[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
COMPENSATION STRUCTURE AND SYSTEMIC RISK
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
JUNE 11, 2009
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-42
U.S. GOVERNMENT PRINTING OFFICE
52-398 WASHINGTON : 2009
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIK PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
C O N T E N T S
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Page
Hearing held on:
June 11, 2009................................................ 1
Appendix:
June 11, 2009................................................ 69
WITNESSES
Thursday, June 11, 2009
Alvarez, Scott G., General Counsel, Board of Governors of the
Federal Reserve System......................................... 14
Bebchuk, Lucien A., William J. Friedman and Alicia Townsend
Friedman Professor of Law, Economics, and Finance, and
Director, Corporate Governance Program, Harvard Law School..... 43
Breheny, Brian V., Deputy Director, Division of Corporation
Finance, U.S. Securities and Exchange Commission............... 15
Minow, Nell, Editor and Founder, The Corporate Library........... 41
Murphy, Kevin J., Kenneth L. Trefftzs Chair in Finance,
University of Southern California, Marshall School of Business. 46
Sperling, Gene, Counselor to the Secretary of the Treasury, U.S.
Department of the Treasury..................................... 12
Turner, Lynn E., former Chief Accountant, U.S. Securities and
Exchange Commission............................................ 44
Verret, J.W., Assistant Professor, George Mason University School
of Law......................................................... 47
APPENDIX
Prepared statements:
Carson, Hon. Andre........................................... 70
McCarthy, Hon. Carolyn....................................... 71
Price, Hon. Tom.............................................. 72
Speier, Hon. Jackie.......................................... 73
Wilson, Hon. Charlie......................................... 77
Alvarez, Scott G............................................. 78
Bebchuk, Lucien A............................................ 92
Breheny, Brian V............................................. 148
Minow, Nell.................................................. 161
Murphy, Kevin J.............................................. 169
Sperling, Gene............................................... 183
Turner, Lynn E............................................... 188
Verret, J.W.................................................. 209
COMPENSATION STRUCTURE AND
SYSTEMIC RISK
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Thursday, June 11, 2009
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Waters, Maloney,
Watt, Sherman, Moore of Kansas, Capuano, Hinojosa, Clay,
McCarthy of New York, Scott, Green, Cleaver, Ellison, Klein,
Wilson, Perlmutter, Carson, Speier, Adler, Driehaus, Kosmas,
Grayson, Peters; Bachus, Castle, Royce, Biggert, Hensarling,
Garrett, Barrett, Neugebauer, McHenry, Campbell, Bachmann,
Marchant, McCarthy of California, Posey, Jenkins, Lee, Paulsen,
and Lance.
The Chairman. The hearing will come to order.
I am told that the Ranking Republican is on his way, so we
will begin. We are going to have 30 minutes of opening
statements, by agreement between the two sides, and I will
begin.
First, I want to make a very important distinction that
doesn't always get made. We are not here today talking about
the pay restrictions that apply to recipients of TARP money.
There is a separate set of considerations there. We are talking
about entities which received capital infusions from the
Federal Government.
This hearing today is looking forward as to whether or not
there should be bills enacted that deal with compensation
without regard to whether or not people have taken TARP money
going forward.
I believe that it is now clear, and I am reinforcing that
by a number of authorities--Paul Volcker for example, Chairman
Bernanke, people in the British Financial Services Authority--
that the problem with compensation is that it has encouraged
excessive risk-taking. That is, once we leave the area of the
recipients of TARP money, it is not any part of my concern as
to the dollar amounts that were given, from the governmental
standpoint. We are not talking here about amounts. We are
talking about the structure of compensation.
And I believe that the structure of compensation has been
flawed. Namely, we have had a system of compensation for top
decisionmakers in which they are very well rewarded if they
take a risk that pays off but suffer no penalty if they take a
risk that costs the company money.
Now, risk is a very important part of this business, and we
are not trying to discourage people from taking risk. That is
not the government's job. But it should not be a system in
which risk is artificially encouraged, in which excessive risk-
taking takes place.
Now, I said, and I should correct myself before someone
else does, that we weren't talking about dollar amounts. We are
in one sense; I do think there is a problem with the overall
compensation, but it is not one the government should try to
solve in any specific way.
What we do instead here is, to borrow from our English
neighbors and competitors, because people say you can have a
competitive disadvantage, the system known as say-on-pay in
which shareholders are empowered to vote. A number of my
friends are great supporters of shareholder democracy until we
try to implement it and say that the shareholders, the owners
of the company, should vote. No, shareholders should not be
running a company day-to-day; that is why you have a board of
directors. But I think the evidence is overwhelming, as is the
logic.
The relationship between boards of directors and CEOs is of
necessity a fairly intimate, ongoing one. They have selected
each other. They work together. It simply doesn't work to say
that on 1 or 2 days a year, this group who works so closely
together will now assume the arm's length positions of labor
and management and bargain with each other as if there was that
independence. Therefore, this is an exception to the normal
rule, it seems to me, where shareholders ought to have a role.
Boards of directors and CEOs are not going to be able to do
that, I think, entirely by themselves. say-on-pay empowers the
shareholders, and that is where any questions about amount
would come in.
But what we should do now is deal with the structure, which
should diminish the extent to which people get these
incentives. I must say, I am somewhat puzzled when some of the
most influential, highly-paid people in this country who
represent very important institutions come to me and say they
need these bonuses to align their interest with those of the
company. Why a CEO of a major bank or investment firm does not
already consider his or her interest aligned with the company
is a strange one. They are apparently implicitly pleading to
some contractor flaw that says, unlike the rest of us, they
need to be specially incentivized to treat their employee's
interest fairly. Most of us in this society are able to go home
without that.
That is up to them and their shareholders, but it should
not be done in a way that incentivizes too much risk. And I
think it is irrefutable that it has happened in the past.
I do differ with the Administration in that hope springs
eternal. And that position seems to be that, if we strengthen
the compensation committees, we will do better. I agree with
what they are trying to achieve there. I agree with their
statement of goals. I have less confidence than they do that we
will be able to find compensation committees among these boards
that will have that independence. So I would go somewhat
further.
But we do agree on the goals, and we do agree with the
Administration on say-on-pay. And I would simply say this is
the first in a set of hearings that will lead this committee, I
hope, to begin marking-up in a month a set of financial
regulations that I hope we will have to the Floor of the House
before we adjourn for the summer that will put in place rules
that derive from the lessons we have learned in the most recent
crisis. And as I said, we are here not because of concerns over
the amount of compensation in general, but fundamentally
because we think the incentive structure has contributed to
excessive risk-taking.
The gentleman from Alabama is recognized for 5 minutes.
Mr. Bachus. Thank you, Mr. Chairman.
Mr. Chairman, I thank you for holding today's hearing on
executive compensation, which is the first of a series on
regulatory reform in the future of our financial system.
There is no question that there have been some questionable
decisions made by some of our major corporations regarding
executive pay. However, I strongly believe that it is neither
the Executive Branch nor Congress' role to mandate compensation
policies, or the role of this Congress or the Executive Branch
to determine who sits on a corporate board of directors or to
interfere with corporate governance in any way.
What we need instead is a strategy to get us out of what we
have witnessed in the past 6 months, and that is government
command and control of businesses. We need to get the
government out of businesses, and what we need is no further
intrusion in what should be private economic decisions made by
corporations or directors and their shareholders.
Mr. Chairman, the series of regulatory reform hearings
scheduled will, I believe, be among the most important the
committee will be holding this year, and perhaps the most
important hearings that we will hold in the 111th Congress. In
these hearings, we will determine how we rebuild our financial
system and whether we lay the foundation for economic growth
and prosperity or whether we repeat the same mistakes that led
us to the brink of ruin and those we have made since September.
Later this afternoon, the Republican leadership of the
Financial Services Committee will unveil a proposal to reform
our financial regulatory system. The Republican regulatory
reform proposal calls for a return to market discipline and an
end to bailouts, government intrusions into business, and the
government picking winners and losers. The government plan
addresses the major flaws in our current system exposed by the
financial crisis.
And I look forward to working with my colleagues on both
sides of the aisle on this and other proposals for reforming
our regulatory system.
Over the past year, we witnessed unprecedented government
interventions into the financial system and into corporate
governance. Hundreds of billions of dollars have been spent
recapitalizing individual financial institutions, some of which
were probably insolvent and should have gone into bankruptcy
proceedings instead of being propped up with taxpayer dollars.
The Federal Reserve's balance sheet has more than doubled
from roughly $870 billion before the crisis to over $2 trillion
now, according to remarks made by Federal Reserve Chairman Ben
Bernanke. In the short run, government interventions may have
stabilized the market, but I fear that these repeated
multibillion dollar taxpayer bailouts are weakening our
financial system and now threaten our economic future.
Combined with the current Administration's borrow-and-spend
fiscal policy, many have come to believe, including myself,
that the vast expansion of the Fed's balance sheets is in
itself becoming a systemic risk to our national economy far
greater than the failure of any private financial institution.
It also I think fundamentally affects our ability to borrow
money and the price at which we borrow that money.
To restore our economy, we should reject the philosophy
that has transformed us into a bailout nation. However, there
are some who want to go further in trying this failed
government policy of rescuing too-big-to-fail institutions by
crafting a resolution authority or systemic risk regulator
which would give the government and government bureaucrats the
power to use taxpayer money to prop up certain financial
institutions.
We may think that we own AIG, the government, but in fact,
I think AIG and these companies end up owning us.
Mr. Chairman, the appropriate response to this very real
problem of handling market failures is, we should resolve
insolvent nonbank institutions, no matter how large or
systemically important, through the bankruptcy system.
Bankruptcy is a transparent and impartial process with well-
settled rules and precedents. It is far preferable to a vaguely
defined resolution authority that encourages moral hazard and
further entrenches megabanks and other large institutions as
wards of the State.
In conclusion, it is important for the regulators to
monitor the interactions of various sections of the financial
system and to identify risks that could endanger the stability
and soundness of the system. But it is unwise for Congress to
place the stewardship of our economy in the hands of a super
regulator thought to possess superhero powers to spot bubbles
in excessive risk-taking before markets crash, given that we
have no way of telling whose forecast will be right and whose
will be wrong.
In conclusion, I would remind my colleagues of a comment
made by the Fed Chairman on March 28, 2007: ``At this juncture,
the impact on the broader economy and financial markets of the
problem in subprime markets seems likely to be contained.''
My colleagues know I have the highest respect for Chairman
Bernanke, but in this case, he obviously could not have been
more wrong. This committee must have the courage to reject
cause for a new regulatory regime that depends on the
infallibility of the government regulators who have so far
shown themselves unable to anticipate crises, let alone prevent
them. We must encourage a return to market discipline.
Thank you.
The Chairman. The gentleman used an extra minute and 10
seconds. I would be glad to add that to both sides if that is
acceptable.
Mr. Bachus. Thank you.
The Chairman. So another minute and 10 seconds on that.
Mr. Bachus. I appreciate the chairman.
The Chairman. The gentleman from Georgia for 2 minutes.
Mr. Scott. Thank you, Mr. Chairman.
I think this is a very, very timely and important hearing
as we grapple with the issue of how the compensation structure
affects systemic risk.
I think that I can understand pay for performance, but for
the life of me, I cannot understand pay without performance. I
think that gets to the heart of the matter here--pay without
performance. So much of the compensation structure, I think, is
inequitably distributed through salaries and then their
bonuses. I think it is the bonus structure that we have to look
at very carefully.
Now, we are responding to an issue that we did not create
here in Washington or in Congress. This issue was created by
overexuberant, overeager executives who were compensated for
lack of performance.
The bonus structure is set up so that there is a reward
system, hopefully a reward system for superior performance, but
there is no downside to that. There is no reaction for failure.
If we look back at the history of our performance, we will
find that many of these executives were rewarded for driving
companies into the ground. As we and as the American people
observe this and are looking at this, multimillion dollar
bonuses on taxpayers' money while the American people are just
hanging on by their fingernails in an economy where the salary
and wage disparity has continued to widen and widen and widen;
so if we look at the history and retrace the unraveling of our
economy, there is a very significant role that this out-of-
control compensation packaging of executives have led to a
degree of the cause of the problem.
And Mr. Chairman, I appreciate this opportunity to explore
this issue further.
The Chairman. The gentleman from Delaware is recognized for
2 minutes.
Mr. Castle. Thank you, Mr. Chairman.
I believe we need to be very cautious in the path that we
are going down. The form of capitalism we have had in this
country for decades, generations, even centuries at this point,
has worked well. The States have created our corporate laws.
The shareholders elect directors, and the directors set pay.
Obviously, there have been abuses in this area, and I think
we all agree on that. And I tend to agree that the compensation
structure could have some effect on systemic risk. But does
that mean that the Federal Government should step in with
legislation and try to correct this? Given that stockholders
themselves can be individuals who are not necessarily a person
owning 10 shares or 100 shares but corporations and others who
own tens of thousands of shares, mutual funds or whatever, who
may not have the true interest of the future of the corporation
in mind, other than the immediate profit possibilities, and so
as a result that potentially can be dangerous.
I think we need to emphasize to stockholders that they have
a right to change directors. We need to emphasize to our States
that they need to have good laws with respect to the ability to
be able to change directors.
And I think we need to be very careful in Washington. We
have gone through a bailout situation. I don't think anybody
looks at Washington and thinks, gee, these people really know
how to run things, either at the Executive Branch or at the
Legislative Branch.
And one reason that people are not being penalized because
of losses is that we have been willing to step forward with
bailouts. I think we need to be very careful about that. I
don't think the government intervention is an acceptable end as
far as this is concerned.
So I would encourage all of us to listen carefully, because
I think there are some good points to be made, to think deeply
about what we are doing and make sure that we do not upset
something which has the history of working pretty well in this
country. Maybe we can tweak it, but we need to be cautious
about how far we go.
I yield back, Mr. Chairman.
The Chairman. Mr. Sherman for 2 minutes.
Mr. Sherman. Thank you, Mr. Chairman.
I agree with the ranking member that if we have a risk
regulator, this should not morph into an agency that could put
taxpayer money at risk or engage in bailouts. It should not be
permanent TARP.
As to TARP, it provides for appropriate standards of
executive compensation. I regret the fact that the
Administration seems that it will apply this only to those
entities that have received three scoops of ice cream. I would
think that, if you read the law, it should apply to any company
that receives even one infusion of TARP funds.
The people of this country were outraged at executive
compensation. That was not only understandable; it was
valuable. And it will lead promptly to the return of some $68
billion to the Treasury by various banks that they would not
have done if it was not for this outrage and the governmental
reaction to it.
As to the proposals we are considering today, as to say-on-
pay, I believe we ought to look at that being binding, not just
advisory, and we ought to set as many of the standards here in
this room rather than just transfer authority to the SEC. We
are talking about shareholder democracy. Democracy starts by
legislating by the elected representatives of people, not just
granting power to an unelected board.
There are those who say that corporate boards will exercise
the authority, and if they don't, well, there can be
shareholder elections. The process of picking shareholder
boards would make Hugo Chavez blush. After all, corporate funds
can be used in unlimited quantities to back one side and to
fight the other.
As to the pernicious incentives, I think we are all against
them. It will be extremely difficult to design a system where
an executive's compensation reflects whether that executive
actually helped the company in the long term rather than simply
made it look good in the short term. This will be easier for
those who have company-wide decisionmaking since we could give
them restricted stock in the entire company. But those who led
to the success or failure of a single unit, it will be far more
difficult.
I yield back.
The Chairman. The gentlewoman from Illinois for 2 minutes.
Mrs. Biggert. Thank you, Mr. Chairman.
I am disappointed that some Federal officials are moving in
the direction of government-determined pay, not just for senior
executives of United States companies, but for their
secretaries, the analyst, and the janitor. I think that is a
slippery slope or worse.
Don't get me wrong; financial criminals must be brought to
justice, but most importantly, risky behavior in the financial
services industry must be addressed. And I think we can do that
with smarter, more effective financial services regulations
that rein in reckless behavior, risky leveraging and
concentrations of capital.
In addition, our financial services institutions need to
retain the best and the brightest. We need not induce fear in
our future financial service leaders or workers but provide
them with improved guidelines that foster competition for the
benefit of U.S. consumers, businesses, investors, and our
economy.
And with that, I yield back.
The Chairman. The gentleman from Kansas is recognized for 1
minute.
Mr. Moore of Kansas. Thank you, Mr. Chairman.
I want to commend you for your leadership on executive pay
issues and for holding today's hearing so we can review how
compensation affects risk-taking for better or for worse as we
consider financial regulatory reform. One of the most important
lessons I think we can learn from the financial meltdown is
that excessive risk-taking and overleveraged activity with
little or no oversight will lead to instability. As this
committee considers financial reg reform we need to guard
against destabilizing activity and identify the proper role of
risk in a thoughtful way by improving compensation, risk
management, and corporate governance practices.
I look forward to hearing our witnesses' testimony on these
important issues.
And again, thanks, Mr. Chairman.
The Chairman. The gentleman from Texas, Mr. Hensarling, for
2 minutes.
Mr. Hensarling. Thank you, Mr. Chairman.
Executive compensation limits to address systemic risk are
the wrong remedy for what is probably a nonexistent problem.
Any compensation legislation considered by Congress ought to be
driven by two key principles:
Number one, executives of failed companies who come to
taxpayers with tin cup in hand must be subject to compensation
limits, period; let there be no doubt.
Number two, except for the first principle, Congress has no
business setting artificial and mandatory limits on anyone's
pursuit of their American dream. If someone aspires to be the
next Bill Gates, Oprah Winfrey, Warren Buffett, or Charles
Schwab, we should tell them, the sky is the limit, go for it,
not, we are the U.S. Congress, you will not be allowed to go
beyond the 10th floor, and, oh, by the way, take the stairs.
Now, I will be the first to admit that many compensation
arrangements strike me as risky, illogical, unreasonable, if
not downright offensive. But the solution to any concerns
regarding executive compensation practices is for, number one,
the shareholders to vote for a change in management or to take
their investment dollars elsewhere; and for Congress to
reexamine the Tax Code, which probably helps drive a lot of
these arrangements in the first place; and even more
importantly, to quit bailing out companies who fail in part due
to flawed compensation systems.
Finally, I hope, I hope that in America the term ``systemic
risk'' is not now being used the way the term ``internal
securities'' was once used in the farmer Soviet Bloc, a
justification for almost any and all government intervention.
For those who truly want to reduce systemic risk, I suggest
a first look to Fannie Mae and Freddie Mac.
I yield back the balance of my time.
The Chairman. The gentleman from Indiana is recognized for
3 minutes.
Mr. Carson. Thank you, Mr. Chairman, for your tremendous
leadership on the issue of executive compensation and for
holding this hearing.
This issue promises to be one of the most important of the
upcoming regulatory reform legislation. Recently, there have
been a number of interesting characterizations of efforts to
reform executive compensation structures on Wall Street.
In the wake of the worst economic crisis since the Great
Depression, many financial industry leaders have insisted that
CEO compensation is self-correcting. They urge inaction on
reform, insisting that shareholder and media scrutiny has
already moderated pay for leaders of poorly performing
companies. They claim, if we enact stronger reforms, our
financial talent will be driven overseas and our economic
recovery will be delayed.
What is missing from that argument is both clarity and
reason. For the 175 executives whose companies helped fuel the
current economic crisis that ultimately required hundreds of
billions of dollars in taxpayer assistance, I believe a capable
compensation overseer should have the discretion to determine
whether or not these companies' compensation packages are
reasonable.
In any other industry, when someone takes excessive risks
that lead to monumental failures, there are repercussions. Wall
Street seems to expect a separate set of rules.
For my constituents, this double standard is nothing new.
They know that, 30 years ago, the CEOs took home 30 to 40 times
what average workers made, and now that number has exploded to
344 times an average worker's pay. They know that while the
average CEO pay dropped by $1 million last year, many average
workers were laid off. They know that the average bonus
payments to Wall Street executives represent more than they
hope to earn over a lifetime. And they know that, once again,
Main Street is paying for the actions of Wall Street.
My hope is that industry leaders understand that calls for
executive pay reform are not a retaliation for our current
economic reality but rather an attempt to usher in a new era of
real corporate responsibility. I hope that executives realize
that performance incentives that are tied to the long-term
success and soundness of an institution are essential if we
hope to monitor systemic risk and restore confidence in our
markets.
With that in mind, I look forward to working with the
Administration, the chairman, and my colleagues on this
committee.
Thank you, Mr. Chairman. I yield back.
The Chairman. The gentleman from New Jersey is recognized
for 2 minutes.
Mr. Garrett. Thank you, Mr. Chairman.
I appreciate the gentleman who just spoke, his comments,
and I appreciate the witnesses here today and the chairman for
holding this hearing.
