The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here’s news from this WSJ article:

U.S. financial regulators are focusing renewed attention on Wall Street pay and are designing rules to curb compensation packages that could encourage excessive risk taking. Regulators are considering requiring certain employees within Wall Street firms hand back bonuses for egregious blunders or fraud as part of incentive compensation rules the 2010 Dodd-Frank law mandated be written, according to people familiar with the negotiations. Including such a “clawback” provision in the rules would go beyond what regulators first proposed in 2011 but never finalized.

The clawback requirement, which is being hashed out among six regulatory agencies, would be part of a broader compensation program in which firms are required to hang onto a significant portion, perhaps as much as 50%, of an executive’s bonus for a certain length of time. The Dodd-Frank law included provisions for an incentive-compensation rule to help ensure Wall Street incentive packages are aligned with a company’s long-term health rather than short-term profits.

Exactly which firms will be covered is still a matter of debate among the agencies involved in the discussions, but the 2010 law requires regulators to impose incentive-compensation rules on banks, broker dealers, investment advisers, mortgage giants Fannie Mae and Freddie Mac and “any other financial institution” deemed necessary. It also remains to be seen what type of behavior—besides fraud—would trigger a clawback and whether conduct identified by the firm or regulators would necessitate reclaiming compensation.

Some banks are already voluntarily recouping money from employees who engage in misconduct or excessive risk. J.P. Morgan Chase & Co. clawed back about two years’ worth of total compensation from three traders involved in the 2012 “London whale” trading debacle, which cost the firm $6 billion. Many banks have implemented stricter bonus practices since the 2008 financial crisis, including deferring more pay and linking more compensation to longer-term performance.

Shareholder activists say the existing clawbacks some firms have are too weak and that it remains unclear how often those policies are invoked because banks don’t usually disclose when the tool is used. The New York City comptroller has been successful in getting banks such as Citigroup Inc. and Wells Fargo & Co. to expand their clawback policies in recent years. But many big banks have resisted the office’s efforts to have them routinely disclose when and how much compensation they claw back, according to the comptroller’s office. “While many banks now have strong clawback policies on paper, absent disclosure, it’s impossible for investors to know when and how they are being applied,” New York City Comptroller Scott M. Stringer said in an email statement.

Work on the incentive-compensation proposal has renewed after more than three years of dormancy, but the details are far from settled. At the end of last year, informal discussions among staff from the various agencies prompted the three major bank regulators—the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp.—to send a conceptual proposal to the Securities and Exchange Commission, according to people familiar with the discussions. The document sparked several areas of debate, including how long the deferral period should be and how to treat asset managers under the rule. Fed governor Jerome Powell in a Jan. 20 speech said regulators plan to reissue a revised draft proposal for public comment, though he didn’t give a specific timeline.
He hinted at the contours of banking regulators’ proposal, saying regulators are aiming at “deferral of larger amounts of compensation over a longer period for people who are senior in these companies or important risk takers” and for that compensation to come “in particular form…with particular triggers for forfeiture and clawback.” He said forfeiture should happen when “there appears to have been risk-management errors or…malfeasance.”

As for clawbacks—or plans that require employees return compensation already paid if losses occur later—Mr. Powell said “that’s fairly extreme, but there should be the possibility for that.” Big Wall Street banks have instituted their own changes to their bonus pay practices since the financial crisis, with the encouragement of regulators and shareholders. Many banks moved to defer more of employees’ bonus payments over several years and give more of those bonuses in stock as opposed to cash compared with the years preceding the 2008 crisis, consultants say. Goldman Sachs Group Inc. in January disclosed it would subject part of top executives’ bonuses paid in restricted shares “to performance conditions” going forward. The banks “went way further than anybody else in financial services and that became a competitive disadvantage to get people [and] keep people,” said Alan Johnson, managing director of Johnson Associates.

Yet some banks have already begun reversing some of those moves in the face of rising competition for talent from hedge funds and asset-management firms, paying more cash and delaying a smaller portion of bonus payments, consultants say. Late last year, Morgan Stanleyannounced it would defer for several years about half of employee bonuses, down from an average of about 80% at its peak a few years ago. A 2014 analysis by Johnson Associates estimated about 36% of a $1 million bonus on Wall Street is deferred, compared with 45% in 2010. In October, President Barack Obama gathered the heads of the top U.S. financial regulators for a White House meeting and urged them to finish the outstanding compensation rules required by the 2010 Dodd-Frank law, a White House spokesman said at the time. Top Fed officials including New York Fed President William Dudley have stressed that changing compensation practices can help address ethical lapses on Wall Street.

Work on the rule had stalled after an initial proposal in March 2011 sought to have the largest financial firms—those with $50 billion or more in assets—hang on to at least half of the bonuses paid to top executives for at least three years. Smaller firms with at least $1 billion in assets would be subject to less prescriptive rules but would have to get the signoff from regulators. The Fed, OCC and FDIC circulated their draft proposal at the end of last year in a bid to move negotiations forward with the SEC by securing their agreement on the concepts or soliciting changes, one person close to the discussion said. It follows a pattern that regulators followed to restart work on the high-profile Volcker rule in 2012. It is unclear if the document was shared with the other two agencies tasked with writing the rule, the National Credit Union Administration and the Federal Housing Finance Agency.

One flash point in the current talks is how long firms should defer compensation for executives, according to people familiar with the discussions. It is still early and officials haven’t landed on a specific period yet, a person familiar with the matter said. The debate over the rule is said to at least partly mirror the 2011 proposal, when Republican members of the SEC objected to any mandatory-deferral requirement, saying the agency was poorly equipped to dictate the specifics of how individuals must be paid at companies.

Another wrinkle, according to a person familiar with the discussions, is how to apply the rule to financial institutions that have different methods for compensating executives than a traditional bank. For instance, regulators are still debating how to defer the compensation—and potentially claw some of it back—from an asset manager, who is primarily compensated with “carried interest” as opposed to a salary and year-end bonus, the person said. Carried interest is a share of a partnership’s profits. Still, the rule has the potential of capturing hedge funds, private-equity firms and investment advisers that haven’t been covered by prior efforts to regulate executive compensation. Also up in the air is whether the rule would apply to fraud or excessive risk taking that occurred before the regulation was in place.