[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
EXECUTIVE COMPENSATION OVERSIGHT AFTER
THE DODD-FRANK WALL STREET REFORM AND
CONSUMER PROTECTION ACT
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
SEPTEMBER 24, 2010
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-160
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62-685 PDF WASHINGTON : 2010
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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:
September 24, 2010........................................... 1
Appendix:
September 24, 2010........................................... 35
WITNESSES
Friday, September 24, 2010
Alvarez, Scott G., General Counsel, Board of Governors of the
Federal Reserve System......................................... 4
Baily, Martin Neil, Senior Fellow, The Brookings Institution..... 22
Cross, Meredith B., Director, Division of Corporation Finance,
U.S. Securities and Exchange Commission........................ 5
Steckel, Marc, Associate Director, Division of Insurance and
Research, Federal Deposit Insurance Corporation................ 7
Stuckey, Darla C., Senior Vice President, Policy & Advocacy,
Society of Corporate Secretaries and Governance Professionals.. 25
APPENDIX
Prepared statements:
Alvarez, Scott G............................................. 36
Baily, Martin Neil........................................... 49
Cross, Meredith B............................................ 60
Steckel, Marc................................................ 70
Stuckey, Darla C............................................. 86
EXECUTIVE COMPENSATION OVERSIGHT
AFTER THE DODD-FRANK
WALL STREET REFORM AND
CONSUMER PROTECTION ACT
----------
Friday, September 24, 2010
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10 a.m., in room
2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Watt, Moore of
Kansas, Green, Hodes, Ellison; Bachus, McHenry, Posey, and
Lance.
The Chairman. The hearing will come to order. I apologize,
I lost track of the time, and I am sorry. We will begin with
the gentleman from Texas, Mr. Green, for an opening statement
for 3 minutes.
Mr. Green. I thank you, Mr. Chairman, and I thank the
witnesses for appearing today. I am honored, Mr. Chairman, that
you called this hearing and I thank you for doing so.
I would like to mention very briefly a few pieces of
statistical information that I think are exceedingly important.
Currently, we have in this country a poverty rate that consumes
about 43.6 million Americans. And this poverty rate is
juxtaposed to persons who are making inordinate amounts of
money and paying a capital gains tax. The numbers speak for
themselves.
We had in 2007 a person who made $69.7 million working for
one of our leading firms. And by the way, I salute people who
make large amounts of money. I want people to make as much as
they can honestly earn. But it is interesting to note that
$7.25 cents an hour, what this person has made in 1 year would
take a minimum-wage worker 4,878 years to make. That person who
made the $69.7 million is making about $9.3 per second. And, of
course, this person has reason to envy the hedge fund manager
who in 2007 made $3 billion, which would take a minimum-wage
worker about 198,000 years to make, as the person making the $3
billion makes roughly $400 per second.
Finally, I had mentioned the hedge fund manager who made $4
billion in 2009 which would take a minimum-wage worker 265,252
years to make, the hedge fund manager making about $534 per
second.
I mention these not because I begrudge the persons who make
these sums of money. I mention it because we have people in
this country who work very hard, who make minimum wage, and it
is very unfortunate that the people who support the maximum-
wage earners, the persons who can make these hundreds of
dollars per second, $400 per second, $534 per second, support
the maximum-wage earners but would eliminate the minimum wage.
Support the maximum-wage earners paying a capital gains tax of
15 percent, but would eliminate the minimum wage. The minimum-
wage workers deserve as much consideration as the maximum-wage
workers. I stand for helping both, and I will not allow the
minimum-wage workers to be left behind.
I yield back the balance of my time.
The Chairman. The gentleman from Florida is recognized for
how much time--
Mr. Posey. I thank you, Mr. Chairman. And I want to thank
you for calling this hearing.
The Chairman. Three minutes for the gentleman from Florida.
Mr. Posey. I want to thank you for calling this hearing,
Mr. Chairman. This is a subject which has long interested me.
When we had the major bank CEOs here, one of the members asked
them for their compensation and they said what it was. And then
they were asked what it was the year before as the ship was
sinking and, to be sure, they included bonuses, and they went
from I think about $12 million to $60 million, something like
that. I wouldn't want to be held to that. And it left you to
wonder, obviously, if one of them had gone down in a plane
crash, if in fact their stockholders would have been hurt to
the tune of $12 billion, $20 billion, $60 billion in their
absence.
So the question that begs for an answer, of course, is what
relationship there is between the people on these compensation
committees and the people they compensate? I hope you will
address that in your remarks today and we will discuss it in
questions: How much transparency is there now? How much
transparency is opposed? Have there ever been any findings or
prosecutions for an improper relationship for which the
citizens, the stockholders, suffered?
Those are some of the interests that I have and that I hope
you will address today. And I want to thank the chairman again
for holding this hearing.
The Chairman. Any other requests for time on our side? If
not, I will just take a few minutes to say that the genesis of
this hearing, frankly, was an article in the New York Times by
Robert Shiller with whom we have had good conversations, in
which he wrote that he thought executive compensation had to be
addressed, and I noted that we had in fact done that. He wrote
about the Squam Lake Group which consisted, as I recall, of
economic officials from the second Bush Administration, I
believe, and the Clinton Administration not currently involved.
And we noted that we had done some things, and I invited
them to come and testify. We have given the regulators
authority and we would like them to talk about how they are
going to use it. One thing we should be clear on: At no point
did any of our legislation, either on say-on-pay, which applies
to all corporations or the more specifically financial ones
here, have we addressed the dollar amount. That is not our job
and we do not try to fix the amounts. We did, in the say-on-
pay, try to empower the shareholders. In this, the financial
area, the problem is not the level but the incentive. There is
a widespread view among many analysts and subscribed, it seemed
to be, by all the regulators including those appointed by the
Bush Administration and the Obama Administration, that the
incentive structure was the problem. That a problem of heads I
win, tails I break even, did not appropriately incentivize
people.
So what the legislation does is not in any way to set
dollar amounts or authorize anybody to set dollar amounts but
to deal with the question of the incentive structure and try to
empower the regulators and to mandate them to so structure the
rules so that people are not incentivized to take risks
excessively, by which we mean assist, whereby people take a
risk and if it pays off, they do well; and if they take a risk
and it does not do well at all, they break even. That is not a
rational incentive structure.
And so we are pleased to have with us a couple of
economists who have been--one of the economists who has been
involved in this and also someone from the industry. And that
is the genesis of this hearing, it did come from an article by
Professor Shiller and a representative of the group, the Squam
Lake Group, will be here.