Today, we are exploring compensation structure and systemic
risk. But to me, as I look at it, the Federal Government really
is the one that poses the single biggest systemic risk, and it
is really not even close.
Part of the reason the government poses such a large
systemic risk is because of the often misguided Federal
Government policies we have seen. Yet government officials with
their long-term track record of success continue to come
forward with proposals that, to one degree or another, dictate
to private firms just about how they should properly compensate
executives and measure performance.
Look, there is certainly room for improvement at particular
individual companies in putting together compensation
practices. And to the extent this discussion today, just like
the gentleman from the other side just made his comments just
now, helps to inform boards as they take a closer look at their
compensation policies, that could all be a positive
development.
But you know, I have a problem. I believe the American
people are growing weary of recent government overreach into
the private sector. With the government now owning GM, and with
the way the rule of law was disregarded in the Chrysler
bankruptcy case, dangerous actions are taking place which will
create uneven playing fields and increasingly inject political
decisions with so many unintended consequences into our
economy.
So individual boards from companies have a responsibility
for establishing compensation packages that not only take into
account the long-term best interest of the company and its
shareholders, but also allow them to attract the best available
talent. This is a fundamental underpinning of our free market
economy, and it should not be put in the hands of government
bureaucrats.
With that, I yield back.
The Chairman. The gentleman from Florida for 2 minutes, Mr.
Klein. Is he here?
We will hold off then. And let me go to the gentleman from
Texas, Mr. Neugebauer, for 2 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman.
One of the things that has happened over the last few
months is we have formed new entities called TSEs, that is
taxpayer-supported entities. And that is where the American
people were impressed to be shareholders in companies that, in
many cases, they wouldn't have invested on their own. But,
unfortunately, that marriage was made.
And I would guarantee that if you think the marriage isn't
working very well, wait until you see the divorce as we try to
unravel these. But yet this looks like we are moving in the
direction of increasing the consequences of this marriage.
One of the things that I think is ironic is we are focusing
on compensation rather than performance. And one of the things
that is most embarrassing, I think, about all of this is that
we have people who have never run anything trying to tell
companies how to run their own business. We have people that
the only risk they may have ever taken is to buy a lottery
ticket trying to tell companies how they should move forward
with their business plans.
I think it is a poor direction for us to move. If we really
want to help the shareholders and help the American people,
first, we need to get them out of these businesses. Second, we
need a regulatory structure that ends these bailouts; ends the
government picking winners and losers; and more importantly
begins to put a market discipline into these companies. Letting
them fail, knowing that there are consequences.
If you think shareholders will have an uprising, wait until
they think that they are about to lose their investment. Today,
we send a signal, hey, you may not lose your investment, or
more importantly and more sadly is, we say to the American
people, guess what, you didn't buy shares in that company;
well, we are going to buy them for you because we are the
government, and we think we know what is the best investment of
the American taxpayers' money.
And by the way, we don't have any of this money. This is
all money that we are borrowing. We are borrowing from China
and Japan and from people that we are selling--we are having to
buy energy from on a daily basis.
The American taxpayers are sick and tired of being
shareholders. Let's get them out of that. Let's get an exit
strategy. And more importantly, let's don't let the Federal
Government encroach in the business any more than it already
has.
The Chairman. The gentleman from California for 2 minutes.
Ms. Waters. Thank you, Mr. Chairman.
I would like to begin by thanking you for facilitating this
hearing this morning.
Executive compensation has been a complicated and
reoccurring issue in our discussions on financial reform. As
you yourself have mentioned, compensation that promotes
excessive risk is a systemic concern. To that end, what occurs
in financial centers, such as Manhattan and Charlotte, affects
everyone across the country, including residents from my
district in California.
Some of the compensation packages that were lavished on top
executives are mind-boggling. Former executives, such as
Merrill Lynch's John Thain or Countrywide's Angelo Mozilo, were
collecting salaries and bonuses into the multimillions while
running their companies into the ground.
To the extent these CEOs and others were incentivized to
produce short-term profits, they were equally as incentivized
to flood the market with predatory loan products, such as
subprime mortgages; weaken their shareholders long-term
prospects for financial gain; and increase systemic risk. As a
result of this increased systemic risk, the American taxpayer
has been asked to bail out financial institutions through
liquidity tools, such as the Capital Purchase Program and the
Term Asset-Backed Securities Loan Facility, or TALF. That gift
is not a gift but rather a loan from the public and, as such,
requires certain protections. One of these protections is a
special master or pay czar who will place transparency into the
system so the public and shareholders are properly informed.
To the extent bonus compensation poses a systemic risk, it,
too, merits some limits.
I thank our witnesses today for helping us to frame a
discussion on which bonus compensation limits may be
appropriate to rein in systemic risk. That said, I do not
believe non-TARP recipients should have their salaries capped
by the President or the Congress.
Thank you, Mr. Chairman. I yield back the balance of my
time.
The Chairman. We will do 1 minute now for Mr. Moore, then
Mr. Campbell, then Mr. Peters, and we will be finished.
Mr. Moore for 1 minute. I apologize. All right. Then we
will go to Mr. Campbell for 1 minute.
Mr. Campbell. Thank you, Mr. Chairman.
You know, there is no argument that there have been
instances, a number of them, in which people in companies have
been paid a great deal for not very much performance. The
question is, what do we do about it?
As someone who has designed incentive compensation plans
for hundreds of employees in my own business over a 25-year
career, I will tell you that it is not easy; that sometimes you
pay people too much for too little performance and sometimes
you pay people too little for too much performance, for a lot
of performance. And the idea that somehow that some Washington
bureaucracy, distant Washington bureaucrat, can do this better
than people in a business and in the company is simply
ludicrous.
Also I believe the idea of having a direct shareholder vote
opens up the idea of direct democracy within corporations which
leads to the question of, well, should we also have them
approve union contracts, approve major expenditures, etc., all
of which arguably have done more to bring companies down over
the years than excessive compensation.
Instead, in my view, the SEC is moving in the right
direction by giving shareholders greater rights to make
nominations for and changes in the board of directors when they
get too cozy with management. I yield back.
The Chairman. Finally, the gentleman from Michigan, Mr.
Peters, for 1 minute.
Mr. Peters. Thank you, Chairman Frank, for holding this
hearing and for your leadership on this issue.
It is estimated that as many as 100 million Americans own
stock either in individual accounts or through a mutual fund,
and those investors have lost trillions in the current stock
market decline. There is no doubt that one of the causes of the
current financial crisis was executive compensation schemes in
place in many of the largest financial institutions, from the
top executives to the traders on the floor, people who are
receiving a compensation package that emphasized short-term
gains rather than rewarding long-term growth and shareholder
wealth.
I am happy that the Obama Administration has announced that
they are taking steps to address this issue by calling on
Congress to pass legislation that requires companies to hold an
advisory shareholder vote on compensation and mandating their
corporate boards use independent compensation advisors.
Tomorrow, I will be introducing legislation that will do
that and more. It will also include a number of other
provisions that I believe will reform corporate governance
practices by empowering shareholders to have a greater
oversight over the management of the companies that they own.
I look forward to hearing the testimony today.
Thank you, Mr. Chairman.
The Chairman. I thank the members.
And we will begin with the witnesses.
Let me say we have an important subject. We have, as
always, too many members on this committee, and I am going to
hold everybody strictly to the 5-minute rule. No one will be
recognized as a member after the 5 minutes. We will allow
witnesses to give a short answer to finish up. And if you ask a
complicated question with 30 seconds left, it will be your
fault if you don't get a serious answer.
We will begin with Mr. Sperling.
STATEMENT OF GENE SPERLING, COUNSELOR TO THE SECRETARY OF THE
TREASURY, U.S. DEPARTMENT OF THE TREASURY
Mr. Sperling. Thank you, Chairman Frank, and Ranking Member
Bachus. It is very good to be here. I appreciate that you are
holding this hearing. I think there is little question that one
contributing factor to the excessive risk that was central to
the crisis was the prevalence of compensation practices at
financial institutions that encourage short-term gains to be
realized with little regard to the potential economic damage
such behavior could cause, not only to those firms but to the
financial system and the economy as a whole down the road.
Compensation structures that permitted key executives in
other financial institutions to avoid the potential long-term
downsides of their actions discouraged a focus on determining
long-term risk and underlying economic value while reducing the
number of financial market participants who have an incentive
to be the important canary in the coal mine.
I want to make clear, as Secretary Geithner said yesterday,
our goal is to help ensure there is a much closer alignment
between compensation, sound risk management, and long-term
value creation for firms and the economy as a whole. Our goal
is not to have the government micromanage private-sector
compensation.
As Secretary Geithner said yesterday, we are not capping
pay. We are not setting forth precise prescriptions for how
companies should set compensation, which can be
counterproductive. And we come to this with a clear-eyed sense
of both the seriousness and the humility one must bring, both
the importance of the issue but also the care and rigor one
must take to ensure that well-intentioned actions do not lead
to unintended consequences.
I will mention just a few of the principles that Secretary
Geithner laid out yesterday, a couple of examples, and then I
look forward to the discussion.
One, compensation should accurately measure and reward
performance. And I think this is an important issue. It is a
lot easier to get everybody to agree that performance--pay
should be performance-related. But it is a lot more complex to
find out what is that right mix of metrics that ensures that it
is true performance.
Simply using stocks, as they say, can confuse brains for a
bull market and, on the other hand, not properly rewarding an
executive who may be doing enormously well in a difficult
economic time. I think one of the things we should study
carefully is what is the careful mix of metrics that truly
rewards performance in fact and not just in name.
Secondly, compensation should be structured in line with
time horizons, the right time horizons. A friend of mine said
to me recently, it is like there is an entire industry which
is--you know entire sets of financial actors which are able to
realize private gains in a single year for risks they are
creating over a 30-year period, which could be externalized to
either their firm or, as we have seen, the economy as a whole.
We need to have structures that help internalize those risks to
make sure that we are having--that those--that it is not easy
for financial actors to simply put off the potential harm they
could be leaving to their firm, their shareholders, and the
economy as a whole.
Third, compensation practices should be aligned with sound
risk management. Now, this authority and dependence of risk
managers within firms, ensuring they are independent,
compensated well, is most important when you are going through
a period of excessive optimism, where asset depreciation can
temporarily make the reckless look wise and the prudent look
overly risk adverse.
Former Federal Reserve Chairman William McChesney Martin
once said, the job of the Federal Reserve is to take away the
punch bowl just when the party starts getting interesting.
Likewise, risk managers must have the independent stature and
pay to take the car keys away when they believe a temporary
good time may be creating even a small risk of a major
financial accident down the road.
Fourth, we should examine whether the prevalence of golden
parachutes and supplemental retirement packages truly align the
interest of executives with shareholders. Lucien Bebchuk, who
will be speaking to you, has written that firms use retirement
benefits to provide executives with substantial amounts of
stealth compensation, compensation not transparent to
shareholders that is largely decoupled from performance.
And concerning golden parachutes, there is more evidence
that they are prevalent, not tied to performance or even
mergers and acquisitions. And I fear that they leave the
understandable impression that there is a double standard in
our economy when top executives are rewarded for failure at the
same time working families are forced to sacrifice.
Finally, we believe that it is very important to have
greater transparency and independence. The say-on-pay
legislation that Chairman Frank has long sponsored, and of
which President Obama as Senator Obama was a co-sponsor in the
Senate, would be a very significant move forward in terms of
transparency and accountability. The evidence in the UK shows
that it has had a positive impact.
And in terms of the independence of compensation
committees, I will just say briefly, we start with the same
premise as Chairman Frank that independence in name does not
mean independence in fact. But we do believe that if you gave
the comp committee the funding and authority to be the sole
hires of the compensation consultants and the counsel and that
you had the SEC go forward to ensure a reduction or elimination
of conflicts of interest for compensation consultants, it is
our hope that we would at least make progress and move the ball
forward. Thank you very much.
[The prepared statement of Mr. Sperling can be found on
page 183 of the appendix.]
The Chairman. Thank you.
Mr. Alvarez.
STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Alvarez. Thank you, Chairman Frank, Ranking Member
Bachus, and other members of the committee for the opportunity
to offer the Federal Reserve's perspective on compensation in
the financial services industry. Compensation practices at
financial firms and other business organizations can have a
significant effect on the safety and soundness of banking
organizations and on financial stability.
Compensation arrangements, which include salary, bonuses,
retention payments and other forms of compensation, at any type
of organization serve several important and worthy objectives.
For example, they are important for attracting skilled staff,
promoting better firm and employee performance, promoting
employee retention, providing retirement security to employees,
and allowing the firm's cost base to move along with its
revenues.
It is clear, however, that compensation arrangements can
also provide executives and employees with incentives to take
excessive risks that are not consistent with the long-term
health of the organization. This misalignment of incentives can
occur at all levels of a firm and is not limited to senior
executives.
In addition, incentives built on producing sizable amounts
of short-term revenue or profit can encourage employees to take
substantial short or long-term risks beyond the ability of the
firm to manage just so the employees can increase their own
compensation.
Risk management controls and frameworks have proved
incapable alone of acting as a break on excessive risk-taking
where compensation programs have created overly strong
incentives to take risk.
These and other weaknesses in the ways that firms have
thought about and implemented compensation programs have become
apparent during this period of economic stress. As a result,
many financial firms are now reexamining their compensation
structures to better align the interests of managers and other
employees with the long-term health of the firm. The Federal
Reserve is also actively working to incorporate the lessons
learned from recent experience into our supervisory activities.
The Federal Reserve played a key role in the development of
the principles for sound compensation practices issued by the
multinational Financial Stability Board in April 2009. In
addition, we are in the process of developing our own enhanced
guidance on compensation practices at U.S. banking
organizations. The broad goal is to make incentives provided by
compensation systems at these institutions that we supervise
consistent with prudent risk-taking and safety and soundness.
In developing this guidance, we are drawing on expertise
within the Federal Reserve, as well as on research from the
broader academic community and other compensation and industry
experts. Our investigations suggest that there are certain key
principles that should guide efforts to better align
compensation practices with the safety and soundness of
financial institutions.
First, to be effective, compensation practices must be
properly aligned throughout a financial firm. This includes
careful review and construction of compensation programs at the
level of middle management, traders and other individuals who
can alter the risk profile of the firm. Firms' boards of
directors and supervisors must broaden the scope of their
review of compensation practices beyond the traditional focus
on senior executives.
Second, compensation practices must take into account the
risks of the activities and transactions conducted by the firm
and not simply be based on targets for short-term profits,
revenues or volume. Substantial financial awards for meeting or
exceeding volume revenue or other performance targets without
due regard to the risk of the activities can create incentives
to take unsound risk. Moreover, incentives that reward good
performance but that do not adjust compensation downwards when
risks are increased or performance targets are missed are not
effective in limiting risk.
Third, more can and should be done to improve risk
management and corporate governance as it relates to
compensation practices. This will involve more active
engagement by boards of directors and risk management functions
in the design and implementation of compensation arrangements
firm-wide. Improvements in compensation practices are likely to
be harder to make and take longer than anyone would like. One
size will not fit all firms.
However, well-crafted supervisory principles can play an
important role in moving practices in the right direction. I
appreciate the committee's interest in this important topic,
and I am happy to answer any questions you may have.
[The prepared statement of Mr. Alvarez can be found on page
78 of the appendix.]
The Chairman. And finally, on behalf of the SEC, Mr.
Breheny.
STATEMENT OF BRIAN V. BREHENY, DEPUTY DIRECTOR, DIVISION OF
CORPORATION FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Breheny. Good morning, Chairman Frank, Ranking Member
Bachus, and members of the committee. I am pleased to be with
you here today to testify on behalf of the Securities and
Exchange Commission so that I may share with you our thoughts
on the topic of executive compensation.
As an initial matter, I think it is important to note that
as the landscape of compensation practices continues to change,
the Commission is committed to keeping the disclosure rules we
administer up-to-date so that investors have the information
they need to make informed investment and voting decisions.
As we all know, in recent years, the issue of executive
compensation has garnered significant public attention. As
revelations about executive compensation come to light, claims
have been made that bonuses and severance packages at some
companies have been exorbitant. Indeed, executive compensation
has been a lightning rod amplified by the recent financial
crisis for concerns about the accountability and responsiveness
of some boards of directors to the interest of their
shareholders.
We believe that, in order for public markets to function
properly, it is crucial that shareholders, the owners of the
company, be able to make informed decisions about their
investments and that shareholders can hold the members of the
board of directors accountable for their decisions.
Notwithstanding the Commission's current rules, we recognize
that there is an ongoing vigorous debate between those who
believe that there should be more substantive constraints on
pay and those who believe the Federal Government should never
or rarely set pay parameters. It is important to note, however,
that this debate is significantly more meaningful as a result
of our disclosure rules.
However, the challenge the Commission has always faced in
promulgating and administering its executive compensation
disclosure rules is that compensation practices are not static.
As a consequence, the Commission has revised its disclosure
rules as necessary to keep pace with new developments in
compensation practices. Most recently, in 2006, the Commission
adopted a comprehensive package of amendments to its rules that
was intended to significantly improve the existing regime of
executive and director compensation disclosure.
While the adoption of the 2006 rule revision significantly
expanded the extent and strengthened the caliber of
compensation disclosure, the Commission is once again
considering further possible enhancements. It has been
suggested that some companies' executive compensation has
become disconnected from long-term company performance because
of the interests of management, in the form of incentive
compensation arrangements, and the interests of shareholders
are not sufficiently aligned.
Critics have complained that, in some cases, the incentive
structure created by executive compensation may have driven
management to make decisions that significantly and
inappropriately increase company risk without commensurate risk
to management's compensation should the decision prove costly
to the company. Indeed, one of the many contributing factors
cited as a basis for the current market turmoil is the
misalignment at a number of large financial institutions of
management's financial interests with those of shareholders.
Compensation policies and incentive arrangements represent
just one of the issues that the Commission plans to take up
next month when it considers a broad package of proxy
disclosure enhancements. Many of these enhancements are
designed to provide shareholders with additional information
about their company's key policies, procedures, and practices.
For example, the Commission plans to consider whether greater
disclosure is needed about how a company and the company's
board in particular manages risk, including within the context
of existing compensation plans and setting compensation levels.
The Commission also plans to consider whether greater
disclosure is needed about a company's overall compensation
approach, in particular as it relates to the company's risk
management and risk-taking beyond decisions with respect only
to the highest-paid executive officers.
The Commission further plans to consider proposing new
disclosure requirements regarding compensation consultant
conflicts of interest.
In addition to these executive compensation disclosure
enhancements, the Commission plans to consider proposals
related to the directors themselves. For example, it plans to
consider whether to enhance disclosure of director-nominee
experience, qualifications, and skills so that shareholders can
make more informed voting decisions.
The Commission further plans to consider proposed
disclosures to shareholders about why a board has chosen its
particular leadership structure, such as whether that structure
includes an independent Chair or perhaps combines both the CEO
and the Chair in one position, again so that shareholders can
better evaluate the board when making a voting decision.
Notwithstanding the Commission's executive compensation
disclosure requirements, however, it has been argued that,
absent a more effective way for shareholders to exercise their
fundamental right to nominate and elect directors to the
company's boards of directors, board accountability to
shareholders cannot be maximized. Accordingly, on May 20th, the
Commission voted to approve for notice and comment proposals
that would give shareholders a more effective way to exercise
their State law rights to nominate directors.
Under the proposal, shareholders who otherwise have the
right to nominate directors at a shareholder meeting would,
subject to certain conditions, be able to have a limited number
of nominees included in the company proxy materials that are
sent to all voters. To further facilitate shareholder
involvement in the direct nomination process, the Commission
also proposed amending its shareholder proposal rule to require
companies to include proposals related to the nomination
process in their proxy materials, provided that certain other
requirements of the rule are met.
If adopted, we believe these new rules would afford
shareholders a stronger voice in determining who oversees
management in the companies that they own.
Thank you again for inviting me to appear before you today.
On behalf of the Agency, we look forward to working with
Congress and with this committee going forward on these issues.
I would be happy to answer any questions you may have.
[The prepared statement of Mr. Breheny can be found on page
148 of the appendix.]
The Chairman. Thank you.
Before I get to questions, I do want to comment on some of
what we have heard earlier from my member colleagues. I think
what we have heard today is the final repudiation of the Bush
Administration by many of my Republican colleagues, because we
have heard a fairly vigorous and thorough denunciation of the
various actions of that Administration; no more bailouts, no
more taking over companies.
Well, AIG, I remember, in September of 2008, being told by
Secretary Paulson and Chairman Bernanke, two Bush appointees,
that they had decided with no congressional input or even
advice to advance $82 billion to AIG.
Two days later, we were asked by the same two Bush
appointees to initiate the TARP program of $700 billion.
