[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

                              ----------                              
                                                                   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

                              ----------                              


                        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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