We have given the authority to the regulators and we want
to talk about how it should be used.
The gentleman from Alabama.
Mr. Bachus. Thank you, Mr. Chairman. General Counsel
Alvarez and Directors Cross and Steckel, I am not sure how you
were assigned the job to draft these rules, but I suppose you
are going to use your real names on the draft; is that right? I
guess it is a thankless job and it is a difficult job, but it
could be more difficult if you were charged with looking into
the pay of athletes or entertainers. So there is probably some
silver liner there.
Obviously, this is a subject that is very popular and
almost everything has been said about it that can be said, but
at least this hearing, the scope of this hearing is limited to
executive compensation oversight after the Dodd-Frank Wall
Street Reform and Consumer Protection Act, so this hearing is
limited, and I think maybe something newsworthy will come out
of the hearing.
We look forward to your testimony, but I know you have a
difficult job and there are literally thousands of different
opinions on what you ought to do. And it is a difficult
subject. I thank you.
The Chairman. Any further requests for time? If not, we
will begin with our witnesses and we appreciate their
testifying. We should note that when we originally called this
hearing, the assumption was the House would be in session. It
is not, and therefore you have fewer members, but that may or
may not distress you.
I remember touring a Hollywood studio in 1981 in my first
year, because I was on the Judiciary Committee and dealing with
copyrights and they were giving me a tour of the studio. They
were making a movie with Nastassja Kinski, and I forget who
else, and it involves people who turned themselves into
panthers or who were turned into panthers by some other force.
And when we toured the site, the people from the studio
apologized to me because the panthers weren't there. I said I
wanted to be very clear. As far as I was concerned, no one ever
had to apologize to me for not putting me in the presence of
panthers.
And so maybe, that is the way the witnesses feel; no
apology is needed for the fact that there are fewer panthers
here than there might otherwise be. But in any case, we do
appreciate their coming, and we will begin with Scott Alvarez
and your statement, Mr. Alvarez.
STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Alvarez. Thank you very much, Chairman Frank, Ranking
Member Bachus, and all the members of the committee. I
appreciate the opportunity to discuss the oversight of
incentive compensation practices, an area in which the Federal
Reserve has undertaken significant initiatives.
Incentive compensation is an important and useful tool for
attracting and motivating employees to perform at their best.
At the same time, poorly designed or implemented compensation
arrangements can provide executives and other employees with
incentives to take imprudent risks that are not consistent with
the long-term health of the financial organization. To help
address these problems, the Federal Reserve led the development
of interagency guidance on incentive compensation that was
adopted by the Federal banking agencies last June.
We are also close to completing a horizontal review of
incentive comp practices at large complex banking
organizations. Section 956 of the Dodd-Frank Act provides
important support to these efforts by requiring that the
Federal banking agencies, the SEC, the NCUA, and the Federal
Housing Finance Agency prescribe joint standards governing
incentive compensation.
The guidance adopted by the Federal banking agencies is
based on three key principles:
First, incentive comp arrangements should provide employees
with incentives that are appropriately balanced so they do not
encourage employees to expose their organizations to imprudent
risk.
Second, these arrangements should be compatible with
effective controls and risk management.
And third, these arrangements should be supported by strong
corporate governance, including active oversight by the
organization's board of directors.
The guidance applies to senior executives. It also applies
to non-executive employees who either individually or as a
group have the ability to expose the banking organization to
material amounts of risk. The guidance recognizes that
activities and risks may vary significantly across banking
organizations and across employees within a particular banking
organization. As a result, one approach to balancing risk and
reward will certainly not work for all.
Moreover, the guidance includes several provisions designed
to reduce burdens on smaller banking organizations. At the same
time, in order to help ensure that large banking organizations
move rapidly to bring their arrangements into compliance with
the principles of safety and soundness, last fall the Federal
Reserve initiated a special horizontal review of incentive comp
practices at a number of large complex banking organizations.
We are currently reviewing a substantial amount of information
collected in this horizontal review and expect to provide each
firm with individualized feedback this fall.
After the assessments are completed, implementation of the
incentive comp plans will become part of the supervisory
expectations in normal supervisory process for each of these
organizations. Firms have put forth significant effort to find
constructive solutions to the issues we and they have
identified.
In addition, over the course of the horizontal review, we
have observed and encouraged real, positive change in incentive
compensation practices. While significant improvements have
been achieved, it should not be surprising that time will be
required to implement all the improvements that are needed,
given firms' relatively unsophisticated approach to risk
incentives before the crisis, the complexity of compensation
issues, and the large number of employees who receive incentive
comp at large banks.
Importantly, the Federal Reserve expects large complex
banking firms to make significant progress to improve the risk
sensitivity of their comp for the 2010 performance year. After
2010, the Federal Reserve will prepare and make public a report
on trends and developments and incentive comp practices at
banking organizations in order to encourage improvements
throughout the industry.
Section 956 of the Dodd-Frank Act supports these efforts
and improves the ability of Federal regulators to collect
information about incentive compensation arrangements at a wide
range of financial firms.
The Dodd-Frank Act also empowers the appropriate Federal
agencies to prohibit any type or feature of incentive comp
payment arrangements that encourage inappropriate risks by a
covered financial institution. By expanding the scope of
coverage to include many large nonbanking firms, as well as
supporting the Federal banking agencies' efforts, the Dodd-
Frank Act helps level the playing field and reduces the
potential for sound practices at banking firms to be undermined
by arrangements at other financial competitors.
I appreciate the opportunity to describe the Federal
Reserve's efforts in this area and I am happy to answer any
questions.
[The prepared statement of Mr. Alvarez can be found on page
36 of the appendix.]
The Chairman. Our next witness is Meredith Cross, who is
the Director of the Division of Corporation Finance at the SEC.
STATEMENT OF MEREDITH B. CROSS, DIRECTOR, DIVISION OF
CORPORATION FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION
Ms. Cross. Good morning, Chairman Frank, Ranking Member
Bachus, and members of the committee. My name is Meredith
Cross, and I am the Director of the Division of Corporation
Finance at the U.S. Securities and Exchange Commission. I am
pleased to testify on behalf of the Commission today on the
topic of executive compensation oversight.
The Commission's role in this important area has
traditionally been to require timely, comprehensive, and
accurate disclosure to investors about a company's executive
compensation practices and procedures. One challenge the
Commission faces is that compensation practices continually
evolve and become increasingly complex. The Commission has
revised its disclosure rules to address these changes,
including most recently in 2006 and 2009.