Subsequently, we worked with the Bush Administration, and
after we were unable to pass a bill because the House passed it
and the Senate didn't, involving the auto companies, the Bush
Administration initiated it.
So we are talking now about a Bush Administration
initiation of funding for AIG, a Bush Administration request to
Congress to create the TARP, and the Bush Administration
intervention without congressional final action in the auto
companies.
How that became a Democratic agenda puzzles me. Perhaps I
will be enlightened later on.
I do know that I have colleagues who believe that the world
was created only 4,000 years ago. I had not previously known
there were some who thought it was created on January 20, 2009.
So I do want to say, we are engaged in this, and we are
engaged and have been engaged for months in dealing with the
consequences of decisions made by the Bush Administration, some
of which I agreed with, although I thought they weren't carried
out well.
I would note on the TARP money that, thanks in part to an
increase in the conditions that have been imposed on TARP
recipients both by the Congress and the Obama Administration,
more than one-third of the money advanced to banks has already
been repaid to the Treasury. Now, we have to decide what we do
with that.
But those who consider the whole $700 billion gone have to
cope with the fact that of approximately $200 billion advanced
in less than a year, more than $70 billion has come back, some
of which exceeded the loans because there was some interest.
Now, these are complicated questions to be worked out. And
I would not ordinarily have brought this up, but listening to
what I heard before, it did seem to me the history was
relevant. Yes, we have had a problem with bailouts.
The second point I would make is that a say-on-pay comes
from England. It is not some intervention. It is not a bailout.
The compensation matters we talk about, and I try to be very
clear, it is one thing to have fairly intrusive compensation
restrictions when people are getting money directly; it is
another when we are talking about risk assessment.
And so I will now ask my question of these three gentlemen.
One of the arguments we have heard is that if we restrict
compensation, it will contribute to capital fight, that people
will flee America. It has been my experience that, in the first
place, American corporate executives were rewarded far better
in dollar terms and other ways than others. Sometimes I think
the Japanese executives and American executives are paid the
same amounts, except in our case it is dollars, and in their
case it is yen, and so the yen-dollar difference means that
ours are getting a lot more.
But I would ask all three of you, is there a danger if we
were to adopt say-on-pay or some of the other rules that you
are proposing, that we would have the capital flight that some
of the best and brightest who have run the financial system
with such elan would now decide that they were not sufficiently
appreciated and would move to other countries?
Let me begin with Mr. Sperling.
Mr. Sperling. Chairman Frank, I suppose if one were to put
a hard and arbitrary cap on the top talent at a firm, that
could lead to flight and the kind of deterioration that you
mentioned.
But as far as I know, I can say with certainty that there
is nobody in the Obama Administration who is proposing such
things. What we are proposing in the legislation we did put
forward yesterday is greater transparency and accountability to
the owners of the company. We find, and I think practice has
shown, that sunshine and transparency does have a powerful
deterrent effect on improper or ill-advised behavior. And I
think, even more important, it starts an important dialogue.
The Chairman. I want to talk strictly about the competitive
piece.
Mr. Sperling. I do not believe that anything we are
proposing today or that you have proposed would have a
deterrent impact.
The Chairman. Let me ask Mr. Alvarez.
Mr. Alvarez. Mr. Chairman, I think one good piece of
information here is that the world is looking at this problem
as well. So the British have already begun to consider it. The
Swiss have proposed some principle similar to what we have
discussed today.
As I mentioned, the board has worked on an international
panel with a financial stability board. So this is a global
issue with a global set of solutions that the globe is coming
to consensus on.
The Chairman. Thank you.
Mr. Bachus?
Mr. Bachus. Thank you, Mr. Chairman.
Mr. Chairman, your earlier remarks, I will just say that
whether we tag this on Bush, sort of pin the tail on the
donkey, or whether we pin it on the elephant, it is now all of
our problems. And it is now; it is not then. And I just ask
that we all work together to get us out of this, these bailouts
and these government-funded programs, and that we extricate
ourselves from that and the deficit spending that we have
witnessed.
So we will work together on that I hope.
Let me say this. Gene, you and I have worked on several
things. I have a deep respect for you. I very much agree with
you that one of the contributing factors to the excess risk-
taking that was central to the crisis was compensation that was
linked to short-term gains without any consideration of the
long-term risk. As you say, across the subprime mortgage
business, brokers were compensated in ways that placed a high
premium on volume without regard to whether the borrowers had
the ability to make those payments. That is pretty clear. I
associate myself with all of those remarks.
I also associate myself with the remarks you have made that
top executives offered those golden parachutes weren't aligned
with shareholder interest. You said it creates the impression,
and a lot of my constituents have this impression, that there
is a double standard in which top executives are rewarded for
failure at the same time that working families are forced to
sacrifice. We have seen instances and a lot of cases where
executives received these tremendous salaries as they went out
the door on failing corporations, and at the same time, most of
the workers were being given pink slips or their retirement
benefits or health care was being cut back.
Having said that, I take those as givens. You say that the
goal of the Administration now is to move compensation
committees from being independent in name to being independent,
in fact, and not only would committee members be truly
independent, but they would be given authority to appoint and
retain compensation consultants and legal counsel, along with
the funding necessary to do so. This legislation would instruct
the SEC, and I think we have had testimony from the SEC, to
create standards for ensuring the independence of compensation
consultants, providing shareholders with the confidence that
the compensation committee is receiving objective, expert
advice.
Would all of you gentlemen admit that is a major mandate by
the government in the corporate governance?
Mr. Sperling. Thank you, Congressman. I feel that this is
just simply trying to ensure that the independence of comp
committees is as it is advertised, which is independent. The
reality is, and I say this as a person who has participated in
a board of directors, if the CEO controls the compensation
consultant, you can have an independent compensation committee,
but the power and the information that is being gathered is
being gathered by somebody who almost inherently has a conflict
of interest in this situation.
I think one of the things that you try to do is not to
intervene or micromanage, but I think when you can have
transparency and reduce conflicts of interest, then you are
laying foundations for capital markets to work more
efficiently.
Mr. Bachus. But you are putting independent people within
the corporate governance and you are mandating that they be
independent and be compensated. That is a type of corporate
governance. I guess what I am saying is that 95 percent of the
corporations never made a mistake or never performed in a risky
manner, so you are basically taking and you are saying to all
of those corporations we are going to change the rules.
Mr. Sperling. Well, as we have seen, it doesn't take that
many types of excessive risk-taking to do a lot of damage that
goes not only to the shareholders but to the economy as a
whole.
We believe if we advertise to shareholders and the public
that compensation committees are independent, and yet we know
that if the company itself hires the compensation consultant,
if that compensation consultant can also be taking other fees
and being paid by the company, then you have a bit of false
advertising. I think what we are doing here, far from being
intrusive, is simply ensuring that the independence of
compensation committees, as advertised, is independent, in
fact.
The Chairman. The gentleman's time has expired.
The gentlewoman from California.
Ms. Waters. Thank you very much, Mr. Chairman. I would like
to thank our panel for being here today to help us wrestle with
one of the most serious problems in the financial services
community dealing with compensation and bonuses, etc.
There are some things that we have learned about actions
that were taken that are very disturbing. I don't know that we
have gotten any information to help us understand what went on
in some of these actions. For example, I want to know what you
have discovered, starting with Mr. Sperling, about the
authorization for $5 billion for bonuses to be given to Merrill
Lynch employees at the time the merger took place between Bank
of America and Merrill Lynch. I have read accounts in the paper
and heard information that Bank of America knew and signed this
agreement that these bonuses could take place.
Later I am told that the CEO said that he was made to sign
an agreement understanding that these bonuses were going to be
given. Normally these bonuses were given at the beginning of
the year. They rushed them so that they would be given toward
the end of the year and prior to the signing of the agreement.
What do you know about this?
Mr. Sperling. Congresswoman, there obviously has been very
contentious discussion which has gone out to the public between
former Secretary Paulson and the chairman of Bank of America
over what transpired during that transaction which as you know
was months before I entered the Obama Administration.
Ms. Waters. Yes.
Mr. Sperling. I would have to go back, and would be happy
to do so, and get what our Administration's best understanding
is of that dispute. But it is an ongoing dispute with I believe
our own Justice Department engaged in it, so I don't have
intimate knowledge of where that is right now. But I would be
happy to get back to you.
Ms. Waters. Well, as we try and create public policy around
some of these issues, what would any of you suggest that we
should include in legislation that would prevent this kind of
action?
Mr. Sperling. Well, one thing I would mention is, with the
legislation that you all have already passed, let's remember
that in the situation of TARP, which I know we are going well
beyond, but obviously the legislation you have passed would
have limited those types of bonuses to one-third of overall
salary. So in the case of someone receiving TARP, a recipient,
had Merrill been a TARP recipient at that point, it would not
have been permitted under the law.
But more generally, again, our view is very much to try to
have greater transparency on the practices, greater
independence; and we feel very much that these type of
practices, when brought to light, that the transparency is
often decisive. And so when people say, for example, say-on-pay
is nonbinding, I don't think that is the way it works, in fact.
I think it is very, very troubling for a company to face a
negative vote in those areas, and few want to take that type of
public risk.
Ms. Waters. Any other comments on this issue?
Mr. Alvarez. Madam Congresswoman, one issue I would add to
what Gene has said, it is important when an organization has
not performed well that bonuses be adjusted for that. One of
the principles that we think is very important and that the
Federal Reserve will incorporate in its guidance going forward
is that the compensation should be risk sensitive. It should
reward good performance. But when performance doesn't meet
goals or when there are losses, then the compensation has to be
adjusted in the other direction.
Ms. Waters. That is the Barney Frank law. He is the first
one who emerged with the risk assessment relative to the
management of risk basically. He maintained from the beginning
that those persons responsible for creating the risk would have
to accept the responsibility for the failures. And so I think
we are on that path for sure. But I just want to make sure that
I understand when mergers are occurring, buy-outs are taking
place, what the purchasers are being forced to do by anybody. I
want to understand that better, and I will continue to pursue
that.
Mr. Sperling. I think, as the chairman would say, in the
say-on-pay legislation proposal, there is often a separate vote
on the golden parachutes in exactly that merger transaction.
The Chairman. The gentleman from Texas.
Mr. Neugebauer. Thank you, Mr. Chairman.
Mr. Sperling, in your testimony, you said that you all were
going to be asking the President's Working Group to provide an
annual review of compensation practices so the government can
monitor whether they are creating excess risk. How will that
work? How will you determine whether compensation is actually
creating excess risks?
Mr. Sperling. I think the reason Secretary Geithner felt it
was good to put this on the agenda, and it is the same reason
that you hear Mr. Alvarez talking about it from the Federal
Reserve's perspective, we have all learned painfully that
compensation is closely related to the safety and soundness
obligation, not only the Federal Reserve, but all of us have.
I think we also are aware that one always has to be worried
about fighting yesterday's war. New practices, new trends can
emerge, and I think to ask the major supervisors in the U.S.
Government to take a yearly look or annual review of what those
trends are could be again one more check against the type of
excessive risk-taking that we have seen, which too often can
get a pass in exactly a bubble atmosphere where again everybody
looks smart because assets are all going up year after year.
These are exactly the times when you need to have more risk
management in place at companies, and perhaps at the Federal
level as well.
One of the things that Secretary Geithner did was to invite
many of the major organizations, nonprofits and business
groups, to be part of that process so we are reviewing not just
what may be going wrong but also best practices. I think one of
the positive things that are coming out of the discussion, and
we heard in the expert meeting that we did, which was a very
wide group that went from Nell Minow, who you have speaking
today, to the Business Roundtable, was that there was enormous
optimism that there could be an emerging sense of best practice
if this discussion is rigorous enough and if there is enough of
a spotlight shined on it.
Mr. Neugebauer. One of the things you said in your
testimony, you said you think one of the major causes of the
financial crisis we are in today was based on compensation. The
problem I have with going down this compensation road is where
in the chain was the compensation inappropriate for the risk
being taken? Was it the young originator of the loan, or was it
at the person at the financial institution that was packaging
the loan? Or was it the securities company that was
securitizing it? Or was it the investment company that was
buying those loans? Where in the process was the person being
overcompensated and the risk and compensation out of
proportion?
Mr. Sperling. I think it is less how much, but it is more--
what you don't want, whether it is the person originating the
subprime mortgage or the executive, is you don't want to
encourage compensation practices where one gets to internalize
the gains short term and externalize to others the potential
risk and harm down the road. So, for example, if a subprime
mortgage originator, if part of their compensation might be
based on how the mortgages were being paid, that would be a way
that you would ask that person to think not just about how much
volume that I can push this year, but whether or not you give
have them an incentive or their unit an incentive to consider
how it is going to perform. Some firms are now doing bonuses
banks. What they are saying basically is that if everybody knew
their bonus was going to be held for a few years before they
got all of it, then if people said we are doing some
excessively risky things here, there would be a lot greater
incentive for people to be self-checks in their own businesses
because they would see their compensation reduced.
Across the system, too many people could internalize
private gains by the volume of what they were doing regardless
of its quality or the risk it was externalizing to the firm,
the shareholders, or as we have painfully learned, the economy
at large.
Mr. Neugebauer. I have a quick question for the three
panelists: If you gave me $1,000, and in 2 years, I had made
that into $1 million, would it be fair for me to get a $10,000
fee for doing that; yes or no?
Mr. Sperling. It depends.
Mr. Neugebauer. Mr. Alvarez?
Mr. Alvarez. I couldn't say.
Mr. Breheny. I couldn't say.
Mr. Neugebauer. So you all are going to set compensation
for companies, yet you do not know what adequate compensation
for return is, and this is the problem.
The Chairman. The House is in recess, so we are not going
to have to disrupt this.
The gentlewoman from New York.
Mrs. Maloney. Thank you, Mr. Chairman. I thank all of the
panelists. I would like to note for my colleagues that I have
worked closely with Kenneth Feinberg during the 9/11 recovery
for New York City. He took on an incredibly difficult task
determining what the compensation would be for families who had
lost their loved ones. It was a very difficult task, and he won
applause from everyone. He did a magnificent job with a murky
and confusing problem. So I compliment the Treasury Department
on your selection, and I wish him great success and that he
will be as successful as he was with the 9/11 Compensation
Fund.
My question to Treasury is, how did you determine the seven
companies that are going to have their compensation determined
or guidelined by Mr. Feinberg? Some people have said if there
was 40 percent ownership by the taxpayer, was that the
standard? What was the standard that determined who the seven
companies were?
Mr. Sperling. In the regulation itself, it actually
mentions the specific names of the programs that they are
under. But I think your question actually goes more towards
what is the logic and rationale.
I think that our feeling is that some of the things we have
done, some of the facilities that were set up are set up to be
generally accessible to companies, financial institutions at
large. And they are often set up because we think that there is
a positive public purpose in them participating. We think if
community banks wanted to not have more capital, if they wanted
to do less loans, we believe it is in the interest of recovery
to have stronger capitalization of banks and a stronger lending
profile. So those are generally accessible programs.
Where a company comes to the U.S. Government and U.S.
taxpayer and requires exceptional assistance that is not being
offered to their peers because they face an enormous threat to
their fundamental financial stability that we find to have such
an impact on the economy as whole that we have to intervene,
that is an exceptional case and that requires of us at the
Treasury Department to have a stronger fiduciary duty to the
United States taxpayer. And so even though the legislation and
Congress has spoken, there is the law of the land in the
Recovery Act; we felt that the law as stated does not have a
limit on salary. We felt that in the case of companies who
received such exceptional taxpayer assistance that we had to
have a stronger fiduciary duty and we spent a lot of time
trying to think what was the best way to do that.
In the end, we felt that if we could find somebody of the
judgment and stature of Ken Feinberg who could look across
these companies and look at a set of principles on risk and
performance, but also on whether it is going to lead taxpayers
to get return on their dollar, that extra level of protection
for the taxpayer was necessary and important there in the way
it would not be if simply a community bank in your district
chose to participate in the capital purchase program partly
because their government thinks it is a good thing for them to
have stronger capital and be in a stronger position to lend.
Mrs. Maloney. Well, I think everyone understands that if
you take taxpayer money, you are subject to a higher form of
oversight and accountability. But the question basically that I
am hearing from my constituents is, what was the standard? It
would be helpful if it was more clear. Is it 40, 50, 60, 80
percent of taxpayer dollars? If it is a standard that the
public could understand; and connected to that question, what
would trigger the eighth company to come into the fold? I
certainly don't think it would be totally the discretion of one
individual. It should be some form of public standard that
people can understand and hopefully support.
So my second question is: What would trigger, say, an
eighth company to be under the same type of supervision as the
seven companies named in the legislation? I will go back to the
legislation, but I am still a little unclear as to what was the
standard and I think it would be helpful if the standard was
clearer to the public and to Members of Congress as to how
these particular companies were selected. I would think that
the easiest form is what is the degree of public funding that
has gone into them.
The Chairman. The gentlewoman's time has expired. Is there
a brief answer?
Mr. Sperling. The reason that I feel that exceptional
assistance is the right standard as opposed to ownership: let's
say that we decided that we did not want to lever up GM and put
them in the situation of having extremely high debt, which was
the problem they had, so we gave our assistance through
equities. But had we done so through very exceptional lending
on attractive terms, that would not have given us a certain
ownership perspective, but you would have looked and thought
they are receiving exceptional taxpayer assistance that their
peers are not. By being in that situation, that brings on a
higher fiduciary duty. I think that general principle is the
right principle.
The Chairman. I would advise members we have to be
conscious of the time and questions with no time left are hard
to get answered.
The gentleman from Delaware.
Mr. Castle. Thank you, Mr. Chairman.
I have an abiding concern what the Federal Government is
doing in this area versus what the States are doing and in
general what the Federal Government has been doing in terms of
bailout situations and whether it is really working or not.
My first question to you is, have any of you or your
different agencies studied who the shareholders are? I say that
knowing that in many corporations, wealthy private individuals,
private firms, mutual funds and others become the stockholders
of record and sometimes very often the voting stockholders. I
am afraid their interest may be absolutely no different than
some of the so-called greedy executives who are looking for
immediate compensation? In other words, they are trying to get
in and out in a relatively brief period of time. Are we really
serving the public by making these changes? I realize as you go
through each corporation it would be different, but is there a
general sense who the shareholders are in American corporations
today that has been well analyzed?
Mr. Sperling. I will let my colleague from the SEC answer;
but I would say that we have to be very careful in a one-size-
fits-all metric for rewarding behavior. And I think some of the
experts you are going to hear in the next panel are very
persuasive in making that case that simply using stock, while
often successful, is not foolproof. I think it is something
that we should all, us included, be studying very carefully and
listening to the type of people that you have coming up on the
next panel.
Mr. Breheny. I appreciate the question and having an
opportunity to answer it. I don't know that I have a fulsome
answer, but I will work with you to get that.
The issue you bring up is one that we absolutely have
considered in rulemaking matters that I have been involved in,
interest of shareholders, long term, short term, percentage
ownership, small companies versus large cap companies, are many
of the issues that we think about when adopting rules. It is
certainly something that we seek comment on when we issue
rules, and we have been thinking about economic interest and
voting interest in going forward.
I am aware of those issues, and we think about those
issues. I don't know that I have a full answer, if I can give a
response, can I tell you the makeup of the American
shareholders, but those particular interests are definitely
raised with the Commission, and it is something that we think
long and hard about before we adopt rules.
Mr. Castle. I think it is important and we need to keep an
eye on it. My next question is sort of general and it goes back
to what I said at the beginning.
What should we in the Federal Government be doing versus
what the States are doing? Most corporations in this country
are at the State level. States are beginning to make some
changes, not dissimilar from what you are saying. As I have
indicated, I think there are some concerns about some of the
compensation factors, but I am not sure that the Federal
Government should be stepping in and doing this. My concern is
if we do this, are we going to be expected to take the next
step, whatever it may be, or are we better off discerning
exactly what the problem is and then allowing the States to
make whatever the decisions are that would be corrective in
this case versus doing it at the Federal Government level?
Mr. Breheny. I am not sure that the Commission itself has
weighed in on that particular issue. But I think if you go back
and look at the provisions adopted in Sarbanes-Oxley, the
provisions, the rules that the Commission has adopted, we have
gone to great lengths to maintain that balance between the
interest of the SEC, the authority that Congress has given to
the SEC to protect investors, versus the very important State
law rights that all shareholders have.
I think you will see that in many of the rulemakings that
the Commission has gone through, there is a balance. It is a
policy question you need to answer, which is why you are asking
me the question. I don't know that I can tell you. I think it
is an important balance. I think State-Federal rights are
recognized throughout the rules that the Commission has and the
authority that the Congress has given to the Commission.
Mr. Castle. I understand what you are saying, but I think
we need to be very careful about how encroaching we are being
with respect to dictating in terms of corporate structures and
corporate methodologies involving the Federal Government. I
think it can be putting the foot in the door for what can
happen in the future. I think we need to be very cautious.
