller businesses. Treasury recommendation didn’t address this topic.

– Investment Managers Report How They Vote – Requires certain types of investment managers to report annually how they voted on say-on-pay at the companies for which they own at least $100 million of their equity at some point during the preceding 12 months. Treasury recommendation didn’t include this likely-to-be controversial item.

– No Tabular Format for Golden Parachute Disclosures – For say-on-pay on golden parachutes, tabular format eliminated during mark-up; and mark-up clarified that golden parachutes previously approved by shareholders must be disclosed, but need not be voted upon again. I can’t figure out why tabular disclosures were dropped – in my opinion, dropping it was not a good idea.

– Clawbacks Still Possible Even If Shareholders Approve Compensation – The mark-up had produced an amendment that would have prohibited clawbacks of compensation arrangements that had approved by shareholders – the only amendment made to the marked-up bill on Friday was striking this new provision. So under the bill approved by the House, clawbacks are still possible even if the compensation disclosure has been approved by shareholders.

2. Compensation Committee Independence: Section 3

– Even Longer Effective Date – The exchanges (as directed by the SEC) wouldn’t be required to adopt listing standards to implement this Section until 9 months after the bill was enacted.

– Compensation Committees Must Be Independent – The thrust of this section is to have independent compensation committees (although mark-up eliminated requirement that comp committee members not be “affiliated persons”). Some of the more controversial aspects of the Treasury’s recommendations were reined in by the House bill, as noted below.

– SEC Might Exempt Small Businesses – Gives authority to the SEC to exempt certain types of companies from this Section; SEC might use this to exempt smaller businesses. Treasury recommendation didn’t address this topic.

– No Need to Disclose Why Didn’t Hire Compensation Consultant – During the mark-up, the requirement to provide potentially embarrassing disclosure regarding why a compensation committee didn’t hire a consultant was struck. However, companies would be required to provide funding for compensation consultants (as well as lawyers) if the compensation committee wanted to hire one.

– Compensation Consultants Must Be Independent – The SEC must adopt independence standards for compensation consultants. The mark-up clarifies that these standards must be competitively neutral.

– Lawyers Need Not Be Independent – During the mark-up, the requirement for the compensation committee’s counsel to meet independence standards was eliminated.

– SEC’s Study – Within two years, the SEC must provide a study regarding the impact of its new independence standards to Congress.

3. Regulation of Compensation at Large Financial Institutions: Section 4

This Section would regulate pay at large financial institutions – those with more than $1 billion in assets – particularly their incentive-based pay packages. It would require federal regulators to prohibit “certain compensation” structures at large financial institutions if they could have a “serious adverse effect on financial stability.” It would also require federal regulators to adopt rules requiring these institutions to disclose their incentive-based pay plans for executives and employees – and then the regulators would determine if the pay packages are “aligned with sound risk management.”

This is quite a controversial Section (eg. the issue of whether the government can abrogate a private contract) – and it was not part of the Treasury’s recommendations. I would be surprised to see this Section survive the Senate, even with all the public anger over Wall Street bonuses. This recent Bloomberg article notes skepticism over this Section expressed by the Obama Administration and some Senators.

There is a hodge-podge of other provisions in the bill. One example is a GAO study of the correlation between compensation structure and excessive risk-taking. Note that the foregoing recap is subject to the caveat that we haven’t yet seen the final bill as adopted. Let me know if I got something wrong…