Currently, we are focused on implementing the requirements
in the Dodd-Frank Act which address an array of compensation
issues. I will briefly summarize those provisions and our plans
to implement them.
Section 951 requires a shareholder advisory say-on-pay vote
at all companies subject to our proxy rules at least once every
3 years, and a separate advisory vote on the frequency of say-
on-pay votes at least once every 6 years. This section also
calls for new merger proxy disclosure about, and a shareholder
advisory vote on Golden Parachute arrangements. Although no
rulemaking deadline is specified, the Commission's goal is to
adopt final rules in time for the 2011 proxy season, since the
say-on-pay and say-on-frequency advisory votes apply to
shareholder meetings beginning January 21, 2011.
Section 957 requires the national securities exchanges to
amend their rules to prohibit brokers from voting uninstructed
shares on certain matters including executive compensation. On
September 9, 2010, the Commission approved changes to the New
York Stock Exchange rules that implement this mandate, and the
Commission expects to approve corresponding changes to the
rules of the other exchanges soon.
Section 952 requires the Commission to mandate new listing
standards concerning compensation committee independence and
compensation consultant conflicts of interest, and to adopt
related disclosure requirements. These rules generally must be
prescribed by July 16, 2011, and the Commission anticipates
proposing these rules soon.
Sections 953 and 955 direct the Commission to amend our
rules to require three new disclosures concerning executive
compensation:
First, the relationship between executive compensation
actually paid and the financial performance of the company.
Second, total annual compensation of the CEO, the median
total annual compensation of all other employees, and the ratio
between these amounts.
And third, whether employees or directors are permitted to
engage in certain hedging transactions against the downside
risk of company equity securities.
Section 954 requires the Commission to adopt rules
mandating changes to listing standards so that listed companies
will have to adopt and disclose clawback policies for
recovering compensation from current and former officers in
certain circumstances.
The Act does not specify deadlines for rulemaking under
Sections 953, 954, or 955, but the Commission's goal is to
publish proposals by July 2011.
Finally, Section 956 requires the Commission and other
Federal regulators to jointly prescribe regulations or
guidelines applicable to covered financial institutions,
including, from the SEC's perspective, registered broker-
dealers and investment advisers with assets of a billion
dollars or more.
The regulations or guidelines, which must be prescribed no
later than April 21, 2011, will require disclosure to the
appropriate Federal regulators of the structures of incentive-
based compensation and prohibit incentive-based payment
arrangements that the regulators determine encourage
inappropriate risks.
We are working with our fellow regulators to develop these
regulations or guidelines within this timeframe. The SEC's Web
site has a series of e-mail boxes to which the public can send
comments before the various Dodd-Frank implementation rules are
proposed and the official comment begins.
So far, comments on the executive compensation provisions
range from those expressing general concern about compensation
practices, to others providing detailed suggestions for
implementation of specific provisions of the Act.
The Commission is committed to ensuring that our disclosure
rules provide investors the information they need to make
informed voting and investment decisions and to implementing
the provisions of the Dodd-Frank Act, addressing compensation
issues as required by the Act.
Further, we are committed to working with our fellow
regulators to prescribe regulations or guidelines for covered
financial institutions to prohibit incentive-based payment
arrangements that encourage inappropriate risk, as mandated by
the Act.
Thank you again for inviting me to appear before you today.
I would be happy to answer any questions you may have.
[The prepared statement of Ms. Cross can be found on page
60 of the appendix.]
The Chairman. And finally, Mr. Marc Steckel, who is the
Associate Director of the Division of Insurance and Research at
the FDIC.
STATEMENT OF MARC STECKEL, ASSOCIATE DIRECTOR, DIVISION OF
INSURANCE AND RESEARCH, FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. Steckel. Good morning, Chairman Frank, Ranking Member
Bachus, and members of the committee. I appreciate the
opportunity to testify on behalf of the FDIC at this hearing on
the oversight of executive compensation after passage of the
Dodd-Frank Act.
The structure of employee incentive compensation programs
can affect banks' risk profiles and long-term performance.
Without question, compensation programs that rewarded short-
term profitability without accounting for risk were one in a
series of factors that contributed to the recent financial
crisis.
As deposit insurer, the FDIC brings a unique perspective to
the regulation of incentive compensation practices. When a
bank's compensation programs encourage the poorly managed risk-
taking that precedes many bank failures, the Deposit Insurance
Fund pays for the consequences of that excess.
Prior to the passage of the Dodd-Frank Act, the FDIC began
to increase its efforts to curb the risky compensation
practices that helped precipitate the financial crisis. As
early as November 2008, the FDIC and other Federal banking
agencies issued a statement addressing the need to rein in
risky compensation practices in an interagency statement on
meeting the needs of creditworthy borrowers.
In January of this year, the FDIC issued an advance notice
of proposed rulemaking to examine whether the FDIC's risk-based
assessment system should be updated to consider the risks
presented by poorly designed incentive compensation programs.
The ANPR solicited public comment on whether the deposit
insurance assessment system could be used to complement
supervisory standards--to incentivize banks to use compensation
programs that are even less risky than those allowed under
safety and soundness guidance and regulations.
Using the deposit insurance pricing system in such a way
would be consistent with existing features of the system,
which, for example, provides a comparative advantage to banks
that choose to operate with capital levels greater than those
mandated by supervisory standards.
The FDIC has reviewed the comments received in response to
the ANPR and continues to work with the proposal. While our
work isn't done yet, I can share that the Federal Deposit
Insurance Corporation does not seek to limit the amount of
compensation that employees can earn. Our view is that
addressing the structure of compensation programs would be a
more effective approach.
Moreover, we do not believe that a one-size-fits-all
approach is the best policy either. Our view is that employee
incentive compensation programs that are balanced and aligned
with the long-term interest of all the banks' stakeholders
present lower risk to the Deposit Insurance Fund.
Based on the comments received from the public, academics,
and others, and our own research, FDIC staff has identified
certain features of incentive compensation programs that we
believe can help protect the Deposit Insurance Fund.
First, boards of directors and senior managers of financial
institutions must take primary responsibility for ensuring
incentive compensation programs effectively align employees'
motivations with the long-term interests of the institution.
Second, portions of employees' incentive compensation
should be deferred and subject to meaningful lookback
mechanisms that allow awards to be reduced or rescinded if the
original justification or the award proves over time to be
invalid. Employees who have a portion of their incentive
compensation deferred have less incentive to engage in risky
behavior and, furthermore, must be concerned with the long-term
health of their employer to ensure that they will receive the
award at a later date.