Mr. Sperling, I was going to ask you about the structures
and the timelines you talked about at the beginning, but I will
submit that question in writing because the red light is now
on.
The Chairman. I thank the gentleman for his sensitivity to
the time. I now recognize the gentleman from North Carolina for
5 minutes.
Mr. Watt. Thank you, Mr. Chairman. I apologize to the
witnesses for not being here for their testimony, but I have
been reviewing it.
I want to take the semantic way in which Mr. Sperling
addressed these issues differently and ask a broader question.
The first three principles that you outlined in your
testimony, Mr. Sperling--compensation plans should properly
measure and reward performance; compensation should be
structured in line with the time horizon of risk; and
compensation practices should be aligned with sound risk
management--are all kind of general principles. But then in the
fourth and fifth principles, and you may not be aware of this,
in the fourth and fifth principles, you shifted to a different
phraseology. You say we should reexamine whether golden
parachutes and supplemental retirement packages align the
interests of executives and shareholders. And number five, we
should promote transparency and accountability in setting
compensation. My underlying question is: Who is the ``we,''
first of all? And the extent to which authority already exists,
either at the SEC or the Fed, to do some of this under existing
statutes, or whether there are specific things that this
committee and Congress must do to change the law to address
these issues?
Mr. Sperling. Thank you.
Perhaps in the fourth, I did not use our words well,
because I think they are actually different.
I think on the issue of golden parachutes and supplemental
retirement packages, we were not coming with a particular
legislative or even regulatory proposal. We really were in a
sense trying to shine a spotlight on a practice that we think--
Mr. Watt. The ``we'' in that case being the Treasury
Department?
Mr. Sperling. The Treasury Department. We are trying to
suggest that based on our review, this is a practice that, that
there are practices on the supplemental retirement accounts,
excessive retirement accounts for executives and golden
parachutes, that shareholders and management should reexamine.
There may be times that they are appropriate, but there seems
to be increasing evidence that they have been more prevalent.
Mr. Watt. And my second question?
Mr. Sperling. I perhaps chose my words poorly if that
implied that we, the Treasury Department, had a specific
proposal.
On the fifth point, there we were coming to the table with
a specific proposal and it was a proposal to essentially give
the SEC the authority they need to do two things that we, that
the Treasury Department and the SEC both feel are in the
interest of a sounder--
Mr. Watt. And those two things, quickly, are what?
Mr. Sperling. Are the say-on-pay legislation, which again,
we are giving the SEC authority to do, and giving the SEC clear
legal authority to strengthen the independence of compensation
committees in the way that after Enron Congress gave the SEC
the authority to strengthen audit committees.
Mr. Watt. I thought the SEC already had this authority, Mr.
Breheny, and maybe it is not just exercising it. Do you need
more authority or is it just that the SEC that we have had has
not exercised the authority that they already had?
Mr. Breheny. No, I don't believe we have the authority to
require companies to have a say-on-pay proposal or to
strengthen the compensation committee consultants. The Chairman
of the SEC is on board supporting both the say-on-pay
legislation--
Mr. Watt. Well, if the SEC doesn't have it, do the
regulators have it? Or are we talking about all public
companies that don't have regulators? What about with banks,
regulated banks, would the regulators already have the
authority to say, you have to have a more aggressive
compensation committee on your board? Would they have the
authority already to say you have to give your shareholders a
right to have say-on-pay?
Mr. Alvarez. No, on say-on-pay. We would not have the
authority to require those kinds of disclosures. That is not
safety and soundness related.
On strengthening compensation committees, we may be able to
do some actions there, but I am not sure we would be able to
get as far as the Treasury Department would like.
Mr. Watt. Thank you, Mr. Chairman.
The Chairman. I think historically, safety and soundness
has more often been used to invoke nondisclosure than
disclosure.
The gentleman from Texas, Mr. Hensarling.
Mr. Hensarling. Mr. Sperling, I listened carefully to your
testimony, and in listening to it, I must admit I find myself
in agreement with most, if not all, of the principles that you
lay out. Compensation plans should properly measure and reward
performance, structured and aligned with time horizons of risk,
should be aligned with sound risk management, and the rest.
For most of my life I have signed the back of a paycheck,
but there was a time I actually signed the front of a paycheck.
There was a time I served on the compensation committee of a
New York Stock Exchange company, and not unlike the gentleman
from California in his opening statement, I thought I worked
very hard to try to ensure that these principles were put into
place.
I remember an unhappy CEO when I was part of a comp
committee informing him he would not be getting the pay package
compensation structure that he had desired.
I guess my question for you is, since I have found this
challenging, and I was in the private sector for 12 years, and
I have been a Member of Congress for 6\1/2\ years, when I came
to Congress, I didn't have any kind of epiphany that now I know
what the perfect compensation structure is. Going back to what
the gentleman from California said, why can you do better?
Mr. Sperling. I don't think there is anything that we are
proposing that suggests we could. I think we are perhaps
suggesting on the compensation committees, when you were in
that position, if you had the authority to hire your own
compensation consultant, if there was not an ability for the
compensation consultant to have a conflict of interest because
they were being paid by the CEO and some other measure, that
would strengthen your hand.
You seem to have been able to, in your situation, strike
that type of independence, and I compliment you on that. But I
can say that many people find on a compensation committee that
if the company itself is hiring both the counsel and the
consultant, it is very difficult. In fact, there is a study
that shows that CEO pay does end up being higher when you use a
compensation consultant that has conflicts of interest.
Mr. Hensarling. I appreciate your approach in that regard.
It will be an open question in my mind whether or not there are
ways to strengthening the hand or the powers commensurate with
the responsibilities of comp committees of public companies. I
have an open mind about that. I can tell you from my experience
on this committee, though, that there have been many witnesses
from private enterprise sitting at that table who have received
strong suggestions from this committee that this is a way that
you might want to do something because if you don't do
something, we will do it for you. So I am somewhat fearful that
once we go down this road, we may go way beyond merely
strengthening the hand of compensation committees.
Also, Mr. Sperling, on page 4 of your testimony, you state
that, ``when workers who are losing their jobs see the top
executives of the firms walking away with huge severance
packages, it creates the understandable impression that there
is a double standard.'' I agree with that impression. Let me
ask you since the executive compensation first has arisen in
terms of TARP, I want to ask you a TARP-related question. The
Administration put forth a reorganization plan for GM. Under
that plan, GM bond holders, many of whom are middle-income
Americans, including blue collar workers and tradesmen who
invested money in GM bonds for their 401(k)s for their
retirement, the GM bond holders under the Administration plan
get 10 percent of the company for $27 billion in claims,
warrants for an additional 15 percent, the United Auto Workers
get 17\1/2\ percent of the company for less in claims, $20
billion, and $10 billion in cash, $6.5 billion in preferred
stock, $2.5 billion IOU, and warrants for an additional 2\1/2\
percent of the company. Would that not create an impression of
a double standard?
Mr. Sperling. I really don't believe so. I really believe
that the bond holders represented themselves very well. I think
they were better off than had they allowed for a completely
uncontrolled bankruptcy. And in terms of the VEBA, it is going
to require a very painful sacrifice from retirees, retirees who
did nothing wrong and were not part of contributing to this
financial crisis. I believe there was very careful, shared
sacrifice in that arrangement.
Ms. Waters. [presiding] Thank you.
Mr. Sherman?
Mr. Sherman. Thank you, Madam Chairwoman.
I am not sure that the bond holders were hurt. Rather, a
huge infusion of taxpayer money helped all the old
stakeholders. I think we were more generous with the workers
than we were with the bondholders. But if anybody is not being
treated well in this, it is the taxpayers.
I want to recognize Kathleen Connell who is here in the
audience, who for 8 years was controller of the State of
California.
I notice that quite a number have railed against
government-controlled pay. I should point out that these are
companies that have taken and are holding our TARP money.
I want to join the chairman in welcoming Republicans when
they reject virtually every Bush Administration economic policy
of the last 7 months of his Administration, but I think it is
now time for Democrats to reject with the same intensity
virtually all of those policies.
We are told that only a few TARP recipients have received
extraordinary help, and only those few should face real limits
on executive compensation. I would say that TARP is an
extraordinary departure from free enterprise and only those who
got one infusion of, say, $25 billion of capital, should be
viewed as getting extraordinary help.
I have one question for the record, because I would like
all three of you to answer it, and it is way too complicated to
do so orally. I want you to imagine how we would design an
executive compensation system for the derivatives unit of AIG,
or some other derivatives unit inside a big company. If you
just said, we will give them restricted stock and restrict it
for a few years, they might take extraordinary risk so the unit
looked extraordinarily profitable, get an extraordinary amount
of AIG restricted stock, they would have believed that AIG
would have been a solid company no matter what their unit did.
I don't think anybody in that unit or in this country realized
that unit could bring down that enormous company.
Likewise, keep in mind, at least for this example, assume
that this unit might show profits for accounting purposes for 5
or 10 years in a row before it imploded, and now try to figure
out what kind of executive compensation system would reward the
people in that unit for taking the right kinds of risks but
would actually penalize them for taking the wrong kinds of
risk.
Now for a question for our representatives from the SEC.
There were elections in Venezuela to control the government of
Venezuela. Our State Department criticized Hugo Chavez for
using the resources of the government to affect the outcome of
the elections for representatives to control the government. So
what can you do to propose to Congress or to your own board for
regulatory changes, rules that would prevent corporate
management from using the resources of the company to unduly
influence the outcome of the election without giving similar
resources to the other side?
What would you do to certain challengers who were supposed
to get resources, and what has the SEC done to make sure that
the challengers have equal space in the proxy statement which
is the one document you do control?
Mr. Breheny. Thank you, Congressman. That exact issue was
the point that the Commission took up on May 20th. And as you
may know, this is the third attempt that the Commission has
made to give shareholders, who have a State law right to
nominate directors, the ability to have those nominees included
within the company's proxy material.
So the issue about disclosure and the ability to provide
disclosure about their nominees is all included, and that rule
proposal is up on the Commission's Web site as of last night.
Mr. Sherman. I would hope that you would propose
legislation that would go far beyond the proxy statement. Trust
me, it is a very boring document. What is needed is equal
amounts of, and in some cases millions of dollars to call
shareholders and try to get their proxies, and that process
needs to be equal. My time has expired.
Ms. Waters. Thank you.
Mr. Garrett.
Mr. Garrett. Before I go to my questions, let's go back to
the opening of the hearing where the chairman was talking about
history and how history is relevant. Indeed, it is. More the
pity that revisionist history is not relevant. Yes, there were
some Republicans on this side of the aisle just now repudiated
what the past Administration did with a lot of the bailouts.
Unfortunately, the chairman and others were not repudiating it
when it was going through the House. And you will remember, as
some said, the chairman carried the water for the past
Administration to make sure that legislation was not only
engaged in and made sure that the TARP legislation actually
passed. And we must also remember that history tells us that
this new Administration has basically adopted hook, line, and
sinker the past Administrations of the bailout philosophy.
So, yes, there are a number on this side of the aisle who
repudiated in the past, and on the other side of the aisle
maybe there is one that I see who joined with us in that fight
against the TARP bailouts and all of the string of bailouts
that followed. So let's remember what history was.
I also see we have the counselor to the Treasury Secretary
here with us. Remember also that Mr. Geithner at that time was
with the New York Fed, and at that time the New York Fed was
considered the architect of the AIG bailout and this
Administration adopted Mr. Geithner as their Treasury
Secretary. So I think there is the pity that this
Administration is continuing on in the mold and continues on
with the bailout and that is what a number of us thought was
wrong then and continue to fight against now with our
legislation and what we will roll out later on.
With history now clarified, Mr. Alvarez, I see in your
testimony you say that employees throughout a firm who expose a
firm to significant risk, and improperly designed compensation
programs might incite a wide range of employee behavior. You
also say we should adjust compensation so that employees bear
some of the risks associated with their activities. An employee
is less likely to take an imprudent risk if incentive payments
are reduced or eliminated for activity that imposes higher than
expected losses. I agree. How does that occur in the Fed right
now with the activities that the employees take that have a
risk not only on themselves but the entire economy? Or can they
do anything that they want without any risk?
Mr. Alvarez. There is no one at the Fed who can do anything
that they want without taking risk.
Mr. Garrett. As far as their compensation?
Mr. Alvarez. No, as far as their actions as well. So there
is performance. At the Federal Reserve, there is a tie between
performance and pay. We are all rated on our performance, and
we all have adjustments to our pay based on our performance. We
are not paid with bonuses like the way the industry is that we
are talking about today.
Mr. Garrett. For all of the panel, looking at the proposal
that is coming from this Administration that the chairman is
talking about, some would suggest that the proposal would have
higher cost for businesses to operate. Most would agree with
that. Some would argue that larger corporations could probably
bear that cost. Others would argue that may be the case, but
smaller firms would have difficulty dealing with those pretty
significant additional expenses. Does anyone have a comment on
how smaller firms would have to deal with these costs to the
operation?
Mr. Alvarez. I would say that smaller firms actually do a
better job of aligning risk and rewards than the larger firms
do in part because typically in a smaller firm the CEO, the CFO
if there is one, knows the employees, knows the risks that are
coming onto the balance sheet, knows what the employees are
doing, and so is able to adjust the compensation practices.
Mr. Garrett. If we set up any additional requirements as
far as outside requirements, doesn't this add to the cost of
them doing business? Will they be able to absorb that?
Mr. Alvarez. I will defer to the others on theirs, but the
kind of approach that the Federal Reserve is considering is
outlining principle.
Mr. Garrett. Thank you, Mr. Alvarez, I appreciate that. And
I ask Mr. Sperling on the Administration's proposal?
Mr. Sperling. The two proposals that Secretary Geithner put
forward, the say-on-pay and the independent comp committees, I
don't believe would have a significant cost. It would obviously
apply to public companies. It doesn't mandate that there is--it
does not put a mandate. It says if you are a comp committee, if
an independent comp committee is going to hire a consultant or
counsel, that committee needs to have the authority and funding
to do their job without conflicts of interest.
I feel the things that we have put forward right now would
be affecting public companies, but I share your view that one
always has to do an analysis of what the differential impact
would be.
Ms. Waters. Thank you.
Mr. Moore.
Mr. Moore of Kansas. Thank you, Madam Chairwoman. Before we
learned about the $165 million AIG bonuses in March, we also
learning from New York's comptroller in January that Wall
Street executives were paid $18.4 billion in bonuses last year.
I was troubled by this news, especially during a national
emergency when the Federal Government is providing billions of
dollars of taxpayer funds to stabilize the financial sector.
Under normal circumstances I don't believe, and I think most of
the American people don't believe, that we, Congress, should be
involved in any way in setting executive compensation or
compensations for board of directors of shareholders. We
shouldn't be setting those salaries. But we are not in normal
circumstances, and that is why I filed H.R. 857, the Limit
Executive Compensation Abuse Act, which for TARP recipients
only would have limited the annual executive compensation to
the same level of compensation that the President of the United
States gets paid, $400,000.
Mr. Sperling, do you believe compensation practices can
pose a systemic risk or jeopardize a firm's safety and
soundness? How should Congress guard against risks to the
financial system without stifling reasonable compensation
practices?
Mr. Sperling. I think we have learned the hard way that
they can contribute, and I think it has been part of the
discussion that we have had today.
And I do want to say that we often do mention or use the
examples of the extreme cases or where people were truly bad
actors. But a lot of the danger comes from building systems
where even good people are not given the right focus. We talked
before on the whole practice from the origination of subprime
mortgages to their packaging to their sales. You almost have a
chain of financial transactions where you were paid by fees by
the volume of what you did, and then you either externalized it
to the firm or kind of moved it on to the next person. Of
course, what happens is when you are in kind of a bubble, an
asset bubble situation, the people who are being cautionary
start looking like they are overly risk adverse. And the people
who are being reckless starting looking wise and right and
making good money.
That is exactly why a company has to believe in risk
management, and it has to be something that they do throughout
the system, and they have to empower that person that even when
the going is getting good, why was it. In firms throughout the
financial industry, there was so little effectiveness of risk
management when there were no shortage of people writing that
there was a potential housing bubble. Perhaps people didn't
realize the degree, the depth of what we would go through, but
there was a problem.
So I do think that companies have to believe in strong risk
management, and they have to empower their risk managers. They
have to have the stature and independence to stand up even in
good times and say yes, this practice has worked the last few
years; but when we look at the underlying value of what is
happening, we think that we are creating risks in the outyears
for our company, our shareholders, and the economy as a whole.
Mr. Moore of Kansas. Thank you, Mr. Sperling.
Mr. Alvarez, do you have any comments.
Mr. Alvarez. The only thing I would add is that the
industry recognizes that there was systemic risk, and risk to
the health of the firms through the compensation practices of
the past.
If you recall 15 or 20 years ago, there was quite an effort
to just get pay tied to performance as a beginning spot. And so
the methods that were used to tie pay to performance have shown
in this crisis to have flaws to it. I think everyone is
recognizing that, and so it is an opportunity. We have an
opportunity now to make some strides to improve the health of
the system and firms individually.
Mr. Moore of Kansas. I thank you. My time is up.
The Chairman. The gentleman from Florida.
Mr. Posey. Thank you, Mr. Chairman. I am still trying to
figure out what would make some of the compensation boards or
committees recommend the incredibly high compensation that they
did when it was clear that the ship was on the rocks and it was
going down. How did the compensation laws that we have now, if
they do, how do they affect gifts between, say, a CEO of a
company and members of the compensation board?
Mr. Breheny. Thank you, Congressman. The SEC's rules have
quite a bit of requirement with regards to disclosure about
conflicts between members of the compensation committee and
other executives of the company. In fact, it is a New York
Stock Exchange, a listing company requirement, that today,
compensation committee members have to be independent. And
those rules are quite extensive. I think what you are hearing
from my colleagues on the recommendations that were made
yesterday was to increase the independence of the members of
the compensation committee beyond what they currently are today
to restrict all sort of connections between compensation
committee members and the board. I think we are looking at
heightened compensation.
But there is an independent requirement today and there is
quite a bit of disclosure already required under the SEC's
rules.
Mr. Posey. Have you ever found that to be violated in the
history of the SEC or the law?
Mr. Breheny. Unfortunately, I don't have that information
to give you a thoughtful answer. I would be happy to look into
that. Certainly the Commission takes its authority to enforce
the rules with regards to violations of disclosure rules or
other rules very serious, but I would be happy to get back to
you with information about that.
Mr. Posey. Mr. Alvarez and Mr. Sperling, why do you think
they would pay out such incredibly high bonuses when they see
the ship is on the rocks?
Mr. Alvarez. I think one reason is what we call a
collective action problem: No one wanted to be the first to
rationalize bonuses for fear that they would lose their best
talent. That is actually one of the reasons why we as
supervisors can be helpful here by increasing the priority of
the board of directors and the management to pay attention to
the incentives in compensation, helping to outline best
practices and good principles.
We can push the whole industry to act together. In that
way, there is a little bit of safety. Then there is less
concern that an institution that does make the proper
adjustments, does, for example, take away bonuses when
performance is poor, won't be left as the only one doing it,
and that will improve the practices of everyone.
Mr. Posey. Do you think it would make any sense just to
impute some culpability to stockholders in their losses if you
act poorly like this? That opening the exposure to liability
could be just as effective?
Mr. Alvarez. Shareholders already do share. When there are
excessive bonuses paid to executives, that is costs that are
borne by shareholders.
Mr. Posey. When was the last time you are aware that was
utilized?
Mr. Alvarez. It is reflected in decreasing in the price.
Mr. Posey. I understand in theory. But most stockholders
that I know, and they are small investors, not big investors,
they think that these humongous bonuses are just a necessary
evil and there is nothing they can do about them, it is just as
bad one place as another. Everybody is misbehaving. They are
not going to find anything better to their bottom line if
everybody is misbehaving to the same extent and nobody has done
anything about it; and, quite frankly, I don't believe that you
are going to be able to regulate people into doing the right
thing. I think that just holding them more accountable
individually and personally liable and accountable would just
make a little more sense. Mr. Sperling?
Mr. Sperling. I actually think the proposals we are talking
about would be effective. I agree with Mr. Alvarez that there
is a bit of--and you see this in the whole way that the
compensation consultants work. There is less of is this
fundamentally sound, fundamentally good for the shareholder,
and more how does it compare to the practices of your peers.
And so you do get a bit of a collective action problem where
people simply say our five competitors do this, and that
becomes the beginning and end of the discussion.
I think that empowering compensation committees, but also
the say-on-pay, bringing this to light, does have a powerful
deterrent impact. The U.K., and even the study from the Harvard
Business School, which was a little more skeptical, said its
positive effect was in deterring high payouts to those who
clearly performed poorly.
