Views on improving the integrity of global capital markets
07 February 2011

Financial Services Pay Reform — Blunt Force Trauma

Previously in this space, we highlighted the fact that Wall Street and Bond Street — and any other street where finance fat cats live and work — may soon face new “rules of the road” when it comes to executive compensation. They could, as we suggested, take a proactive approach by assessing pay levels and processes for determining compensation and making necessary changes at their firms, and in the industry as a whole, to stave off regulatory intervention. But time is running short.

Today, U.S. bank regulators will propose holdbacks on bonus pay for up to three years as well as clawbacks as the way to force big financial firms to limit monster annual bonuses and encourage greater emphasis on longer-term performance. About as subtle as a wooden ruler to the knuckles. See the recent Wall Street Journal article, “U.S. Seeks to Defer Portion of Bonuses.”

I am not saying that the financial services industry does not deserve greater scrutiny, or that it is unexpected. Rather, how unfortunate we failed to do everything within our control to address this ticking time bomb, particularly as big bonuses face greater scrutiny in the post-bailout environment. The image that emerges in discussions with nearly every industry observer we talk with is one of a self-indulgent profession that will take as much as it can, for as long as it can. And without much consideration for the message it conveys. As one industry leader recently declared, the time for apologies for being well compensated is over, as if to say, “Those big bailouts are ancient history.”

Some hope remains for an industry self-correction. The final details of the rule are not yet determined; only a draft is up for an FDIC vote this week that, if approved, will likely be circulated for broader public comment. And, as noted in the Journal article, a number of firms already have reigned in executive pay and established long-term incentives to link compensation with performance targets.

But the fact the U.S. FDIC is proposing the rule speaks volumes, as does the fact that London and greater Europe also have zeroed in on the issue. Meanwhile, the fact that industry executives, both in the U.S. and across the pond, are still defending the status quo raises serious questions about the profession’s resolve to address the situation itself.

One suggestion may be better communication and disclosure. Just as we urge our portfolio companies to convey their compensation and incentive strategies clearly, the finance industry can also make clearer how and why compensation is structured as it is. Levels of pay should be defensible in light of value delivered, and incentives should be geared to the success of clients. Anything short of this invites being cast in the same light as the banking industry by regulators and the public.

Absent action by practitioners, these draft rules will turn into broader regulations and industry coverage. Next stop: a wooden mallet to the forehead.

See our previous post on this topic.



About the Author(s)
Kurt Schacht, JD, CFA

Kurt Schacht, JD, CFA, is the Senior Head, Advocacy Advisor, Capital Markets Policy at CFA Institute, where he oversees advocacy efforts and the development, maintenance, and promotion of the highest ethical standards of practice for the global investment management industry.

2 thoughts on “Financial Services Pay Reform — Blunt Force Trauma”

  1. peter chepucavage says:

    These are valid comments but my friends in NY would say that they are now getting mostly stock and that Bear and Lehman proved how truly risky that can be.This would be a geat topic for a program in connection with the SLC meeting this fall. and the Institute should be out front on it.

  2. Bob Dannhauser, CFA says:

    Indeed, those who got paid in stock of failing firms have vivid experience with the downside of compensation arrangements that are aligned with shareholder interests Peter; I think it is still an open question as to whether the upside is equally well aligned (i.e. when mediocre firms’ stock prices rise along with bull markets.) One interesting alternative idea we’ve heard is to pay incentive comp in debentures – which would lend new urgency to risk management! As Kurt makes the case, it should be about real value delivered, both for corporate managers and investment managers. Excellent suggestion re SLC programming; we’ll make sure to have people here start thinking about that.

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