In early 2010, the FDIC joined the Federal Reserve to
review compensation practices used by large banking companies.
Later, in June of this year, the FDIC joined the other Federal
banking agencies in issuing the interagency Guidance on Sound
Incentive Compensation Policies.
Turning to the implementation of the compensation
provisions of the Dodd-Frank Act, I would note that Section 956
is the provision that most involves the FDIC. This section will
strengthen the authority of the FDIC and other regulators over
incentive compensation practices at covered financial
institutions.
The FDIC has begun discussions with other regulators on how
to implement the requirements of Section 956. The FDIC will
continue to work with our fellow regulators and continue to
seek ways to bring our unique perspective and capacity as
deposit insurer to bear on this important issue.
I appreciate the opportunity to testify and will be happy
to answer any of your questions.
[The prepared statement of Mr. Steckel can be found on page
70 of the appendix.]
The Chairman. I thank all of you.
First of all, let me ask--we did try to work with you-- the
provisions of the bill that you all work with, my impression is
that those are generally consistent with the direction you were
going in on your own.
Are there any things in the bill that could be a problem
for you and that need to be fixed? We don't think so, but my
sense is that we were basically empowering you and encouraging
you to do what you wanted to do anyway.
Mr. Alvarez?
Mr. Alvarez. I agree with you, Mr. Chairman. We think this
has been very helpful. If there is anything that comes up as we
get further into this process, we will certainly come talk with
you.
The Chairman. Anybody else?
Ms. Cross. We agree.
The Chairman. The question, then, is what we are told of
course, is nice try, but all those smart business people will
outwit all those bureaucrats and they will come up with some
new ways. I think we anticipated that by giving you general
authority not to circumscribe.
But let me ask you, do you believe--first of all, you have
obviously begun talking to and have been talking to some of the
people you variously supervise. What is your sense of their
approach? My own view is that, frankly, if this is done
uniformly, a number of companies would welcome it; that is, we
have control for the competitive advantage, that if everybody
is under a set of fair rules, they appreciate that because you
don't have a kind of a competitive effect and the reaction you
are getting from the various institutions under your
jurisdiction.
Mr. Steckel, let's start with you.
Mr. Steckel. Thank you. We got comments on the Advance
Notice of Proposed Rulemaking that we issued earlier this year.
We got over 15,000 responses and most of them--in fact
predominantly, they were in favor of us pursuing some approach.
The minority of the comments we got were not supportive, and a
lot of those were sort of on technical matters, and there were
a few that were just philosophically opposed to the government
having any role in compensation.
The Chairman. Of course the FDIC had moved--the Federal
Reserve, before we acted, but I take it the statute is in
general consult with the direction were you moving in.
Mr. Steckel. That is right. I think the statute is
supportive of the approach that we were pursuing.
The Chairman. Let me ask you the final question I have,
which is the argument, yes, but all those smart people in the
financial institutions will outsmart all you stodgy bureaucrats
and all of us benighted politicians and find ways around all
this.
A two-part question. Is there any indication that they are
trying to do that? And if there is, do we need to give you more
authority in case they do? Let's start with Mr. Alvarez.
Mr. Alvarez. I think one of the things that is helpful here
is that the banking institutions at least understand the
problem as well and accept the problem as well. So we don't
sense the motivation to get around what we are trying to do. We
find the institutions are really embracing the opportunity to
limit risk in incentive compensation.
I think your first two points, though, were very key to
this; we are not trying to limit the level of compensation. We
are not putting caps on salaries, so there is less incentive to
try to get around that. We are trying to align incentives and
aligning incentives is what the industry wants to do as well.
And also by having this broadly based across all banking and
financial firms, we remove the disincentive. I think firms were
very worried that if they were the first one to move, the first
one to limit this compensation, they would lose the best
people, and we are taking that away.
The Chairman. I think that was one of the things we had in
mind, which is as you were doing this through your various
agencies, unless you could have all done it in total lockstep,
which is hard to do, there would have been a complaint about
institutional advantage versus another.
Ms. Cross?
Ms. Cross. I would first note this will be a new role for
the SEC as it relates to the broker-dealer and investment
adviser compensation oversight. So my fellow regulators have a
head start, but we are learning from them and working with them
to get there. I think there are a few points worth noting that
should make this successful. I think first off is that it is a
principle-based approach as opposed to caps and so it is hard
to find--avoid a principle, the principle being that you are
not supposed to structure your compensation to create
inappropriate risks.
Another aspect that I think makes this successful is that
the compensation committee is responsible for oversight of
compensation, at least as to higher paid executives, and they
are subject to fiduciary duties and they will be accountable;
and there will be the say-on-pay vote so there are enough
different pieces of this to make it have a lot of sunshine and
a lot of shareholder input.
And then lastly we have--the SEC adopted disclosure
requirements last year that would require disclosure if you
have risks that expose you--have compensation programs that
expose you to inappropriate risks. So I think that combination
of factors suits us well and it should be successful.
The Chairman. Thank you. Mr. Steckel, do you have anything
you want to add?
Mr. Steckel. Yes, I do. There are two points, I think. The
FDIC has pursued a lot of thinking around the idea of deferral.
Large bonuses can be awarded and in many cases are earned and
deserved. We don't have an argument about that, but in some
cases they have been paid out but later the risks that were
assumed blow up and cause problems for an awful lot of people
and sometimes the public interest. We think meaningful lookback
mechanisms are an important part of this.
Also we have explored the topic of aligning employees'
interests, incenting employees to consider all of the banks'
stakeholders. We think current practice currently aligns
employees' interest with those of shareholders pretty well,
probably to the detriment of some other stakeholders.
The Chairman. Thank you.
Not as a question, but as to procedure, we are going to be
going to the second panel, which includes Mr. Baily who is,
again, a representative of the Squam Lake Group. So I would
hope that either you or some of your staff could stay behind.
We thought that was a very thoughtful, bipartisan cross-
Administration approach, and we hope you would able to listen
to what they say and work with them as well.
Mr. Bachus?
Mr. Bachus. Thank you, Chairman Frank. In my opening
statement I mentioned entertainers and athletes. But the
distinction that I would argue and I think is correct is
athletes and entertainers don't lose billions of dollars of the
assets of their corporations, and therefore there is no
negative impact on the shareholders and on the broader economy.