The Chairman. We have a vote, so we will take a break after
Ms. McCarthy.
Mrs. McCarthy of New York. Thank you, Mr. Chairman. I
appreciate that.
Many years ago, my husband worked on Wall Street. He
started on Wall Street when he was 17, and he worked his way up
and he worked for a very large financial service company.
He was in compliance, and he had the whole northeast
corridor to go to all the little offices to make sure that they
were complying with the FEC rules, but also for the company
rules. And he always found it amazing because he never
announced when he was going to be there that he would go into
an office and allow them, obviously to follow all the rules and
regulations, no problems. But there were certain offices that
did not follow those rules and regulations and he would write
them up and then make another surprise visit back to see if
they cleaned everything up. They did not. And that is when they
got in trouble with the company. And these were usually large--
well, large offices that produced a lot of money for that
particular location.
And I think when we talk about why we are here today, and
even talking about what we are doing, I think people have
forgotten that we are here because the companies did what they
did and they are trying to get their reputation back now. The
banks have to get their reputation back now, the financial
services have to get their reputation back. People do not trust
them yet. And it is our responsibility as the government to try
to protect our constituents. They lost trillions of dollars.
People are hurting and they are still hurting. We are happy to
see that things are starting to go forward, I believe, because
of what the government did that the markets are starting to
stabilize, we still have a long way to go on housing. But it is
because what we did do.
With that being said, and I have to say also for my
colleague when she mentioned Kenneth Feinberg, he is great, I
worked with him, unfortunately, with an awful lot of my
constituents who lost somebody on 9/11, and I think it was a
great choice. But I will go back to one of the articles--by the
way, that was another thing in the article. Already--this Wall
Street today. Already, many on Wall Street are beginning to
voluntarily change their pay practices through--though it
remains to be seen how long. That is another reason on why we
are doing what we are doing today and hopefully for the future.
But my question to you would be, could you expand on what is
considered exceptional assistance? I actually don't understand
that part.
Mr. Sperling. The easiest way to describe it would be that
in the previous Administration, they set up the Capital
Purchase Program. And this was expanded to all banks. So even
smaller banks can come in. And the idea was to try to give more
banks the capital so that they were in a stronger position to
lend, not because we were concerned about each of those banks,
but because we felt collectively if there was stronger
capitalization of the banking system there would be more
lending and that would be good for the economy. An individual
bank might say, do you know what, we are just going weather
this storm by not lending, we are not going to make much money
but we will get through it. But for us we know that if 5,000
banks all do that at the same time that means there is going to
be less small business lending and there is going to be less
growth and this recession will last longer.
So that is a generally accessible program. And the people
who come to it don't necessarily come because they are weak,
they come because we have a policy goal of wanting banks to
have more capital. Compare that to perhaps Citigroup where they
require government assistance for their fundamental financial
stability. And because of their importance to the overall
financial stability, the economy, because of our desire to not
let something like Lehman Brothers again happen, we make an
exceptional effort, we make an exceptional assistance that they
get that is not available to their peers and it is not based on
a general goal, it is based on an exceptional intervention to
assist them essentially in their fundamental financial
stability. That is a very different situation. And while I
could give you--and I think that principle is one people
understand.
I think people understand that there is something different
about AIG and Citigroup and GM than their community bank that
takes more capital in the capital purchase program. And I want
to make clear, the law of the land that was passed in the
Recovery Act applies to everyone, so the restrictions on
bonuses. We added provisions on luxury expenditure, on say-on-
pay, on having to write in a narrative way what your risk
analysis is. But we were not as intrusive in those situations
because many of those banks are the community banks in your
district where you are giving taxpayer dollars to a company
that would have gone into bankruptcy if they were not
systemically significant we feel a higher obligation, and that
really is, in many ways, the fundamental task.
Mrs. McCarthy of New York. My husband actually believed
nobody should get bonuses, just get a good paycheck.
The Chairman. We are going to return with this panel, and I
am going to call on the Democratic side only those members who
are here and did not yet get to ask questions. New members will
get to question the second panel. So the five members here who
didn't get to ask questions will be called on to finish this
panel, and we will then get to the next panel. If one or two
Republicans show up, we will do that. We should be gone for not
more than 25 minutes. There are only two votes. Most of the
time is gone on one of them. We will be back as soon as we can.
I thank the panel for waiting.
[recess]
The Chairman. Mr. Scott of Georgia is recognized for 5
minutes.
Mr. Scott. Thank you, Mr. Chairman. I want to say two
things at first, because I think that from our various
conversations during the first part of the hearing, just to
make clear, we are all capitalists here, we believe strongly in
the capitalistic system. The reason this committee is moving
and exploring this issue is because we care about the
capitalistic system. And the capitalistic system is not
manifested just with CEOs, it is not structured to take care of
them first. The capitalistic system is geared with public
interest, it is geared with shareholder interest. What we are
concerned with here, particularly in the financial sector, is
the health of our economy. At the heart of the health of our
economy, the heart of it is basically our financial services
industry.
And so what we have here in dealing with this issue of
compensation and the role it plays in systemic risk is that
there is some valve clogging going on. And we need to examine
this so that this heart, the heart of our system, the financial
system, does not endanger itself with a heart attack. Clogged
arteries bring that, and we do have a clogged artery here. It
is clear that excessive compensation has played some degree and
some contributing factor to our financial situation.
I think what we are trying to do here is on two levels.
One, we have to respond to companies like AIG and others that
come and ask for the taxpayers' money to help them. We have to
make sure we are good stewards of that taxpayer dollar, to make
sure that compensation is in line. And it is clear to anybody
with any ounce of caring about the capitalistic system that
giving the $168 million in bonuses and compensation of
taxpayers' money to a failing company asking for a bailout was
excessive.
But what it did was it opened us up to a realization of
perhaps this compensation issue, this heavily unbalanced
structure between bonuses and salaries certainly had some risk
involved. Excessive compensation packages were indeed a
contributing factor because incentives for short-term gains
overwhelm the checks and balances that were meant to mitigate
against the risk of excessive leverage. So the question is how
can we better align our compensation packages with sound
management risk that properly measure reward performance. It is
sort of like Scott Burroughs here with some of these CEOs where
they have gone and cut deals regardless of performance.
So you are paying some of these CEOs as if there were 350
point hitters hitting 50 home runs when they are 220 hitters,
no performance. So I think that what is wrong with having
shareholders to be able to have a say in these packages. Now,
we have an excellent run company in my State of Georgia, Aflac,
that has done this with great success. Shareholders want to see
that their leaders, the people who are running the companies,
they have the best talent, but they certainly want to make sure
they perform.
So we have excellent examples here of shareholders who are
taking part in that. But I just wanted to make sure that is
clear. But my question, Mr. Chairman, before my time runs out,
is just a comment from each of you is how can we better align
our compensation packages with sound management so that they
properly measure pay for performance. And what is wrong with
having shareholders have a say, not the government, not us, but
the people who own that company, they ought to have a say in
what these people are being paid, particularly their hired guns
with contracts.
The Chairman. We have time for one answer.
Mr. Sperling. I truly think the say-on-pay is a situation
of all upside, no downside. You are empowering shareholders
with the ability to have stronger oversight. You are forcing
the company to think more seriously about what they do, how it
will be perceived and not just to go on automatic pilot doing
practices that are not defensible simply because of their peer
group is doing it. All I would say kind of quickly, knowing we
have time issues, is that I think that you need some type of,
some type of long-term compensation or something that at least
makes you internalize some of the risks that you are creating
so you do not get entire industries or entire sets of employees
who are all being paid by volume based on fees and nobody in
the process is looking at the underlying value or the long-term
risk. And then I think the hard part for all of us is that we
don't simply create a world where everybody is out saying, yes,
pay for performance, and we haven't really looked carefully
whether the performance we are now blessing is subject to
manipulation itself. And I think that is going to mean more
complex, more careful, mixes of metrics.
The Chairman. The gentleman from Texas.
Mr. Green. Thank you, Mr. Chairman. Mr. Chairman, I thank
you for your leadership. It has been said that managers want to
do things right and the leaders want to do the right thing. I
think we are doing the right thing. And I would like to have
just a moment of soliloquy because I would like to speak for
many persons who are not here to speak for themselves.
I want to speak for the autoworkers. I speak for them
because today there seems to be some debate as to whether or
not we should endeavor to make some adjustments with reference
to executive compensation in terms of how it can promote
excessive risk-taking. And the autoworkers have had their
salaries maligned, they have been castigated for making too
much money. And it is unfortunate that there are those who
would want to limit the salaries of autoworkers, but would take
a firm stand against making any endeavor to look into whether
or not excessive risk by way of salary has driven some of this
adverse, these adverse market conditions that we have. I have
before me evidence of a bill, H.R. 7321, which proposed
requiring the employees of Ford, GM, and Chrysler to receive
the same compensation, or nearly the same as Nissan and
Volkswagen. It just seems to me that those who would sponsor
this kind of legislation would find it in their hearts to see
that we can look into the type of legislation that we are
considering today.
I have evidence of H.R. 5 which passed the House in 2005
which would have placed a cap on the percentage of damages that
lawyers can receive. It would have capped them at 15 percent of
any fees over $600,000. A lot of money. Not nearly as much as
what some others are making, however. And it just seems to me
that if we can cap or try to cap and cap the fees of lawyers
who represent consumers, we can also look at lawyers who
represent corporations. Those who are not here today, I just
believe they want this said, because there are people who are
suffering who have had their salaries cut who work in the auto
industry. And these are people who are not getting bonuses that
they use to buy second and third homes or to buy additional
cars.
What they lost was money for education, money to pay house
notes, money to sustain themselves. And I find it quite frankly
disenchanting to know that there are those who would want them
to receive cuts and not want us to look at the compensation
that these executives are receiving that can create excessive
risk in the marketplace. So I thank you, Mr. Chairman, for
giving me this moment to voice the concerns of those who are
not here, the blue collar workers and the lawyers who represent
the consumers who have gone to battle for them and made a
difference in their lives and in the lives of people in this
country by causing us to have products that are safe by virtue
of knowing that there are these lawyers who will take on these
challenges and make sure that the consumer is protected.
Consumer protection is important. We had one of the best
consumer protection systems in the world, and it did not cost
the government one penny because we had lawyers who were
willing to stand up for those who could not stand up and speak
up for themselves.
And it is very unfortunate that we choose to regulate these
lawyers, but we don't regulate--don't see the need to regulate
lawyers who are creating excessive risk who work for
corporations. I don't want to see anybody's salary cut. I don't
want to see anybody's salary regulated. But the American people
understand that something wrong has happened, and they want to
see us do something about it. And that takes leadership. We
can't just manage this problem, we have to show some leadership
and make the necessary changes to eliminate this excessive
risk-taking that created much of the systemic problems that we
have had to contend with. I yield back. Thank you, Mr.
Chairman.
The Chairman. The gentleman from Colorado, then the
gentleman from Missouri.
Mr. Perlmutter. Thanks, Mr. Chairman. Just a couple of
questions and comments. My friends on this side of the aisle
have expressed a lot of what I am feeling. And even my friends
on the other side of the aisle who could be the greatest
laissez-faire capitalists in the world have to question when
there is such a serious divide between management and
ownership. And I will take Quest, which is a big company in
Colorado. Quest, one of our CEOs, he has now gotten himself in
trouble, got $148 million, all right. Now, this is comparing
apples and oranges, but the governor of the State of Colorado
gets $90,000. And most people make $50,000 to $200,000 in
Colorado. How is it that an executive gets $148 million. I mean
how does that pay come about. Mr. Sperling, can you--I mean how
does anybody approve that kind of salary for anybody.
Mr. Sperling. Well, I am--I don't know your specific, the
specific case. But I will say one thing, and again you have
some excellent experts coming on, which is one of the things
that, you know one of the things that disturbs me is whether or
not retirement golden parachute type of payments are somewhat
promoted because they are less transparent. People do not know
the walk-away value of what a CEO may have until that moment.
Mr. Perlmutter. Let me give you one that maybe you are
familiar with, or maybe the other panelists. Because I
appreciate giving some more teeth to the compensation
committee, but I mean, there still is a divide between the
owners of the company and the management, and maybe the owners
rein it in. That is laissez-faire capitalism. Let's take Angelo
Mozilo, Countrywide Financial, who has been involved in a lot
of the troubles potentially that we have today. His salary was
$102 million, $102 million. Are the owners of Countrywide
actually having a say in what he is making? I mean, if I am the
owner of the company, I am going to want that in my pocket as a
dividend. Do you think your compensation committee approach
really gives those owners the strength that they need to say
no, that is too much?
Mr. Sperling. Well, I think the case you just mentioned
goes to the heart of the pay for performance. I think there has
been nothing that so promotes the sense of double standard that
I mentioned, and I believe you are mentioning, than the
extraordinary cases of huge sums for CEOs who have failed. And
the juxtaposition between workers losing their jobs, seeing
pensions cut with the failed CEO, receiving enormous amount of
sums as they leave having failed, I think is very destructive
to the kind of public trust in our financial system. And so I
think it really--I think it goes to almost the heart of
everything we are talking about. How do you ensure that there
actually is pay for performance. And I think part of that is
actually shining a spotlight on whether people are just doing
compensation based on what their peer group is, whether it is
acceptable to have these kind of compensation packages that
allow this when there has been no performance. And you know I
am heartened a little bit to see that I saw that a couple of
the companies who were just paying back their TARP without any
push from the government, but I think because of this focus,
put out statements saying they are just going to do pay for
performance, they are going to give most of the compensation
and stock to be held for a long time and they weren't having
any golden parachutes. So I think this goes to the heart of
almost everything we are talking about.
Mr. Perlmutter. All right. Just one more question. When we
say pay for performance, is that going to be tied to like the
stock market, because that is a problem in and of itself.
Mr. Sperling. You are absolutely right. I mean, former
Chief of Staff Erskine Bowles was the first person who told me
that when he was at Wall Street, his boss used to always tell
him never confuse brains for bull market.
Mr. Perlmutter. Exactly.
Mr. Sperling. So, yes. I mean, the idea that performance is
simply a stock price I think it works bad both ways. It rewards
amazing awards for people that has nothing to do with their
performance; just the overall economy is getting better. On the
other hand, I don't have a problem with rewarding an executive
who is doing an exceptional job in a terrible economic time.
But you don't see that symmetry. The sense is that people get
paid a lot when they fail; they get paid when they succeed.
Chairman Frank was in the paper the other day, heads you win,
tails at least you don't lose, on these packages. But I do
think one of the key points is just tying to stock does have
its risk. I know some of the experts we have talked to have
said, you know, be careful, don't make that a one-size-fits-
all, because if I accumulate all of my funds in stock, I have
huge stock holding, and am allowed to take it as soon as I
retire, well, that could create again for a corporate CEO a
strategy to do, strategies about raising their stock price as
they leave. So it is helpful but it is not one-size-fits-all.
Mr. Perlmutter. Thank you.
The Chairman. The gentleman from Missouri.
Mr. Cleaver. Mr. Chairman, I associate myself with the
comments of Mr. Perlmutter, and I will forego any questioning
and wait until the second panel, or I will yield to one of my
colleagues on the other side.
The Chairman. Well, that concludes this panel. And we will
call the next panel. Thank you all very much. As the next panel
comes forward, they do so with my apology. We have a terrible
problem with the size of this committee. I am going to
experiment with new rules. This is a very important panel, and
I appreciate and look forward to learning from them. We may
have to do 2-day hearings so we have one major panel a day. We
will be monitoring this. This is a panel that deserves some
attention. You will get it. I apologize for the fact that some
of us are going to have to be in absentia. Let's move quickly
here people. Thank you. We will send out the word for our
missing witness. And we will begin with a return witness who we
have appreciated having before us, Nell Minow.
STATEMENT OF NELL MINOW, EDITOR AND FOUNDER, THE CORPORATE
LIBRARY
Ms. Minow. Thank you very much Mr. Chairman. This is, I
think, my fifth or sixth time coming before the committee, but
the first time you spelled my name wrong. So I would appreciate
it if we could correct that in the record. There is one ``N''
in Minow.
The Chairman. Yes, we will do that. We just wanted to
differentiate you from the big fish you will be discussing.
Ms. Minow. Okay. I appreciate that. Thank you very much.
Mr. Chairman and members of the committee, I am in the
enviable, and, in my experience, unprecedented position of
agreeing with both sides and with most of the comments that
have been made here today. But I think it is a mistake to say
that we object to the government getting involved in
compensation. The government is already deeply involved in
compensation, often inadvertently. And one of the things that I
want to talk about today is removing some of the inadvertent
obstacles that we have to having optimal pay. The markets and
the government have both failed here.
The primary role of the government is to get out of the way
of the market and remove obstacles to the kind of oversight
that capitalism requires. Bad pay is a risk factor, and I was
very pleased to hear the earlier panel talk about that, and
that the Fed will now look at it. But where are the other
people who are supposed to be looking at risk in the markets?
The rating agencies, the securities analysts, the DNR liability
insurers and the journalists. And it is also important to stop
saying that the company pays the CEO this amount of money or
that amount of money, it is actually the boards of directors,
and we need to put the focus on there. And in theory, as we
talked about with the last panel, it is the shareholders who
elect the boards. But if you are going to give them say-on-pay
and some of these other rights that you are talking about,
proxy access, you have to make sure to remove the obstacles to
their carrying it out.
And our report shows that shareholders fail tremendously
most of the time, and that independence is as important on the
shareholder side as it is on the board side. As I prepared my
testimony, which I am not going to summarize because it is in
the record, I felt a little bit like Dickens; I was talking
about the ghost of compensation past, present, and future. And
I want to really focus on what is going on now, because I did
disagree with the statement made by Mr. Alvarez about the fact
that they have gotten the message. In fact, what we see is that
we have particular concerns about efforts to circumvent even
the preliminary constraints already imposed. Executives will
always be more motivated and agile than regulators and
legislators. With regard to pay structures, I support indexed
options, claw backs, banking of bonuses. With regard to boards
of directors, it is very important that they have the
vulnerability to remind them who they represent; that they can
be removed if they don't represent shareholders. And with
shareholders, I really want to focus on the collective choice
problem, what is called by economists rational apathy and
suggest possibly the appointment of independent voting
fiduciaries. Finally, the billions lost in the financial market
meltdown are dwarfed by the loss of reputation and the brand of
American financial markets. I am a passionate capitalist
myself, and I hope that this committee will work to restore the
credibility of our system of capitalism by removing obstacles
to the role of the market and establishing optimal
compensation. Thank you very much and I look forward to your
questions.
[The prepared statement of Ms. Minow can be found on page
161 of the appendix.]
The Chairman. Thank you. I apologize, but our
Administration at the last minute has raised some issues with
me about some other things they should have raised before, and
I have finally told them to forget about it and show a little
more consideration and I apologize that it spilled over on you.
Another returning witness, Mr. Lucien Bebchuk.
STATEMENT OF LUCIEN A. BEBCHUK, WILLIAM J. FRIEDMAN AND ALICIA
TOWNSEND FRIEDMAN PROFESSOR OF LAW, ECONOMICS, AND FINANCE, AND
DIRECTOR, CORPORATE GOVERNANCE PROGRAM, HARVARD LAW SCHOOL
Mr. Bebchuk. Mr. Chairman and distinguished members of the
committee, one major factor that has induced excessive risk-
taking is that firms reward executives for short-term gains.
Although the financial sector has lost more than half of its
stock market value during their last 5 years, executives are
still able, during this period, to cash prior to the implosion
large amounts of both equity compensation and bonus
compensation. Jesse Fried and I warned about this short-term
distortion in a book titled, ``Pay Without Performance'' that
we published 5 years ago. And following the crisis, this
problem has now become widely recognized. To tie compensation
to long-term performance, executives shouldn't be allowed to
cash out options and shares for several years after vesting.
And similarly bonuses should not be cashed right away but
should further be placed in an account for several years and
adjusted downward if the company learns that the reasons for
the bonus no longer hold up.
In addition to the short-term as a problem, bank executives
had a second and important source of incentives to take
excessive risks that thus far has received little attention.
The payoffs of bank executives were tied to highly leveraged
bets on the value of a bank's capital. Compensation
arrangements tied the interest of executives to the value of
common shares in the bank holder company or even to the value
of options on such shares, and as a result, executives were not
exposed to the potential negative consequences that very large
losses could have for preferred shareholder bond holders and
the government. This gave executives the incentive to give
insufficient weight to the possibility of large losses and
therefore gave them incentives to take excessive risks. To
address this distortion, the payoffs of bank executives could
be tied not to the long-term value of a bank's common shares,
but to the long-term value of a broader basket of securities
which should include at least the bank's preferred shares and
bonus. Now, let me turn to what role the government should
play. For nonfinancial firms, the government should avoid
intervening in the substantive choices that firms make, but the
government should see to it that shareholders have adequate
rights.
