Fed to Propose Bank-Pay Guidelines, Review 28 Firms

The Federal Reserve proposed new guidelines on pay practices at banks and said it will launch a review of the 28 largest firms to ensure compensation packages don’t create incentives for the kinds of risky investments blamed for the financial crisis.

“Compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability,” Fed Chairman Ben S. Bernanke said today in a statement. “The Federal Reserve is working to ensure that compensation packages appropriately tie rewards to longer-term performance.”

The central bank’s action parallels efforts by U.S. lawmakers, the administration of President Barack Obama and world leaders to overhaul incentives to reduce threats to the financial system. Investments in mortgage-backed securities and other complex instruments have led to more than $1.6 trillion in credit losses and writedowns at firms from Zurich-based UBS AG to New York-based Citigroup Inc., triggering the worst economic crisis since the 1930s.



“Today’s proposal is but one part of a broad program by the Federal Reserve to strengthen supervision of banks and bank holding companies in the wake of the financial crisis,” Federal Reserve Governor Daniel Tarullo, an Obama appointee who is leading an overhaul of Fed supervision, said in a statement.

The central bank said it may take enforcement action against banks where compensation or risk-management practices “pose a risk to the safety and soundness of the organization and the organization is not taking prompt and effective measures to correct the deficiencies.”

Bailout Recipients 

The Fed plan comes as the Obama administration slammed Wall Street by ordering pay cuts of an average of 50 percent and caps on benefits for top executives at companies owing the government billions of dollars from taxpayer-funded bailouts.

The news triggered debate about the government’s reach into private industry, whether pay reductions would spread to other companies and if a talent drain from U.S. firms would ensue.

“I don’t think there will be any charity cases on Wall Street,” Representative Barney Frank, 69, a Democrat from Massachusetts and chairman of the House Financial Services Committee said earlier in a telephone interview. “This is a very good thing.”

Executives at seven companies including Citigroup and Charlotte, North Carolina-based Bank of America Corp. will have their pay cut by an average of 50 percent after months of negotiations with Kenneth R. Feinberg, 63, the U.S. special master on compensation.

Cash Portion 

The cash portion of salaries for the 25 highest-paid employees will be slashed 90 percent under Feinberg’s review, released today. Some cash will be replaced by shares that employees will be restricted from selling immediately.

The Fed acted to increase its scrutiny of pay practices after it came under fire from lawmakers including Senate Banking Committee Chairman Christopher Dodd, a Democrat, and Richard Shelby, the panel’s top Republican, for lax oversight of banks and housing before the financial crisis.
As the economy emerges from recession and bank earnings recover, Wall Street firms including Goldman Sachs Group Inc. are starting to boost bonuses again.

Goldman Sachs set aside $16.7 billion for compensation and benefits in the first nine months of 2009, up 46 percent from a year earlier and enough to pay each worker $527,192 for the period.

Compensation Slashed 

Chief Executive Officer Lloyd Blankfein, who set a Wall Street pay record in 2007, slashed compensation last year and went without a bonus after the firm reported its first quarterly loss and accepted financial support from the government.

The Fed guidance was needed not just to correct flaws in bonus practices that played a role in causing the financial crisis, according to documents released today by the central bank.

The federal safety net for consumer deposits may also encourage shareholders to tolerate risks that exceed what is acceptable to keep the financial system safe and sound, the Fed said. Without the guidelines, banks will resist cutting bonuses to avoid losing talented employees to rivals, in what the Fed calls the “first mover” problem.

Senior Executives 

The guidelines would apply to all senior executives who oversee firm-wide activities or business lines and to all employees down the chain of command whose activities expose the bank to material amounts of risk, including traders with large position limits and loan officers.

The central bank’s compensation proposal will be open to public comment for 30 days and may not be adopted for months after that, a Fed official told reporters.

Banks won’t be allowed to wait until then, as the Fed expects all banks to review their compensation arrangements immediately and take corrective action if they encourage excessive risk taking.
In addition, the 28 largest banks must provide the Fed with numerous details on their existing compensation plans--and timetables showing how they will improve the “risk sensitivity” of bonus arrangements and corporate governance.


The Fed won’t apply what it calls “one size fits all” rules by capping pay or outlawing particular pay practices. Even a requirement that banks spread bonus payouts over three years may not sufficiently protect a bank against long-term risks.

Bank Ratings 

The findings from the supervisory reviews will be added to the banks’ ratings, and the Fed may require banks to correct deficiencies in bonus plans. To monitor and encourage improvements, Fed staff will prepare a report after the conclusion of 2010 on trends in banks’ compensation practices.

The guidance will apply to all banking organizations supervised by the Fed, including bank holding companies, state banks and the domestic operations of foreign banks with a U.S. branch or lending subsidiary.

In 2008, the Fed supervised 5,757 U.S. bank holding companies as well as 862 state-chartered banks.

- Via Bloomberg