And certainly in the run-up to the Wall Street crash, we had
numerous instances of traders or employees who took what I
would call bad-tail risk, what you all--if that is the proper
word for it--which actually resulted in insolvency for those
institutions, to the shareholders, and taxpayers and the
general economy suffered. So there are obviously--I think to
address this and financial reform was the proper thing, and I
want to make that clear.
Incentive compensation packages, I think all Republicans
would agree with our members in the majority, a need to be
consistent with safety and soundness practices, particularly if
you have a Federal backstop or Federal safety net.
As we found with systemic risk, our large corporations I
think it is essential, because of the interconnectivity of the
economy, as we have all learned.
I do think with bad-tail risk, that is something I would
assume you are all going to focus on, because we found out that
really one employee, or one or two employees can bring down the
largest insurance company in America. I think bad-tail risk,
you have defined it, or the regulators or the industry, as a
low probability of occurring, but if it does occur, a very high
risk of threatening the insolvency of the institution. So I
would say that is something that you really need to focus on.
I don't know with smaller companies where there is not a
Federal backstop, not a systemic risk if the role is not a
little bit different. But let me say this; your testimony was
very thoughtful, every one of you.
Let me conclude with a question. I usually ask questions.
That was a statement. But I do want to make it clear to
Chairman Frank and to the public that there is widespread
consensus not only among the public, but I think within the
financial industry and within the Federal regulators and all of
us, that compensation practices can threaten the safety and
soundness of institutions and that there has to be some
governance and oversight of that.
My question is, Nell Minow testified last year and she
said, ``I have a low confidence in politicians and
bureaucrats.'' So she actually addressed us in the least
favorable terms, but I will change that to Members of Congress
and government officials, that she has very little confidence
in them being able to review incentive compensation plans at
financial institutions not to micromanage. She's afraid, and I
think that is a fear we all have, that there will be too much
micromanagement. How will your agency embark on this joint
rulemaking and supervision without micromanaging compensation?
I will just ask, do you see that as a problem or could it
be a problem?
Mr. Alvarez. So the approach that we have taken is, first,
we are not trying to set the level of salary of individual
employees, we agree we are not good at that; that is up to the
corporation to deal with itself. So we have been focusing on
structure and process. We are making sure the board of
directors is involved in the decision-making. We are making
sure that the management can explain why it awards bonuses in
one situation and not in other situations.
We think that in order to deal with things like tail risk,
the corporation should take into account deferral practices and
clawback practices and a variety of other practices that are
being developed by the industry, by academics, by HR
professionals, risk management professionals, and bringing that
to bear so the risks that come about from incentive
compensation are not unintended and don't encourage greater
risk to the organization.
So we are not about micromanaging the actual pay for
individuals. We are about making sure the incentive structure
and process leads to a good result.
Mr. Bachus. And if I could get the other two to answer?
Ms. Cross. Although we are at the beginning of this, from
the SEC's perspective, we have the same approach in mind. And I
don't think we have any interest in micromanaging the pay. We
want to make sure we do what Congress directed us to do, which
is to work with our fellow regulators to come up with standards
that should decrease the risk of incentives that are dangerous.
Mr. Bachus. Okay, thank you.
Mr. Steckel. The FDIC has taken a fairly slow approach to
this, because as you study this and you try to do good policy,
it does become apparent that it is difficult and we want to
avoid unintended consequences. I agree with the others in that
we do not want to micromanage. We will not be setting pay
levels. But I think conceptually we do have an interest in the
structure of compensation and that large discretionary awards
in many cases should at least in part be deferred to see if the
tail risk does come up and cause a problem later.
We have spent a lot of time talking to industry
professionals over the past year to help us form our views, and
we are familiar with the work of the Squam Lake Group which has
influenced our thinking somewhat.
Mr. Bachus. Thank you very much. I appreciate it. I think
your written testimony is going to be very helpful to us and I
think, too, to the industry and to the public.
The Chairman. The gentleman from North Carolina.
Mr. Watt. Thank you, Mr. Chairman. I think I will pass. I
was hoping to try to get to hear the second panel's testimony
before I left, so I am going to try to expedite that. This
testimony is very clear. So, Mr. Chairman, I am passing.
The Chairman. The gentleman from Florida, I guess, was here
first by Republican rules.
Mr. Posey. Thank you, Mr. Chairman.
The Chairman. We will get to you.
Mr. Posey. I kind of want to echo the comments made by the
gentleman from Alabama. Your intent and your advice is
thoughtful and well-intended and I hope will be very effective.
But if we tend ever to use a cannon to kill a sparrow, it
causes a little bit more collateral damage than we intend
sometimes. And I just want to express that I think the more
complex you make the regulations, as the chairman said, the
more wiggle room you are going to have and the more plans to
circumvent it or take away the intent of what you are doing.
I think probably the absolute best accountability that we
can have is the absolute best possible transparency, and I am
not sure how all the compensation was arrived at. I am sure
much of it was made in contractual deals downstream that said,
if you do this you are going to get this. And so it may not
have been decisions made after the fact at all, and may not in
the future be made after the fact. It may be a predetermined
set of guidelines that you may or may not have any control
over.
I think with the transparency goes responsibility to have
strict enforcement and prompt prosecution for violations. As we
know, at the SEC we don't have a long history of that. And the
FDIC activities that I have seen most recently in my district
with the bank regulators gives me less confidence than ever in
that agency. I think they are--just as I mentioned in some
discussion yesterday-- going off in a wrong direction out of
fear or self-protection or whatever.
But I would appreciate during whatever time is left if you
could explain briefly the difference between a typical--and I
don't mean everyone would fit in that category--but a typical
executive compensation and the relationship between the
compensation committee and the chairman, or whoever they are
compensating, and the difference between that relationship in
the future as you foresee it under your guidelines.
Thank you, Mr. Chairman.
The Chairman. Was there a need for comment?
Mr. Posey. I would like a comment briefly from each of
them, if you don't mind.
The Chairman. I am sorry, go ahead.
Mr. Steckel. The FDIC, as a policy goal, I think our focus
is on material risk-takers. We are not interested in targeting
many, many bank employees who may get small referral bonuses or
small end-of-year performance bonuses that in no way could
influence them to affect the overall health of an institution.
But some higher paid employees can take those sorts of risks
and can get paid an awful lot of money for that. I think we
would tend to focus on those employees. There is really not a
problem to fix with lower paid employees, I don't think.