And as I testified before this committee 2 years ago, the
rights of shareholders in U.S. private companies are much
weaker than in other common-law countries. We need to introduce
say-on-pay votes to strengthen shareholder power to replace
directors, and shareholders should also have the power to amend
the corporate charter and to change the company's state of
incorporation.
Finally, in the case of executive pay in banks, or more
generally any financial firms that pose systemic risks, here
the government should have a broader role. This is necessary
for the very same moral hazard reasons that provide the basis
for the traditional regulation of bank activities. The interest
of common shareholders of banks are served by having
investment, lending, and capital decisions that are riskier
than is desirable for the government as the government to have
deposits. That is why traditional bank regulation monitors and
regulates these decisions by banks.
By the same token, the interest of common shareholders in
banks may be served by giving executives incentives to take
risks that are somewhat excessive. Therefore, even if and when
internal governance problems in banks are fixed, regulators
should monitor and regulate executive pay in all banks
regardless of whether they get public funding. The regulators
should focus on the structure of pay arrangements, not the
amount, and they should seek to limit the use of the type of
incentives that have contributed to bringing about the current
financial crisis. Thank you.
[The prepared statement of Professor Bebchuk can be found
on page 92 of the appendix.]
The Chairman. Next, Mr. Lynn Turner, who is the former
chief accountant of the Securities and Exchange Commission.
STATEMENT OF LYNN E. TURNER, FORMER CHIEF ACCOUNTANT, U.S.
SECURITIES AND EXCHANGE COMMISSION
Mr. Turner. Thank you, Chairman Frank, and thank you for
the opportunity to be here today, and I applaud the leadership
you exhibited in the past when the House did pass say-on-pay,
and it is unfortunate that your colleagues in the Senate didn't
share the same wisdom. And so as they say--
The Chairman. There is a lot of that going around.
Mr. Turner. --we are back. And the views I express today, I
might add, are based upon not only my time as a regulator but
perhaps more importantly I have been an executive setting
compensation in a large international semi-conductor company,
as well as a small venture start-up and served on the board of
a Fortune 500 company, as well as a small technology software
company where entrepreneurship is very important, perhaps one
of the few if not the only person at the table today with that
type of experience and perspective.
There is no doubt in my mind that when it comes to
influencing people's behavior in a company at the top level and
at the low level there is nothing like pay that drives what
people do. And when you give people pay that drives short-term
performance, as we did on Wall Street where there was very low
base and huge bonuses paid out on an annual basis, you are
going to get the type of short-term thinking and short-term
behavior all up and down the ladder that you turned around and
got. You can't avoid it. If you want long-term thinking and
long-term shareholder value, you have to change that
compensation scheme significantly, and that is up to the
compensation committees to do.
Unfortunately, today the compensation committees are all
too comfy with the CEO. I have seen that on the boards that I
have sat on. And they are very reluctant if not absolutely
against really reining in the compensation. So we have to
really put together a package that includes greater
transparency, greater accountability, and some enforcement at
the end of the day. So for the sake of time let me jump into
some of the recommendations. I just would ask the chairman to
include my whole written testimony in the record.
The Chairman. Yes. Without objection, all of the
submissions will be included in their entirety.
Mr. Turner. In the area of transparency, I think we have to
start with the SEC enhancing its disclosure of compensation
arrangements. In particular, today they don't require
disclosure of the key performance metrics, the things that
really drive how you get that package. So we don't get the
details on how Quest got to $148 million. We don't get the
factors, and we need to see those factors and require those
factors be disclosed by the SEC. They made it voluntary a
couple of years ago. About half of the companies give it, and
half of the companies don't. We need it from all of the
companies on an appropriate level of detail. That includes we
need to get back and figure out what the value of the real
equity grants are when they are given. We have lost that. We
need to have disclosure about the compensation consultants and
whether or not they are truly independent, are they being hired
directly by the comp committee or are they doing a lot of other
work for members of management.
I think we need to see transparency with how the investors
are actually voting. We still have a lot of public pension
funds, corporate plans, hedge funds that aren't disclosing how
they are voting on this stuff, and we need transparency to it.
At a public pension fund I sit on, that has about $30 billion
of assets in our State, we recently went to disclosing our
votes just so all of our members and people can see how we
vote, and we think that sets some accountability.
If we don't do it right, we are going have to explain why
we do it the way we do it. There needs to be something done
with the way shareholders vote. We can put in say-on-pay, and I
certainly support that, strongly support that. And by the way,
I don't view that as government intervention in any way, shape
or form. And to the question of whether or not that would drive
people offshore, I absolutely don't believe it will drive
people offshore. Many of the other countries around the world;
Australia, the Netherlands, many of the European, UK countries,
many of the countries where there is the largest market cap
already have that.
So what are they going to do; leave here to go to another
country with the same regime? I just think that is almost
nonsensical. But we do need to get the shareholders and the
mutual funds voting in the best interest of investors. As I say
in my testimony, almost 90 percent of the time the mutual
funds; the Fidelities, the Barclays, the Alliances of the world
are voting with management. And there is no requirement that
they vote for their investors whose money they are managing as
opposed to voting their own interest.
And Fidelity, Barclays and these all manage a tremendous
amount of money for these large companies with tremendous fees.
That conflict is not disclosed. And it is shown time and time
again they vote that way. So I certainly encourage say-on-pay,
do something about the mutual fund voting, elimination of
broker votes as the SEC has said they are going to do, I think
we need to get to majority voting and the right for
shareholders to also remove directors when they haven't got the
job done. Thank you, Mr. Chairman.
[The prepared statement of Mr. Turner can be found on page
188 of the appendix.]
The Chairman. Thank you. Next, Professor Kevin Murphy from
the University of Southern California.
STATEMENT OF KEVIN J. MURPHY, KENNETH L. TREFFTZS CHAIR IN
FINANCE, UNIVERSITY OF SOUTHERN CALIFORNIA, MARSHALL SCHOOL OF
BUSINESS
Mr. Murphy. Thank you, Chairman Frank. We are here today in
large part because we are all angry that Merrill Lynch and AIG
gave huge bonuses to employees after receiving Federal bailout
funds. Our anger, coupled with our suspicions say that the Wall
Street bonus culture is a root cause of the ongoing financial
crisis has led to an effective prohibition on cash bonuses for
TARP recipients and is leading us today towards more sweeping
regulation of compensation and financial services firms. I
agree that there are problems with compensation structures in
financial firms and in most other sectors, but it is my opinion
that the constraints already currently on TARP recipients will
likely destroy those organizations unless they can quickly
repay the government and avoid the constraints.
Moreover, it is my opinion that regulating compensation and
financial services more broadly will cripple one of our
Nation's most important and historically most productive
industries. The heavy reliance on bonuses has long been a
defining feature of Wall Street compensation going back to the
days when they were privately held partnerships. Such firms
kept fixed costs under control by paying low based salaries and
paying most of the compensation in the form of bonuses tied to
profits. This basic structure remained intact when the
investment banks went public, but the cash bonuses were
replaced with a combination of cash restricted stock and
options.
The primary way that such structures can encourage
excessive risk-taking is through asymmetric rewards and
penalties. That is high rewards for superior performance and
essentially no penalties for failure. Financial firms provide
significant penalties for failure in their cash bonus plans by
keeping salaries below competitive market levels so that
earning a zero bonus is actually a penalty. And bonuses do fall
in bad years. Average bonuses for executives in the TARP
recipient firms were 82 percent lower in 2008 than in 2007.
Take away bonus opportunities and the banks will have to raise
salaries or find other ways to pay or they will lose their top
talent. In addition to cash bonuses, executives in financial
firms receive much of the compensation in the form of
restricted stock and options, and these instruments also
provide penalties for failure.
The average intrinsic value of options held by executives
in TARP recipient firms fell 94 percent from 2007 to 2008, and
the value of their restricted stockholdings fell by 72 percent.
And these statistics only include firms that continue to
operate at the end of 2008, thus ignoring the losses incurred
by executives at Bear Stearns, Lehman, Washington Mutual,
Wachovia and the other casualties of the crisis. Given the
existing penalties for failure there is nothing inherent in the
current structure that leads to obvious incentives to take
excessive risks. To the extent that the firms indeed such risks
we need to look beyond the pay structure to explain it.
In particular, the role of bonuses is likely dwarfed by the
roles of loose monetary policies, social policies on
homeownership, and poorly implemented financial innovation such
as exotic mortgages, securitization, and collateralized debt
obligations.
Looking forward, I am especially concerned about offering
too-big-to-fail guarantees that provide enormous incentives to
take risks, but this isn't a compensation problem. Another way
that compensation can lead to risk-taking is through
inappropriate performance measures. For example, consider
mortgage brokers pay for writing loans rather than writing
loans that borrowers will actually pay back. We saw this happen
at Washington Mutual, Countrywide, Wachovia, and scores of
smaller lenders who weren't overly concerned about the default
risk as long as home prices kept rising and as long as they
could keep packaging and selling their loans to Wall Street. A
solution to this performance measurement problem is to pay
people to write good loans and penalize them for writing bad
loans. The challenge is identifying a good loan without waiting
up to 30 years to see whether the loan is repaid. The answer
involves basing bonuses on subjective assessments of loan
quality.
Unfortunately, most current and projected regulations go in
the opposite direction and require that bonuses be based solely
on objective measures of performance such as the quantity of
loans. The regulatory demands effectively substitute the
judgment of government for the business judgment of the
directors, and this is a dangerous path to go down.
In conclusion it is not my opinion that current
compensation practices are optimal. For example bonus plans
could be improved by introducing and enforcing bonus banks and
claw back provisions and making sure we reward long-term value
creation rather than short-term results. And performance
measurement could be improved by allowing more rather than less
subjectivity and discretion.
However, I believe that regulation will systematically and
predictably make things worse rather than better. Indeed,
Washington has a long history of attempts to regulate pay,
including caps on golden parachutes in the 1980's, the million
dollar pay cap in the 1990's, more recent restrictions on FERC
compensation and the most recent constraints on TARP
recipients. Each of these attempts has created unanticipated
side effects that have generally led to higher levels of pay
and less efficient pay deliveries. I strongly recommend that
the committee consider carefully this history before inevitably
repeating the mistakes of the past. Thank you.
[The prepared statement of Mr. Murphy can be found on page
169 of the appendix.]
The Chairman. Thank you. Professor Verret.
STATEMENT OF J.W. VERRET, ASSISTANT PROFESSOR, GEORGE MASON
UNIVERSITY SCHOOL OF LAW
Mr. Verret. Chairman Frank, Ranking Member Bachus, and
distinguished members of the committee, it is a privilege to
testify in this forum today. My name is J.W. Verret. I am an
assistant professor at George Mason Law School, and also a
senior scholar at the Mercatus Center's Financial Markets
Working Group. I also direct the Corporate Federalism
Initiative, a network of scholars dedicated to studying the
intersection of State and Federal authority in corporate
governance. Before I begin, I also want to say that it is a
particular honor to testify on a panel with Professor Bebchuk.
He was my mentor and without his guidance, I wouldn't be a law
professor today, so that is a particular honor.
Today, I want to discuss executive compensation proposals
currently under consideration. I will also highlight a Wall
Street norm of issuing and feeling pressure to meet quarterly
earnings guidance, which is the central cause of short-term
tunnel vision for Wall Street executives. The role executive
compensation plays in the current crisis is in fact unclear.
There is little difference, and this is key, there is little
difference between the executive compensation approaches of
banks healthy enough to repay their TARP funds and those of
banks likely to need additional injections of capital. If
executive compensation were the culprit the differences between
executive compensation and healthy banks and executive
compensation at bad banks would be much more apparent.
What is apparent is that executive pay packages are of
necessity complex. Compensation packages are designed to link
pay to an executive's performance running the company without
rewarding or punishing executives for factors outside of their
control. Regulatory restrictions and say-on-pay requirements
may limit a compensation committee's flexibility to achieve
this important goal. There are no less than seven executive
compensation initiatives either proposed or recently underway.
Such a wide array of ideas from disparate corners offers to
repeat the lack of coordination that contributed to the present
crisis. The multitude of proposals also threatens to override
two important SEC driven disclosure initiatives that offer some
significant promise in this area.
Former SEC Chairman Cox completed an extensive overhaul of
executive compensation disclosure in 2006. And Chairman Shapiro
is promising further changes. Congress should study the effect
of these disclosures rules before instituting prescriptive
regulation. I would also add that they should think about
studying disclosure rules and the SEC should consider
disclosure rules for proxy advisor firms, which is notably
missing from the chairman's current proposal. I would echo
Professor Murphy's warning about the effect of unintended
consequences, and we have seen them before. In 1993, lawmakers
sought to limit the disparity in pay between executives and the
average worker. The result was quite the opposite, in fact.
Executive compensation increased exponentially, widening the
gap between executives and the average worker. To offer an
unintended consequence already apparent to the current reform
effort pay restrictions had made it harder for American banks
to retain talented executives.
Immediately following the announcement of compensation
restrictions by the Obama Administration, Deutsche Bank poached
12 of Bank of America's highest performing executives. And UBS
used compensation increases as high as 200 percent, this is a
Swiss bank, to hire away financial advisors from top firms. The
greatest risk to the safety and soundness of the Nation's
banking system is not compensation but short-term thinking.
Compensation is how companies may motivate executives to look
short-term, but the real question is why do companies pursue
short-term goals in the first instance. The widely accepted
convention of predicting quarterly earnings drives this short-
term approach. Pension funds, mutual funds and company issuers
all express dissatisfaction with the pressure to predict
quarterly earnings.
But companies feel that voluntarily opting out will be
taken as a negative signal. Pressure to make quarterly
predictions about their earnings companies frequently feel
pressure to cut corners to meet those predictions. I would
recommend that the Treasury Department lift executive
compensation restrictions for those companies and banks that
adopt a bylaw to prohibit quarterly guidance. If this committee
wants to limit systemic risk it should not dramatically
overhaul executive compensation structures. Instead focus on
the destructive pressures caused by the prediction of quarterly
earnings and give the SEC's disclosure reforms time to work.
I thank you again for the opportunity to testify and I look
forward to answering your questions.
[The prepared statement of Professor Verret can be found on
page 209 of the appendix.]
The Chairman. I will just begin. Mr. Murphy, one historic
inaccuracy, you said we are here because of Merrill Lynch, etc.
In fact, the Democrats on this committee raised the say-on-pay
issue in 2006, and in fact, the House passed say-on-pay in 2007
back when I thought TARP was what you used to cover the infield
when it rained. So just historically, because it is not as you
have suggested.
Ms. Minow, let me ask, your general sense is that you
simply have to make it less difficult to replace board members,
that is the central piece, and that other things aren't going
to work out if you don't have a board that is more sensitive.
Ms. Minow. Yes, I do think that is right. But you also have
to have shareholders who are capable of exercising that
authority.
The Chairman. That is what I mean. The key is not say-on-
pay, but say on board.
Ms. Minow. It is kind of a forest/tree thing. I think when
we focus on compensation and we get down to the real fine
details of whether options should be indexed or not or whether
they should be tied to quarterly earnings or not, I think we
are sort of missing the big picture here which is how it got
out of whack here.
The Chairman. Nothing that we are proposing would get to
that level of detail. say-on-pay would do that. So you think
say-on-pay is a step forward. But in the absence of the kind
of--well, let me ask, because we will get to corporate
governance later on. The current SEC proposal they just talked
about with access, does that meet your--
Ms. Minow. I think that it is my opinion, I know the SEC
doesn't agree with me on this, so you are going to need some
legislative clarity on that point, but yes, I think proxy
access would be very meaningful, but I also support majority
vote.
The Chairman. Let me ask all of you compensation experts
something that puzzles me. And that is we have the CEOs and
other top decisionmakers telling us that part of the problem is
that we have to align their interest with those of the company.
Is there something about their character that is lacking that
says that we have to take extra steps to align their interest
with those of the company.
In the normal course of economic life we kind of assume
that your interests will be aligned with the people who are
paying your salary for the job you are doing. What is it about
the financial sector that says the most highly paid members who
have taken on these jobs who have, in fact, fought hard to get
these jobs, that somehow they will not align their interests
with those of the company unless we design special incentives.
Couldn't we expect them to have their interests aligned with
the company even if there weren't these incentive bonuses. Let
me start with Mr. Verret.
Mr. Verret. Mr. Chairman, I think it is not about aligning
the interest.
The Chairman. No, excuse me. My question is the world may
not be, a lot of things aren't. The score of the Red Sox game
is not about that. But my question is because one of the
justifications we are getting for these forms of compensation
is it is necessary to align the interest of these top
decisionmakers with the interest of the company, and I don't
understand why they need that special set of circumstances when
most of us don't.
Mr. Verret. Well, Mr. Chairman, I appreciate your Red Sox
reference. I am a Red Sox fan as well. I think the issue is
risk, the essence is risk. And I think the question is, do we
want them to swing for the fences or do we want them to only
swing for the easy hits and wait to get walked. And sometimes,
I think we want CEOs to swing for the fences.
The Chairman. But if that is the right thing to do, why
shouldn't they be able to--why shouldn't they do that because
that is the right thing to do. By the way, I think to take the
analogy, the answer is whether you swing for the fences or not
would depend on the pitch, it would depend on the score, it
would depend on the inning. If the bases are loaded and nobody
is out in the last of the ninth, no, I don't want you to swing
for the fences, there are probably more effective, less risky
ways to advance your goals.
Mr. Verret. Absolutely.
The Chairman. You are evading the question, which is
however you decide what the interests are, what is it that
makes us have to give them some special incentive to put the
company's interest first?
Mr. Verret. Well, because as you know, some players like to
take the easy way out and some players can take a risk for the
good of the team.
The Chairman. So you think that we have a--but we don't
usually do that with our employment system and with
compensation. Let me ask the others, does anybody know what it
is about chief executives of financial companies that means
that they have to get special bonuses to align their interests?
Mr. Murphy?
Mr. Murphy. And I will try to answer that question, but
remember--
The Chairman. If you are not going to try to answer that
question then--excuse me, Mr. Murphy, I asked you a question.
If you don't want to answer it, you haven't been subpoenaed,
you can pass. Does anybody else want to answer the question Mr.
Murphy didn't want to answer?
Mr. Murphy. Precisely the question is they say they want to
align their incentives because of the human capital driven
organization where they can go start their own firm with
private equity and leave those firms.
The Chairman. Well, first of all, when we do uniform
things, leaving the firm thing is greatly exaggerated,
particularly since American companies pay much more than most
other companies. I haven't seen all that reverse pay grade. But
is that something then? Mr. Turner, would you want to try and
answer that?
Mr. Turner. Yes, Chairman Frank. We all wished everyone
acted in the same way. But my experience, and I have worked
with many executives, including executives in financial
companies, and some do put the shareholders and the company
first and other executives put their own interest first and
that is just people being people, and because of that we have
to put a system in and in this country put in corporate
governance. We know what we have put in to date hasn't worked,
the compensation committees haven't worked. So in light of
that, it is very reasonable to put in--
The Chairman. No, I agree--
Mr. Turner. But not everyone is the same way.
The Chairman. --except I think the lesson we have is that
we have overdone this so-called alignment of interest, that we
have overcompensated them to do what they should have been
willing to do in the first place. And I think if you called
their bluff, they probably would still keep doing it. The
gentleman from Delaware.
Mr. Castle. Thank you, Mr. Chairman. Mr. Verret, I was
interested and intrigued by your testimony until you admitted
you were a Red Sox fan. And I have no hope for the chairman,
but you should know the Philadelphia Phillies are the world
champions. You ought to think about who you are cheering for
out there.
Mr. Verret. I understand, Representative Castle.
Mr. Castle. One of the things you state in your writing,
but you also mentioned in your testimony, the part that I
heard, is the whole quarterly earnings pressure. We talk about
the compensation issues, and I want to talk about that in a
minute. But the quarterly earnings business concerns me. I
don't know if you have any ideas about how to change that. I
mean, do we ask them not to publish anything or do it once a
year or something to make it longer range? Because I am of a
belief that is probably a greater driving force in the managing
of a corporation that even the salaries are. And I am not sure
how we should approach that. I am not sure we should approach
it or the States should be approaching it. But the question I
have is do you have any thoughts about any solutions to what a
lot of us feel is a problem.
Mr. Verret. Well, I appreciate your question,
Representative Castle, and I think the unique thing about this
issue is this something that everybody agrees on. The U.S.
Chamber of Commerce, the pension funds, the mutual funds all
say, we hate quarterly earnings guidance. And companies, when
we ask them privately, they say, we don't like to do it either,
but we feel pressure to do it. And we feel that if one of us
were the first one to stop doing it, then everybody would say,
oh, well, this is because obviously you have bad news about
your quarterly earnings, that is why you are stopping.
Before this crisis hit, things were beginning to change.
About 10 percent of companies stopped providing quarterly
guidance. Intel stopped and I think that Unical stopped, I know
Berkshire Hathaway stopped. In fact, Warren Buffett said it is
both deceptive and dangerous for CEOs to predict growth rates
for their companies. I think that very clearly gives us his
view. So it is already going in that direction. And I think
that perhaps the focus on executive compensation is kind of
stealing attention away from that important issue. And in terms
of specific policy prescriptions, I would say I think that to
the extent we want to lift the restrictions in TARP on
executive compensation, I think it could be tagged.
We could say if you are a TARP company but you adopt a
bylaw, and a bylaw that is in accordance with and legal under
your State corporate law obligations, a legal corporate bylaw,
that says we will no longer provide quarterly earnings
guidance, and boards can do that, then perhaps we could give it
in some sort of a reward, a carrot rather than a stick under
TARP because they have taken steps to limit systemic risk of
their companies. I think that might be one way worth at least
talking about.
Mr. Castle. Let me shift back to the subject of the hearing
today which is the executive compensation question, and just
ask you about the governance of all that. I am concerned that
the Federal Government is getting more and more involved in the
running of corporations. In fact, we own corporations now which
we don't really want to do and hopefully work away from that.
But that is where we are. We seem to be even going further in
that direction with the various things that I am hearing. And
the States, for years, have handled matters of corporate
interest and corporation, etc.
And my concern is that all of a sudden, we are asking that
the Federal Government come in and override what the States may
or may not do. And I am not saying they shouldn't do anything.
I think there are some executive compensation issues that
should be addressed, but I would hope that the States would be
the ones to address that. I would be interested in your parsing
that issue in terms of what we as a Federal Government--
Executive Branch, Legislative Branch--should do versus what
should be done at the State levels, if anything, in the area of
executive compensation.
Mr. Verret. Sure. To the extent that this discussion has
gone towards proxy access and say-on-pay as prudent aspects of
the executive compensation discussion, I think State law does
play a very important role. With respect to proxy access, the
SEC's current proposal is very clear in that it says the
Federal Government should say how proxy access should work, how
State law nomination rights should work. And it specifically
says if you want to exercise your State law rights you have to
make sure that they don't conflict in any way with what the SEC
says is the one single approach to proxy access that we think
should work for all of the over 4,000 publicly traded companies
in the United States. I think it is about 4,000 is my guess. So
I think that is an issue worth thinking about. And with respect
to say-on-pay I think this is basically sort of an attempt to
make a change that companies, that a small subset of
shareholder haven't been able to achieve through proposals.
Just last year, seven proposals for say-on-pay were introduced
at companies in 2008, ten of them were successful.
The average vote was a 60 percent vote against say-on-pay
by the shareholders. At financial companies it is even higher.
70 percent was the average vote against say-on-pay at financial
companies. So shareholders have at least--shareholders at the
majority of companies in a very strong majority way have
expressed dissatisfaction with say-on-pay proposals.
Mr. Castle. I yield back the balance of my time.
Mr. Cleaver. [presiding] I recognize the gentlelady from
California, Ms. Waters.
Ms. Waters. Thank you very much.
I think part of what I was interested in has been answered.
I basically take the position that the government, perhaps,
should not be involved in deciding the compensation for
executives of these companies, but I do believe that, when you
have your banks and financial institutions coming to the
government and accepting TARP money, accepting investments by
the government, that they have to accept some of the rules of
government to go along with it. And part of that may be say-on-
pay.
But I am really interested in the shareholders, and you
just gave us some information that is surprising to me, that
basically the majority, more than a majority of shareholders do
not support say-on-pay. Is that what you just said?
Mr. Verret. Well, I just said, last year, there were 70
proposals at companies to adopt say-on-pay at those companies.
Now, of those 70, 10 of them were successful. And the average
vote at those 70 different elections on whether we should do
say-on-pay, the average vote was a 60 percent vote against.
Among the financial companies subset of this, and this is
from a paper by Jeff Gordon at Columbia Law School, the average
vote at financial companies was a 70 percent vote against say-
on-pay.
Ms. Waters. Well, I need to ask all of you, and you may
have stated this already, whether or not you believe that the
government has a right to say-on-pay and other demands on
companies that receive taxpayer money in the form of loans.
Ms. Minow. Yes.
Mr. Turner. Congresswoman Waters, absolutely.
When you take money from a government, you understand it is
a whole new rule of game. And if you don't want to play by the
government rules, you don't need to take the government's
money. It is as simple as that.
Back to the point on investors' votes on say-on-pay, there
are a couple of other key facts that you need to consider in
those votes. In some of those companies, the compensation, the
investors might have in fact decided that compensation was
satisfactory, and in that case, they tend not to vote for say-
on-pay proposals.
I sit on two large institutional funds, one being the
public pension fund for Colorado, the equivalent of your
CalPERS and CalSTRS, as well as a mutual fund for AARP. If
compensation is fine and we think within limits, one may not
vote for say-on-pay, although typically we still do.
The second thing is that the large mutual fund
institutions, Fidelity, Barclays, etc., vote with management
close to 90 percent of the time. The reason they do is because
they get assets from management, from the corporate pension
funds, to manage, and they get tremendous fees for that. And as
a result of that, they aren't going to vote against management.
They aren't going to vote for say-on-pay because the management
team will take those funds away from them and place them with
another asset manager, and so those votes become very
problematic.
What we need is legislation that says, when the pension
fund--or when the mutual funds vote on behalf of the investors
in that fund, they have to make that vote based on the best
interest of those investors, not their best interest as a
mutual fund.
A prime example is a few years ago when there were
phenomenal, almost $200 million in payouts to an executive
leaving at Pfizer, and there was a question about their board
and all. The Pfizer management team, two senior top people, who
are quite frankly close personal friends, flew to California,
met with Barclays and reminded Barclays that they were getting
$14 million in fees to manage Pfizer assets, and the next day,
they voted straight down the line for Pfizer. And I think that
is a classic example of what goes on and what needs to be
corrected.
Ms. Waters. I appreciate that advice and that information.
I am looking to play a role in some of this reform, and those
are precisely the kinds of issues that I want to deal with, so
you will hear more from me.
Thank you very much. I yield back.
Mr. Cleaver. Thank you.
I will yield time now to the gentleman from North Carolina.
Mr. McHenry. Thank you, Mr. Chairman.
I have a question that one of my colleagues asked the
previous panel that I thought was an interesting one. Mr.
Neugebauer from Texas asked a question. He asked, if I
presented you with $1,000, and in 2 weeks, you brought back $1
million on that investment, that in essence you made me--took
$1,000 and turned it into $1 million for me, would it be
appropriate for me to pay you $10,000? Would that be fair
compensation for the return you have given me?
Mr. Bebchuk, if we can go quickly down the line and answer
this question yes or no.
Mr. Bebchuk. I wouldn't be able to answer it without
knowing more about the circumstances. But none of the proposals
that even anyone here supports, none of the proposals that the
government has put forward, involves this kind of judgment.
They all involve at most either changing the governance
rules and letting make people make decisions or involve
judgment about structure. If you ask me about structure, I will
have clear answers.
Mr. McHenry. Well, the structure is just as I said. If we
could just do quickly; I only have 5 minutes.
Ms. Minow?
Ms. Minow. I think you would be getting a very good deal
for that amount of money.
Mr. McHenry. So it is fair compensation?
Ms. Minow. Yes, or even a higher amount could be fair under
your scenario.
Mr. Murphy. It might not be fair to the agent who should be
getting a higher percentage of the deal.
Mr. McHenry. Interesting.
Mr. Turner. The question may be whether or not you should
pay them more than $10,000 or not if they were able to get you
a million.
The problem is that isn't the facts we are dealing with.
The fact is, instead of paying a thousand, we paid hundreds of
thousands or millions of dollars and instead of getting back
the million dollars of profit, we ended up with billions of
dollars in write-offs that in fact today are in excess of a
$1.2 trillion and requiring government bailout of companies
that failed.
The question isn't should they get a $10,000 bonus, the
real question is should I get my thousand bucks back because
they lost so much.
Mr. Verret. Well, Representative McHenry, I have a lot of
confidence in my investment skills, and I would be happy to put
you in touch with my agent, but I think $10,000 would be way
too low.
I would just offer that this hearing is about systemic risk
and executive compensation. I would rest on my testimony that
if that were really such a strong link, healthy TARP banks that
are about to get out of TARP and bad TARP banks, we could look
at them and we could see some differences in their executive
comp.
I have read through the disclosures of every single one of
them over the last 2 days, haven't done much else besides that,
and there is not much difference between those two comp
policies.
Mr. McHenry. Would it be fair to perhaps up the base
compensation and have fewer incentives? Is that best aligned
with shareholder interest, Mr. Verret?
Mr. Verret. Well, in some cases, yes, and in some cases,
no. I would defer to negotiations between the shareholders and
the board on that issue.
Mr. McHenry. So how can the government proscribe corporate
governance effectively?
Mr. Verret. Well, I think that it is about a combination of
corporate governance issued at the State level that is I think
very effective in a lot of areas. Some corporate governance
disclosures issued at the SEC, and that by the way has become
the central mission of SEC. I think some of the things that the
SEC has been trying to do, especially with respect to the
current proxy access proposal as it is currently designed,
exceeded its authority under the 1933 and the 1934 Acts.
And we have seen the SEC is about 0 for 3 in challenges
before the D.C. Circuit. I think it is going to be 0 for 4
after this proxy access rule. So I think it is about
disclosure, and I think it is about State corporate law and the
protections afforded shareholders at that level.
Mr. McHenry. Is the shareholder proxy vote on executive
compensation the way to go?
Mr. Verret. I think say-on-pay can be particularly
dangerous. And I also think comparisons to the U.K. are
deceptive for a lot of reasons.
The structure of shareholders in the U.K. is very
different, dominated by insurance companies and private
pensions much more where the United States is more retail
investors with a lower voting rate and also substantially more
union pension ownership. So I would say it is not the right way
to go.
Mr. McHenry. Now, in the previous panel, Mr. Sperling
testified that the corporate community is setting best
practices in regard to executive compensation. Do you think
that is the way to go?
Mr. Verret. I think best practices generally are great. I
think we have seen some great best practices promulgated by
Risk Metrics, great best practices promulgated by the Council
of Institutional Investors, and some great best practices
promulgated by the Chamber of Commerce and the Business
Roundtable.
When the government does it, I wouldn't call it best
practices any more. We have seen the government use its moral
authority and the threat of regulation when best practices are
effectively a demand.
Mr. McHenry. How effective do you think the 2006 executive
compensation laws have been?
Mr. Verret. The 2006 disclosures, I think it is too early
to tell because we have only had about 2 years of history
there. I think part of the issue is there is not enough working
history to really work from. And I think part of what Chairman
Shapiro's committee is doing on refining those disclosures I
would also, frankly, support.
Mr. Cleaver. The gentleman from Minnesota is recognized.
Mr. Ellison. Professor Verret, you just made an interesting
point about there not being enough history to make a decision.
And I think that might even apply to your analysis with regard
to banks that paid back their TARP funds and banks that did not
having similar compensation systems. TARP hasn't been around
that long, so how can you be so sure, based on the limited
history that we have? And why is that metric one that we should
rely on when we determine whether or not compensation systems
have a causal effect on risk-taking?
Mr. Verret. Congressman, that is exactly the point; I am
not sure. I am not sure that executive compensation led to
systemic risk issues. The reason why I am not sure is because
of the evidence I have suggested.
Mr. Ellison. When you are not sure, that means maybe it is,
maybe it isn't. The point you are making, I come away with
thinking, well, so what? You know, there is not enough of a
body of information to use that metric to decide whether it is
or it isn't. Can you tell me why I am wrong about that, Mr.
Bebchuk?
Mr. Bebchuk. I think you are actually right. There is no
widely shared consensus that executive compensation incentives
did contribute to the crisis. We can rely on the CEO of Goldman
Sachs who, in an editorial in the Financial Times just 2 months
ago, stated very strongly his view that those compensation
arrangements were flawed, and we need to reform them.
Indeed, financial firms across-the-board now take the view
that they were wrong. They might not like government
intervention, but I think that at this point there is widely
shared consensus that executive compensation arrangements need
to be reformed, and the only room for disagreement is what role
the government should have in bringing about the changes that
everybody agrees are necessary.
Mr. Ellison. Professor Bebchuk, or actually I want to open
this up to anyone. One of the things that I keep hearing is, we
have to let American corporations get all of the money they
want under whatever compensation system that they want because
if we don't, then these really smart, talented people are going
to go elsewhere. What I am thinking, and I know that I am not
doing exact justice to this exact point of view, but you have
heard this line of argument. Ms. Minow, can you comment on this
issue? If we reform the entire American system--
Ms. Minow. Yes, I agree with you, Congressman.
I think that is a bogus argument. The first point is, where
would they go? They would go into private equity, and the
shareholders can invest in the private equity. So that is just
fine.
Second, these guys didn't do that good of a job, so let
them go. Let them go abroad and let them wreck their economy.
Mr. Ellison. Do European firms compensate the way we do?
And in line with that, I mean, is there another way to conceive
of executive compensation, or is the way we have been doing it
the only way to see it? And from what I understand, and I could
well be wrong, European and Asian firms don't pay their
executives this way.
Ms. Minow. Unfortunately, one area where the United States
is way ahead of everybody else is in the area of disclosure,
and so we don't have good, comparable data. So there are a lot
of off-of-the-disclosure-books kinds of payments that we don't
know about.
Mr. Murphy. We have increased disclosure across the world.
I have just completed a study of 27 countries, and one of the
things we find is that the rest of the world slowly is catching
up to the United States.
The United States has higher compensation after you control
for size and industry. But stock options, for example, which
used to be nonexistent in all but a couple of countries 20
years ago, are now prevalent in almost all countries.
Mr. Ellison. I would like you to send me that study. Would
you?
Mr. Murphy. Absolutely.
Mr. Bebchuk. The argument that people will go and work
elsewhere is also unwarranted because everybody here is focused
on changing the structure. So there is really no reason
whatsoever to provide compensation that produces perverse
incentives and destroys value. At most, this argument would be,
give them the same amount but use it to give the incentives to
work for the company, not against it.
Mr. Ellison. Are you familiar with a book called, ``In
Search of Excess'' written in 1991?
Ms. Minow. Graef Crystal wrote that, yes.
Mr. Ellison. So this conversation about excessive executive
pay, whether or not you will buy it or not, it is not a new
argument, is it?
Ms. Minow. No. The book that I would recommend to you even
more than that because it is more up to date is Rakesh
Khurana's book, ``In Search of a Corporate Savior.'' And the
thing I like about that book which influenced my thinking is
that he says payments of executive compensation need to be
looked at in terms of return on investment, like any other
asset allocation.
Mr. Ellison. I think I am out of time. I thank you very
much.
Mr. Cleaver. The gentlewoman from Minnesota is recognized.
Mrs. Bachmann. Thank you, Mr. Chairman.
Mr. Bebchuk, publicly traded companies also pay high
salaries to entertainers, to athletes, and to news anchors. And
what I am wondering is, should these decisions also be subject
to shareholder approval?
Mr. Bebchuk. No, I think not. What we are concerned about,
about top executives, is not so much the amount but the concern
that we don't have arm's-length contracting, that we don't have
the market at work. When you have the market at work, we can
let privately reached decisions stay. But what we are trying to
do with respect to top executives is to make sure that we have
a well-functioning system rather than the one that we have had
thus far.
Mrs. Bachmann. Thank you.
Next would be Ms. Minow. You mentioned in your testimony
that, although disclosure is important that people have to be
able to act based on the information that is disclosed, isn't
the right to sell stock the ultimate way that shareholders can
act? What is your opinion on that?
Ms. Minow. Not really. The one thing that you know about
stock is you want to buy low and sell high. If the stock has
been depressed by bad decisions on the part of management, it
can be cost-effective for you, in fact, to send a message back
to that management rather than to sell out.
Furthermore, many of the investors, including the large
institutional investors, are so large and diverse that they are
either indexed de facto or indexed de jure, they have nowhere
else to go. And these pay plans are so pervasive, they have
nowhere else to go, at least within the United States. So they
don't have the opportunity for what is called the Wall Street
walk.
Mrs. Bachmann. Given the shareholders' ultimate ability
just to be able to sell their shares, shouldn't we be
concentrating our efforts on compensation disclosure in your
opinion?
Ms. Minow. Compensation disclosure is absolutely essential,
and I hope we can improve it. As Professor Verret said, we made
some improvements in 2006, but it doesn't really cover a lot of
the kinds of issues that have been revealed by the financial
meltdown.
Mrs. Bachmann. And you had talked before about preventing
bad compensation practices, that really little can be done
before the structure of the board is fixed. I think that is an
excellent point that you are making. And could you talk about
what your proposal would be?
Ms. Minow. Certainly. Right now, I know it is hard to
understand if you are an elected official, but right now boards
are elected. No one runs against them. Management counts the
votes, and they can serve even if they only get one vote. I
think it is very important that directors not be allowed to
serve unless they get majority support from the shareholders. I
think that way shareholders would be able to remove bad
directors.
Mr. Verret. I would add that contested elections that would
be part of the Commission's current proxy action proposal would
also be, I believe, plurality votes. So the same standard would
apply. It wouldn't be majority voting for contested elections.
Mrs. Bachmann. I would open the questioning up to any panel
member. On my previous question regarding athletes and news
anchors and entertainers, and also on transparency and on
disclosure, if anyone else would like to comment.
Ms. Minow. Lucien is 100 percent right. Those transactions
are very closely negotiated at arm's length. It is the coziness
of the transactions between the top executives and the board
that leads to this problem.
Mrs. Bachmann. Why is it that the board can't be changed?
Ms. Minow. Because the CEO picks the board.
Mrs. Bachmann. And so you have the circle, they are chasing
each other?
Ms. Minow. Yes.
Mr. Bebchuk. I would add that disclosure is helpful only if
investors can then make decisions that would have an impact on
directors using the information that they are given. And right
now, their hands are tied in a number of ways. In addition to
the difficulty of replacing the board, there are staggered
votes, which are a unique American institution, which in a
large a fraction of publicly traded companies prevent the
shareholders from replacing the full board in any given
election. And there is also the inability of the shareholders
to amend the corporate charter so the shareholders cannot
change the rules of the game. If they could, some of the work
that you guys are called on to do could be left to the market.
But right now the market cannot put in place corporate
governance reforms that are viewed as important.
Mrs. Bachmann. Professor Verret?
Mr. Verret. I would counter that about half of the S&P 1500
is declassified. It is difficult, but shareholders have made
some progress in declassifying boards.
I would also just highlight a bit of a market failure, I
think, in proxy advisory services. We saw the problems with
market concentration in the credit rating agencies. It is much,
much worse with proxy advisory services. Risk metrics rules the
roost, and there is no required disclosure in these
independence of competition committee rules. There is no
required disclosure for proxy advisory firms, and I think there
should be.
We are not likely to see it, of course, because the former
chief administrative officer of Risk Metrics is now a special
adviser to the chairman, so I think we are unlikely to see it
at this point. But I think it is worth considering.
Mrs. Bachmann. I yield back.
Mr. Cleaver. I recognize the gentlewoman from California.
Ms. Speier. Thank you, Mr. Chairman.
I want to thank the panel. It has been a very lively
discussion, and I think you underscore for all of us what a
sticky wicket this issue area is.
I would first like to point out that Paul Volcker said it
very succinctly very recently when he said that the financial
demise that we have just witnessed is the result of executive
compensation that has been linked to riskier and riskier
activity. And I think a number of you have pointed that out in
your testimony.
I think that we have no role as a Congress to effect
executive compensation if we don't have an investment, so to
speak. So when it comes to TARP recipients, you bet I think we
have a role to play.
Now what we do have a role to play in other circumstances
is empowering the shareholders. That is what our focus should
be. And I think right now the game is fixed. Based on what you
have just said, if you get one vote, you are reelected.
Wouldn't we all like to have that kind of experience being
elected to Congress?
It sounds fundamentally undemocratic that you don't have
someone independently counting the ballots and that a majority
is not required. So I think, and I keep coming back to Mr.
Sullivan, who was then the CEO of AIG who had performance
requirements for bonuses. He went to his board of directors and
said, we want you to waive the requirement for performance in
this situation even though we have just lost $6 billion and
give the bonuses anyway. And guess what the board did?
Ms. Minow. They said yes.
Ms. Speier. They said yes, and those bonuses were offered
and Mr. Cassano received a million dollars a month after he was
fired. It is extraordinary, and it is wrong, and the American
public is on to it.
My question to all of you is, since you can always
manipulate the system, as Mr. Sullivan did where he actually
had performance requirements in place for purposes of giving
bonuses, why not just require of all of the members of the
board of directors a fiduciary duty to the shareholders?