Ms. Cross. I will mention a couple points. Under the Act,
there will now be a requirement for listed companies that the
compensation committee be comprised solely of independent
directors, and there will be enhanced disclosures about
compensation committee independence. So I think that might get
at part of your concern.
On the who will do this work and what is their relationship
to the people that they are overseeing, boards of directors in
general are responsible for risk oversight at companies.
Sometimes they delegate that to a committee like a risk
committee.
At companies these days, what has been happening is the
compensation committee stays responsible for the executive
compensation and so including, for example, the CEO pay, and
there would be the requirement for independence in the future.
And then the risk oversight would be from the board overall and
that would be for the broader employee programs.
So I think there will be several different checks and
balances within the board, and particularly strengthened by
what you did in the Act.
Mr. Alvarez. I agree with the previous two about the
involvement of the board of directors, and independent
compensation committee in particular, in reviewing the CEO
salary as you raised.
The point I would add is that for the most senior
executives, I think we place particular emphasis on deferral of
incentive compensation awards with adjustment of those awards
as the risks mature and show up in an organization, so that
CEOs in particular have their incentive compensation adjusted
for the health of the company and the risks that show up in the
company in the future. Not all risks show up immediately, so
they need some time for those to mature and we would like those
to be reflected in the incentive compensation award.
Mr. Posey. Can I ask a follow-up question, Mr. Chairman?
Thank you.
But suppose that I am the person in charge of hiring a CEO
for my big bank, and I go to you and I say, look, I am going to
pay you the average salary, $800,000 a year, and I am going to
pay you a bonus based on, hypothetically, let's say 1 percent
of the net profits. And he performs. I got what I wanted, he
gets what he wanted; it will be $4 trillion under those
circumstances. But he wrecked us in the meantime. What are you
going to do?
Mr. Alvarez. The expectation is that the incentive
compensation award would have a way of reducing--deferring that
payment. So that 1 percent that you spoke of, the bonus
wouldn't be paid immediately; it would be deferred over some
period of time to allow the company to realize whether it has
been wrecked. And if losses do indeed show up, then that award
would be reduced. And what that does is, that removes the
incentive for the CEO to take big risks immediately because
they know those will show up in a reduction in their incentive
compensation at a future time.
Mr. Posey. I think that would be--one more question, since
we don't have very many people.
The Chairman. We are already 2 minutes over.
Mr. Posey. Okay.
The Chairman. The gentleman from Texas, thanks to the
generosity of the gentleman from Kansas.
Mr. Green. Thank you, Mr. Chairman. Again, I thank you and
the witness as well. I would like to just briefly explain why
in my opinion it is very important to talk about the amount of
the compensation. If we don't talk about the amount--and I am
not begging the witnesses to do so--but it is important for us
to do so. If we don't talk about the amount of the
compensation, we don't really get an understanding as to why
people would assume the types of risks that they assume, why
they have this incentive to do these things.
And systemic risk is not created by persons who make
minimum wage, not created by persons who are making $50,000,
$60,000, or $70,000 a year, generally speaking. This systemic
risk is created by persons who make hundreds of dollars per
second. I mentioned the CEO who made $534 per second, which in
about 28 seconds allows him to make what a minimum worker makes
all year. This is the kind of compensation what we are talking
about.
And I applaud the bill, I applaud Chairman Frank, and
Chairman Dodd. I applaud you for indicating that we are not
going to micromanage the pay of individuals; that is not what
it is about. It is about making sure that the pay doesn't
produce systemic risk, that is what it is about. But people in
the American public have to understand what the pay is, so that
they can see why people assume this type of risk and why they
will do these kinds of things. It is huge. The amounts of money
are escalating, they are not deescalating. The amount of
executive compensation has been consistently going up, while
creating this gap between low-income workers and maximum-income
earners. We are doing the right thing by putting into place
regulations that will curtail the taking of systemic risk,
which, in my opinion, helped to create the crisis that we had
to contend with.
And finally I will say this, as I am about to make my exit.
I have spoken longer than I actually intended to, but I do want
to say something about the athletes, if I may, and whether they
bring down a team. If they don't perform, the tickets don't
sell. If the tickets don't sell, the stockholders do lose
money. But that is besides the point.
The point that I really would make in terms of making a
distinction between the athletes and some of these persons who
make $500 a second is that the athletes pay ordinary income
taxes, the hedge fund manager pays capital gains tax, 15
percent ordinary income; it could be 36 to 40 percent depending
on how you count it.
But it is not about athletes, it is about systemic risk,
and it is about the inordinate amounts of moneys that I salute
people for making because they have a talent to make, but that
in some way can create liability for others when systemic risk
is produced.
Mr. Chairman, I thank you and I yield back the balance of
my time.
The Chairman. The gentleman from New Jersey.
Mr. Lance. Thank you, Mr. Chairman.
Good morning to you all. I think this is a very important
discussion. The bill states regarding incentive-based
compensation that the regulation community will decide what is
inappropriate.
Could each of you briefly give me your thoughts as to where
you might be headed, as to what you might consider to be
inappropriate. And I know it is a very broad question, but your
initial thoughts as to that.
Mr. Steckel. I think one thing that comes to mind is an
exorbitantly large guaranteed bonus that gets paid regardless
of the performance of the institution.
Mr. Lance. And would you likely place an amount as to what
is exorbitantly large?
Mr. Steckel. No, I don't think we are prepared to do that,
and I am reluctant to.
Mr. Lance. So ``inappropriate'' would be translated as
exorbitantly large.
Mr. Steckel. I think we need to have some policy
discussion.
Mr. Lance. Yes. Ms. Cross?
Ms. Cross. I would describe it in a more principle-based
fashion as pay where the risks to the institution outweigh the
rewards to the institution. So you would need to consider,
looking at the type of pay structure, whether it has that
impact. And if it does, it is inappropriate. You shouldn't be
paying people more to expose the company to more risk than the
company would be rewarded if it worked out well.
Mr. Lance. Thank you. Mr. Alvarez?
Mr. Alvarez. I agree with Ms. Cross. It is very nuanced,
there is no number, there is no automatic piece. It is about
the risk that is incented by the compensation and whether that
is something the company can handle.
Mr. Lance. Thank you. I am sure we will be reviewing it
with you as the process continues. Shareholders, of course,
will have the right on say-on-pay. I think the bill may be
somewhat ambiguous as to whether it should be an advisory or
binding vote.
Does the panel have a position on that? I think that is
particularly directed at Ms. Cross.
Ms. Cross. I am happy to address that. I think the bill is
actually clear that it is nonbinding as it relates to both say-
on-pay and say-on-frequency.
Mr. Lance. Yes.
Ms. Cross. There is some ambiguity as to whether the
frequency vote is nonbinding, but our view is, reading the
entire provision, that the part at the end that says it is a
nonbinding vote applies to the whole Section, so--
The Chairman. If the gentleman would yield, that is
certainly our intent, and if ever they felt we needed to
clarify it, we would I am sure be able to do that quickly. But
the intent was and, I think, in fact it is nonbinding.
Mr. Lance. Thank you. That is clarifying. And I am pleased
that the SEC is of that opinion, and I certainly defer to the
Chair. Thank you, Mr. Chairman. I yield back the balance of my
time.
The Chairman. Let me say, by the way, if I can have a
minute of unanimous consent. One reason that has to be
nonbinding is that if it was binding, you couldn't pay them
anything. It is just a practical thing. And the English
experience which we have looked to is that nonbinding is pretty
influential.
The gentleman from Kansas. And I appreciate his deferring
to our colleague from Texas.
Mr. Moore of Kansas. Thank you, Mr. Chairman. One of the
major concerns that continues to be raised by my friends across
the aisle and the business community is a lack of certainty
when it comes to the new rules businesses face. But given the
near collapse of our financial system, I don't know how anyone
can responsibly argue that a complete overhaul of our financial
rules, as we did with the Dodd-Frank Act, was not warranted.
And while businesses want certainty, they also want well-
thought-out rules that are not hastily written, creating
unintended consequences.
Given this strain between speed and quality rulemaking,
what steps are your agencies taking to implement the new rules
quickly, while also performing due diligence to improve
executive compensation rulemaking?
Mr. Alvarez. The banking agencies have already issued
guidance. We sought public comment from the industry and from
consumer advocates and others about the policies. And we have
already begun, actually, our horizontal review or examination
of the practices at large organizations, which involves a
dialogue with them about how best to improve their systems, the
philosophy they bring to incentive compensation, and then the
principles that we are trying to get them to adopt.
Mr. Moore of Kansas. Thank you. Ms. Cross?
Ms. Cross. With regard to the SEC's rulemaking initiatives,
both for the executive compensation matters and all the other
matters under Dodd-Frank where we have rulemaking, we set up
public e-mail boxes where people can send in their comments
even before we start with public rulemaking, so that we are
able to take those into account as we get the rules ready for
the public; and then, as always, will benefit from the public
comment that comes in.
We are also meeting with many interest groups and posting
the agendas from those meetings on the Web site so the people
can see the topics that are under consideration. We agree it is
very important that we have all the due diligence we can have
so that these rules work well.
Mr. Moore of Kansas. Thank you. Any comments, Mr. Steckel?
Mr. Steckel. Yes. Chairman Bair has made this issue a
priority, before and after passage of Dodd-Frank. We think
Dodd-Frank helps us to our end and we are going to continue to
pursue this vigorously.
Mr. Moore of Kansas. Thank you. And I have one more
question. We have all focused on what went wrong in the
financial crisis and I think it is very appropriate, but I
think it is equally as important to learn from the responsible
actors and build on their successes.
So last month the oversight committee I chair held a field
hearing in Kansas to learn from responsible Midwest banks and
credit unions who were not the cause of the financial crisis.
And my question is, with respect to the new executive
compensation rules that your agencies are drafting and
implementing, what will it mean for community banks and credit
unions? And in the rulemaking, are you avoiding one-size-fits-
all approaches that may unfairly discriminate against smaller
firms?
Mr. Alvarez. Sir, we have been quite clear in our guidance
that we expect the types of adjustments on incentive
compensation to vary based on the complexity, size, and use of
incentive compensation by firms. So smaller banking
organizations tend to not use incentive compensation very much,
and they also have short, flatter organizations, much easier to
police, and understand the risks that are associated with
incentive compensation. So we haven't seen a problem coming up
with smaller organizations. So our guidance makes allowance for
that.
Mr. Moore of Kansas. Thank you.
Ms. Cross?
Ms. Cross. I will cover your question as it relates to the
other executive compensation rulemakings since the banks are
really for my fellow regulators.
There are numerous provisions in the Dodd-Frank Act that
tell us to consider the impact on small business as we
implement the rules, and we will carefully, carefully do so and
request comment so that we can calibrate the rules
appropriately, so that we don't unduly burden small business.
Mr. Moore of Kansas. Thank you.
Mr. Steckel?
Mr. Steckel. Yes. I think you are right. There are an awful
lot of small banks that use limited, if any, amounts of
incentive compensation as part of their business model, and we
will specifically not target them. I don't think they are the
problem that we are trying to address here.
Mr. Moore of Kansas. Thank you very much to the witnesses.
Mr. Chairman, my time is nearly up. I yield back.
The Chairman. The gentleman from North Carolina.
Mr. McHenry. Thank you, Mr. Chairman.
I certainly appreciate your testimony. I wasn't here for
your verbal testimony, but I have read your testimony.
How do you plan to deal with multinationals? Section 953
has been cited by some as a logistical nightmare. How do you
intend to deal with an individual's compensation to the overall
firm's earnings and income that is not simply a domestic bank
but a multinational?
Ms. Cross. I think that one is for me. We are just
beginning the rulemaking process, and we expect to propose the
rules under 953 next summer. It doesn't have the same deadline,
so we will have the opportunity as we prepare the rules to get
input from everyone about how we should address those concerns.
We have heard that there are worries about the logistics of
figuring out the pay in a multinational firm. So we are looking
through those provisions now, working with all the interested
parties, and we will put together a rule proposal we think can
best implement it in a way that is workable.
Mr. McHenry. Okay. So, generally speaking, you are going to
do what you normally do, which is you are going to input and
make a rule; that is basically what you are telling me?
Ms. Cross. The Act directs us to adopt a rule to implement
that provision. So we are doing what we are tasked to do under
the Act.
If we run into problems, we will let you know, and we will
come back if it is something that isn't workable, but we would
first like to try to see if the rule can be implemented in a
way that results in implementing what we have been tasked to do
in a way that is workable.
Mr. McHenry. Okay. Yes.
Mr. Alvarez. One thing I would add, in the banking area,
there is an awareness worldwide that incentive compensation
practices need to change, and we have been working with some of
our foreign counterparts, especially through the Financial
Stability Board, to develop standards that are being used on an
international basis. Our guidance is very much in tune with the
international direction of the FSB. So we are actually
heartened that the other parts of the world are seeing the
importance of all of us moving down this road together.