Mr. Bebchuk. They do have a fiduciary duty, but the problem
is that enforcing fiduciary duties is difficult because there
is the business judgment rule, and courts are not going to
second guess the judgment of the directors. That is why the
main remedy is to make directors accountable to the judgment of
the shareholders.
And you mentioned AIG. We have never had in the history of
the U.S. public markets a control contest for a company the
size of AIG because the impediments to a proxy fight in a
company that large are just practically insurmountable. And
many of the arrangements that people are discussing are
arrangements that tried to expose incompetent directors more to
the discipline of an electoral challenge.
Mr. Turner. I might note that there are almost never any
actions brought against boards of directors. The SEC, to the
best of my knowledge, never brought an action against any of
the directors of Enron; never brought an action against any of
the directors of WorldCom; and only brought one action against
the directors of Tyco, and that was because the guy had taken a
bribe.
So for the most part, given the way that State laws
operate, which aren't very good and quite frankly, the staff of
this committee has been urged to take up a proposal to allow
shareholders to ask for reincorporation in a more shareholder-
friendly State, which is an excellent proposal, by the way.
But for the most part, until you can hold directors
accountable, and in this way it is the proposal just to be able
to throw them out, you are never going to get any action
because the law enforcement agencies literally will not touch
them, have not touched them, even in the most egregious cases
today.
Ms. Minow. Many of the directors of the failed companies
are continuing to serve on boards. It is flabbergasting to me,
but they are still there.
Mr. Verret. I would specifically counter the observations
about State law. Delaware is the corporate State law that I
have spent the most time studying. Delaware is very responsive
to shareholders, particularly responsive. They instituted
majority voting. They made majority voting easier. As a result,
now we have majority voting in, I think, 60 to 70 percent of
companies; this is the withhold vote, kick-the-bums-out sort of
rule. People wanted proxy access. Delaware instituted proxy
access, although the SEC wasn't able to do it. So that was very
responsive to shareholders, I would say.
Ms. Minow. When is the last time a director has been held
liable by a Delaware court for any personal payment out of his
own pocket absent personal corruption?
Mr. Turner. After approving the Ovitz, and the court held
Ovitz could get paid $160 million in the most egregious
situation and said, it is a-okay. The courts in Delaware said
it; it is not an investor-friendly State.
Mr. Verret. The Ovitz litigation is one specific case. That
was 6 or 7 years ago.
Ms. Speier. Thank you, my time has expired.
Mr. Cleaver. The ranking member from Alabama is recognized.
Mr. Bachus. Thank you.
How many of you were at the first panel and heard the
testimony?
Mr. Sperling, I have a great respect for him. He talked
about some of the executive compensation decisions that
actually led companies, they actually increased risk, and I
think when we hear that we think of AIG, and we think of maybe
some of the subprime lenders where people, mortgage originators
were paid by the volume of work without regard to whether the
borrower could repay. Give me a percentage of companies that
you think engaged in this sort of risky dangerous behavior?
I will start with Professor Bebchuk.
Mr. Bebchuk. I think that the widely shared view that I
alluded to before, that incentive structures were flawed,
applies to companies in the financial sector across-the-board.
Most of the companies in the financial sector, this is what
made this financial crisis so difficult. Most of them made
decisions that at least in retrospect seemed to have involved
excessive risk-taking, and they all generally had those
incentive structures that had the short-term flow that they now
generally recognize.
Mr. Bachus. Of just corporate America, how many
corporations do you think engaged in dangerous, risky behavior
that endangered the economy?
Mr. Bebchuk. I think the problem of short-termism, the
practice that is now widely recognized as being problematic,
namely that executives can cash out shares and options
immediately upon vesting and that bonuses are often short term,
this practice is general across corporate America.
Now I would say the financial sector, the opportunities for
risk-taking are not as large as they are in the financial
sector, and, therefore, the fact that we have had flawed
incentives has manifested itself. But it is now generally
accepted that also firms outside the financial sector should
fix this very problem of tying compensation to the long term
and not to short term.
Mr. Murphy. I would like to be careful not to define
excessive risk-taking as just those risks that generate losses
as opposed to gains. Actually, through most of our history, our
problem in corporations has been to encourage individuals,
risk-averse individuals to actually take risks, and the
individuals inside corporations tend to be more risk-averse
than the shareholders. The entrepreneurial spirit is all about
risk-taking.
Mr. Bachus. I agree. Mr. Verret?
Mr. Verret. Just to answer your question specifically, I
think it is a small number of corporations in terms of number;
very large in terms of the assets that they manage. I think
this goes to a related issue of, do we let them get too big?
And I would applaud the Federal Reserve's current initiative to
think about changing capital requirements based on size. I
think that is a useful thing to talk about.
And I would also offer, just highlighting from my
testimony, I would offer that quarterly earnings guidance is a
dangerous thing that affects a lot of companies, and it is
something that companies want to get out of.
Mr. Bachus. Let me ask you this: Do you believe that the
CEO or the board of directors or people inside the corporation,
isn't one of the jobs of the CEO to look at performance and pay
and set executive compensation as opposed to some independent
board?
Ms. Minow. Yes. It is the job of the board to set the CEO's
compensation and to value his performance, including his
performance in setting compensation.
Mr. Bachus. So both the CEO and the board of directors, you
all agree that they primarily should be responsible for setting
compensation?
Ms. Minow. Yes. Absolutely.
Mr. Bachus. Professor Verret and Professor Bebchuk, as I
understand it, the compensation proposal envisions linking
executive compensation to performance of bank debt and
preferred shares. What is your view of that proposal?
Mr. Verret. I would offer just with respect to the idea of
using debt--linking debt to pay, I think three things are worth
thinking about: First, an executive's ability to be rewarded on
the upside would be limited the more you include debt in the
mix. I also thinks he makes an assumption at least in the paper
that I think is absolutely correct, the fact that the moral
hazard of government bailouts means that debt tends to not to
be affected too much when a bank's health is affected. I think
that is an absolutely safe assumption. It is one of the reasons
that debt holders don't police executives as much as they
should. It also means if you were to link debt to executive's
pay, it means that if the debt doesn't go down, the pay doesn't
go down. So you limit the upside, and you also limit the
downside. The amplitude you get is very flat rather than upward
and downward incentives as you add pay into the mix.
Mr. Cleaver. The gentleman from Texas is recognized.
Mr. Green. Thank you, Mr. Chairman, and thank you, members
of the panel. If I interrupt, please forgive me. I don't mean
to be rude, crude and unrefined, but I am trying to make a
point.
Let me start by asking about the executives in the U.K. Do
they in the main make more than executives in the United
States?
Mr. Murphy. No.
Mr. Green. Executives in Germany, do they in the main make
more than executives in the United States?
Mr. Murphy. No.
Mr. Green. Executives in France, do they in the main make
more than executives in the United States?
Mr. Murphy. No.
Mr. Green. The question becomes this then, to those who
contend that if we do anything to encroach upon the current
system, people will flee to other places and make inordinate
amounts of money in other places, leaving us with a brain
drain; the question becomes: Where do they go?
Mr. Murphy. They go to private equity and hedge funds.
Mr. Green. Private equity and hedge funds in the United
States?
Mr. Murphy. Within the United States. And no one is going
to Europe.
Mr. Green. The percentage of private equity and hedge funds
cannot accommodate the number of executives that we are talking
about, so some may go. But the truth be told, the argument is
that we are going to lose them to other countries. That is the
argument that is being made, and there is no other country that
they are going to go to and fare as well as they are faring in
the United States of America.
Mr. Verret. Except that could change if we link pay.
Mr. Green. Excuse me, it could change if the U.K. would
change its laws. It could. It could change if Germany and
France changed their laws. That doesn't seem to be the case
because they seem to be leaning even more towards executive
regulation.
By the way, I am not a proponent of trying to stifle the
free market. I want to see people make as much as they can. But
I don't want to see people at AIG drive a company into the
ground and then walk away with huge bonuses. There is something
wrong with this, and the American people know there is
something wrong with it. And they are going to chastise us if
we don't do something about it. I appreciate the notion that
there are other places for people to go, but they won't find
the coffer in these other places that they find in the United
States of America.
And those who want the auto workers at Ford, Chrysler, and
GM to get salaries comparable to Nissan and Toyota, they don't
look at what the salaries of those CEOs at Nissan and Toyota
are making. Their salaries are not in line with the salaries of
the American auto industry executives in this country. They are
not. Nobody that I have heard, and there may be a voice that I
haven't heard, I confess that I don't hear everything that is
said, but nobody that I have heard has indicated in any way
that we need to make sure that the salaries of the auto
executives in this country are in line with the salaries of the
auto executives in other countries. It is just not being made.
Now, at some point, we have to 'fess up and say we have
some business to take care of, and take care of the business
that we must take care of. If we don't do this, this is our
hour, our moment, this is our time to do what is right; not to
try to manage this, not to try to make sure that we do it, do
this thing right, but do the right thing. That is what we have
to try to do here.
So I am not for taking control of a company. I don't want
to see stockholders micromanage a company. I am not interested
in that. But I contend that the chairman is right when he talks
about how we have promoted excessive risk without consequences
for the failure, not serious personal consequences for the
failure. So we have people who are trying to do all that they
can to make as much as they can, understanding if they don't, I
will just take my bonus and my golden parachute and fly out.
That kind of behavior is what we are talking about, as I see
it, and I think there is room for us to do something, and I
would like to see it done in a bipartisan way, by the way. I am
amenable to working with folks on the other side to come to a
sensible center on this so we can have bipartisan legislation.
But I still contend that those workers who took that cut at
GM and who were taking cuts, they didn't get bonuses cut. They
got bread and butter cut, and there is a difference. And there
is not a big to-do about what is happening to them.
Mr. Chairman, I yield back the balance of my time after
having the opportunity to speak for those who are not here to
speak for themselves.
Mr. Cleaver. Let the church say, ``Amen.''
The gentleman from Florida is recognized.
Mr. Grayson. Thank you, Mr. Chairman.
We are trying to make policy on the basis of recent memory.
For the past few months, we have seen banks that have brought
themselves to the brink of ruin, brought the whole U.S. economy
to the brink of ruin. And what people see, which is so
frustrating to them, is that they see that nobody is being held
accountable for that. Nobody is being punished for that. Maybe
the gravy train has slowed down a little bit for them, but it
is still rolling. And I think people find that frustrating, and
rightfully so.
I am worried that proposals like this don't go far enough.
They don't say, you don't get paid extra if you destroy your
company. You don't get paid extra if you hand the taxpayers a
hundred billion dollar bill. What I want to hear is I want to
hear your best ideas about how we should hold accountable the
people who have already screwed up, the people who have already
caused the destruction of their own banks and caused the
taxpayers to have to give out billions upon billions of
dollars, and I want to know what we should do in the future
about people like that.
Let's start with Ms. Minow.
Ms. Minow. Well, there is the limitation on ex post facto
laws. There is not much you can do about what has already
happened. But I would certainly strongly urge Congress to make
sure that anyone involved could never serve on the board of a
public company or as an officer of a public company ever again.
It is unthinkable to me that these people continue to be
involved.
Mr. Grayson. Let us be specific, when you say ``anyone
involved,'' who would you include in that?
Ms. Minow. I would include the executives and the boards of
directors of all of the main TARP companies, the ones that are
still participating in the program.
Mr. Grayson. So you would apply the same sort of punishment
that the SEC actually frequently applies to people who are
engaged in illegal trading?
Ms. Minow. Yes, I would.
Mr. Grayson. Mr. Turner, your best ideas?
Mr. Turner. I totally agree with you about the frustration
and that there needs to be accountability. I think the SEC in
their announcement just in the last week about Countrywide and
going after them is exactly what we are looking for. I think
there have also been cases filed with respect to fraudulent
reporting by companies such as Citicorp, and I think DOJ and
SEC need to work those through the courts in the most diligent
way. And I think some of the same question applies to Fannie
and Freddie as well with some of their practices. Just as Nell
has said with those who, after due process, people are found
not to do the job; due process is important in this country,
and we don't want to run into cowboy justice, but where due
process is, these people ought to be barred and the SEC has the
authority to bar these people from ever being an officer and
director again, and they haven't had a good track record in
doing it in the past, and they need to do it. And if they don't
do it, then you guys ought to haul the SEC up here and ask them
why.
Mr. Grayson. Mr. Turner, you are talking about cases of
fraud. I am talking about something a little different. I am
talking about cases of gross, gross mismanagement that
literally led to the destruction of a multibillion dollar
institution. How should we treat people like that, not people
who file false statements with the government and the SEC, but
people who destroy their companies and right now maintain
control of those companies only at the benefit--only through
the largess of the taxpayers, what should we do with those
people?
Mr. Turner. When you passed the Sarbanes-Oxley Act, you
gave the SEC to find that when they look at officers and
directors and find that they are substantially unfit to fulfill
those roles, they can bar them forever from serving in those
roles at a public company. I think in some of the instances of
these companies, we are going to find that some of these
directors are in fact substantially unfit to fulfill that role,
haven't demonstrated the fitness ability, and the SEC should
forever bar them from being an officer or director of another
public company.
Mr. Grayson. Mr. Bebchuk, what do you think we should do in
a situation where somebody who heads a bank, or a group of
people who head a bank, have run that bank into ruin and handed
the taxpayers a hundred billion dollar bill? What should we do
with those people?
Mr. Bebchuk. I very much understand the frustration, but I
am concerned about retroactively changing the rules of the
game. So to the extent, and this is hypothetical, if you have
someone who acted completely according to the law, I would try
to--
Mr. Grayson. What should the law be? That is what we do
around here, determine that.
Mr. Bebchuk. But the law we had on the books up to this
point was a law that did not make it criminal, as well as
limited private actions.
Mr. Grayson. Right. Mr. Bebchuk, it is legal to destroy
your company and hand the taxpayer a hundred billion dollar
bill. We understand that. We want to change that. What should
we do?
Mr. Bebchuk. About people going forward?
Mr. Grayson. If you wish.
Mr. Bebchuk. Going forward, you can reconsider the legal
rules that right now completely insulate someone from legal
liability when they engage in gross negligence. So we could
reconsider those legal rules and open them to legal liabilities
and circumstances.
Mr. Grayson. My time is up. Thank you, Mr. Chairman.
If any other members of the panel want to comment on this,
please feel free to write to me and let me know.
Mr. Cleaver. The Chair recognizes the gentleman from
California.
Mr. Sherman. Or better yet, you could furnish your answer
for the record, and we would all know.
Mr. Grayson. Thank you. That is a good suggestion.
Mr. Sherman. I would point out that criminal law can't be
ex post facto, but as Mr. Turner pointed out, we can ban some
of these people from ever serving on the board of a publicly
traded corporation again. And we might also look at the civil
law to see whether those whose actions have cost us perhaps
$700 billion, perhaps less, would be liable to the Federal
Government. Ex post facto criminal laws are much more
constrained by the Constitution.
I would think that Wall Street itself would keep some of
these people off the boards, except I can see some of them
saying these folks didn't show remarkably bad financial
judgment; they showed tremendous political skill. They
separated the taxpayers from $700 billion worth of assets.
Mr. Verret, you have been talking about how we need to keep
talent motivated, but I think it has been pretty well
illustrated by the gentlemen from Texas, nobody is moving to
London let alone Tokyo to make more money, or very few are.
Is there any economic theory that would say, if 10 percent
of the executives who worked for publicly traded banks then
found themselves at the hedge funds, that would mean a
diminution in the quality of financial management in this
country? Would a slight change of talent moving from the
publicly traded sector to the not publicly traded sector, has
anyone proven that would hurt you?
Mr. Verret. I am not an economist specifically.
Mr. Sherman. Are you aware of any such study?
Mr. Verret. I am not aware of any such study.
Mr. Sherman. Okay, thank you.
Professor Bebchuk, I don't believe that we are going to
control or should control compensation for a company, except if
it is publicly traded, in which case we want to make sure that
shareholders are empowered, systemically it puts the country at
risk or is governmentally subsidized, assured, insured, etc.
This leaves the hedge funds, where it is my understanding
that for the most part you do have incentive to take enormous
risks. There is a lot of talk about, well, if the investment
does well, the management should do well. If the investment
does poorly, the management should do poorly. I know of no
hedge fund that is structured that if they lose money, the
management writes a check out of their own pocket.
Is the typical structure of a hedge fund one that
encourages excess risk? By typical structure, I mean one where
the management puts in none of its own money, shares only in
the profits, has no real compensation except for the profits,
and in some cases doesn't share until a 5 or 10 percent rate of
return is achieved. And if so, are some of these hedge funds a
systemic risk to the country?
Mr. Bebchuk. I agree with you that the government should
not constrain the substantive choices that are made in the fee
arrangement between hedge fund managers and their investors.
But I also agree with you that, as part of this general
reconsideration that is now taking place, investors in hedge
funds should take a serious look at those arrangements because
I do share your sentiment that the same sort of focus problems
that we have now witnessed with publicly traded companies exist
in the hedge fund areas. So what we have, there are many hedge
funds where usually the arrangement is they don't give back
money, but there are those high water marks. Therefore, there
is a situation where they might not be able to get extra funds
which creates a lot of distortion because either they fold the
fund or they work without high incentives, so I think it would
be a good idea for investors to reconsider.
Mr. Sherman. Are investors given enough information about
management compensation at hedge funds?
Mr. Bebchuk. Yes. Those are arrangements that are
negotiated with a small number of investors, and they are fully
disclosed.
Mr. Sherman. My next question is, is a fight between
management and insurgent shareholders a fair fight, or is it
more like an election in Venezuela? Do the minority
shareholders have any access to corporate funds, and is
management allowed to use corporate funds as they will to call
and propagandize?
Ms. Minow. I think I am the only one on the panel who has
actually tried to do this. I can tell you that management will
spend every last dime of your money against you. I am not
saying that it needs to be a level playing field, but right now
it is pretty perpendicular.
Mr. Sherman. So much for shareholder democracy. I yield
back.
Mr. Cleaver. I have just one question. Morgan Stanley has
instituted this clawback provision. Are you familiar with it?
It is after the fact, where if a CEO has jeopardized the
company, they will then repossess any bonuses or special
compensation. Is that something that you think would be
applicable for legislation that this committee will consider?
Mr. Murphy. At Morgan Stanley, it is not just the CEO; it
is any executive that they determine has caused harm. I would
have gone further and said, even if you didn't cause harm, if
you got money that you shouldn't have gotten, you should give
it back. But that is the role of good corporate governance and
compensation policy, not the role of government regulation.
Ms. Minow. On the other hand, the executives have raised
their base pay to make up for some of the additional risk they
are taking on, so I don't approve of that.
Mr. Cleaver. Of course, it would be government business if
we put it into legislation.
Mr. Murphy. I understand that.
Mr. Turner. I do support and noted in my testimony the
right of investors. When someone has operated in a reckless or
fraudulent way, I do support giving investors the right to go
for that clawback. In that manner, either the board can ask for
the clawback and get it back or the shareholders can, because
someone ought to go get that money back.
Mr. Verret. I think this goes to the disclosure issue and
the SEC's work in 2006 and Chairman Shapiro's current work in
this area. The right question is, did the board go for a
clawback? If not, it should have to explain why to the
shareholders.
Mr. Cleaver. Thank you. I appreciate all of the time you
have spent with us. And the ranking member has a question.
Mr. Bachus. Professor Verret, Treasury yesterday released a
statement on executive compensation that supported the passage
of say-on-pay. Will say-on-pay be effective, in your opinion?
Mr. Verret. Well, I think one of the problems that I hope I
get across is what we have seen in Britain is that
concentration of the proxy advisory firms has caused sort of a
one-size-fits-all solution to take hold in pay. I think it is
better to have a flexible approach, that compensation
committees should have the flexibility to design compensation
proposals appropriate for their own businesses.
I also worry about the possibility that say-on-pay could
minimize a board's ability to change compensation as required
by major changes in markets and events in midstream between the
annual advisory vote on say-on-pay.
I also worry about the effects of say-on-pay on severance
packages and the ability to negotiate a so-called golden
handshake to facilitate an efficient merger acquisition. Even
if you do a vote, sometimes negotiations happen overnight with
respect to negotiating mergers and acquisitions, and I think
those sort of agreements are very important, and sometimes they
need to be approved very quickly, not with enough time to do a
shareholder advisory vote.
Mr. Cleaver. The Chair notes that some members may have
additional questions for this panel which they may wish to
submit in writing. Without objection, the hearing record will
remain open for 30 days for members to submit written questions
to these witnesses and to place their responses in the record.
This is the end of this hearing. We thank you for
participating.
[Whereupon, at 2:25 p.m., the hearing was adjourned.]
A P P E N D I X
June 11, 2009
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