Mr. McHenry. How important do you think that is with
basically foreign standards that are similar to ours?
Mr. Alvarez. I think it is very important because of the
incentives that are created. We don't want to lose our best
talent to foreign competitors or have businesses move offshore
in order to avoid incentive compensation rules. So it is
important that this be an international work.
Mr. McHenry. Certainly.
Now, Ms. Cross, you mentioned to my colleague from New
Jersey that weighing the balance of pay, an individual's pay,
whether that--the potential gain outweighs the systemic risk,
that is basically what you are--similar to what you said; isn't
that right?
Ms. Cross. That is right.
Mr. McHenry. Isn't that in many respects in the eye of the
beholder?
Ms. Cross. Again, I think that I would like to emphasize
that we don't envision micromanaging the pay of any particular
individual. It is much more of a structural question. So, as
you develop guidelines or regulations that set forth standards
for how the pay is to be structured, limitations really on the
structure of pay that would present those risks, as in the
guidance that has already been issued, you would look in terms
of, what risk does it pose for the company, and are they
appropriately calibrated? Yes, it is in the eye of the
beholder, but the compensation experts have significant input
and have, I think, reflected in the guidance that you can
calibrate it to appropriately reflect risk.
Mr. McHenry. So, therefore, a trader and a CEO can have
different rules?
Ms. Cross. I think that is right. I think there would be
different structures that would be appropriate for a trader
versus a CEO.
Mr. McHenry. Okay. But even in the case of some similar
failed institutions that the Federal Government has a
significant ownership interest in currently, in different
sections, different divisions of the company, you have people
compensated in very similar ways. One lost billions of dollars
for the institution; the other made hundreds of billions of
dollars for the institution. So even with basically the same
incentive packages, you are going to have widely variant
outcomes and widely different systemic risk based on the nature
of their business; is that fair to say?
Ms. Cross. I think that has historically been the case. And
I don't want to speak for the folks who have already done this,
but the horizontal review they have been going through to find
out what are the compensation practices throughout these
organizations should help us as regulators develop guidelines
that would be appropriate so that is more appropriately
calibrated throughout the organizations.
The Chairman. If the gentleman would yield, I would
acknowledge when I called this hearing I was thinking frankly
about the provisions that we initiated, which was the say-on-
pay and executive piece. The Senate added that other piece, and
I share some of the questions about that. I think it was
imprecisely worded. It is not clear.
It seems to me if you look at the wording literally, an
inappropriately large number of people are involved in the
comparison, and obviously if that can be worked out, okay. But
we are very much open to try to fix that legislatively because
that was the Senate piece, and you are right. It is
appropriately on the table.
Mr. McHenry. And let's understand that truly the debate is
not between Democrats and Republicans. The true enemy is the
Senate.
The Chairman. In this case, there is the House-Senate
difference.
Mr. Bachus. Could you further yield? And I appreciated
those questions. I thought they were insightful.
One of the things that I know in the written testimony that
you address, similar to that last question, is that
compensation doesn't vest immediately, and therefore, although
a trade may have a short-term positive, it may be a long-term
disaster. And we talked about the bad-tail risk, and even if
you have one trader who makes a half billion dollars, you have
another trader who gets wiped out for $2 billion--which we have
seen, a very large amount. So the fact that one could make and
one could lose, if the one that loses bankrupts a corporation,
that is a serious risk.
But the other thing is, that often you can maximize short-
term profits at the sacrifice of long-term profits.
The Chairman. If the gentleman would yield. I think we all
agree that is why we haven't tried to be too rigid but have
given discretion to the regulators, precisely on that
compensation.
The gentleman from Minnesota.
Mr. Ellison. Thank you, Mr. Chairman, and thanks for
pulling this hearing together. I only have a few questions.
My first question is, in light of the passage of the Frank-
Dodd bill, the provisions on compensation, have you seen
adjustments within the industry? Have you witnessed any sort of
a self-correcting conduct that would sort of align compensation
with proper incentives for the company?
Mr. Alvarez. We have been doing a horizontal review where
we are actually looking at the practices, and we are finding
that institutions are taking steps on their own. They have
identified some of the very same problems that we had
identified in the guidance. They want very much to remove
incentives to folks to increase risk behind the backs, as it
were, of the control systems these organizations have put
together. So we are finding good cooperation. There are still a
lot of uncertainties. There is still a lot of work that needs
to be done.
One of the things, for example, that is difficult is
getting good metrics for risk. Some areas are easier to
identify risks than others. You may be able to identify, for
example, mortgage loans and the loss rates on mortgages, but it
is not always easy to identify if a certain strategic move is
going to work out. So it takes some time for those things to
develop.
So we continue to work with organizations to find good
metrics and to use judgment that is well informed when there
are not good metrics, but as a general matter, we think the
institutions are willing and interested in making change.
Ms. Cross. I would note that the concept of finding out
whether pay creates inappropriate risk is a relatively new idea
that people are just learning about, and so, for example,
particularly at the nonbanks, the sort of rank-and-file public
companies, they are in the process now of doing inventories of
their incentive programs and figuring out, do these create
inappropriate risks for the companies? And it has been a very
good exercise I think for boards to hear what kind of programs
there are and what kind of risks they may pose, and then the
companies over time can revise those programs. So I think this
is not just at the financial institutions. I think it is
throughout our capital markets, which is a very healthy thing.
Mr. Steckel. I would add that we see banks paying a lot
more attention to this recently than say a few years ago. Both
the passage of Dodd-Frank and also a lot of bad press that was
out there about these companies pushed them in that direction.
We also think that the rulemaking that is required under Dodd-
Frank is also necessary to make sure we don't, over time,
backslide to some of the bad practices that occurred years ago.
Mr. Ellison. Can you all report on what you are seeing
about these rules and the legislation and the application of
the rules that are being promulgated on people who work below
the top executive level? So many decisions are not made at the
top executive level, and I think it is important we pay
attention to those incentives as well.
Just a very quick story. I met with a group of people who
worked in a bank, and they were told they couldn't hand back
over overdraft fees that they were urged to push people to open
up new accounts, and these are people on the bank level working
with customers. Their incentives were to have people open up
more accounts so they would generate more fees, have, you
know--not push back overdraft stuff, and there is just a lot of
pressure on these line employees. I don't think this will
work--do you see that this bill could affect the way they are
compensated? Do you see it traveling down that far?
Mr. Alvarez. Our guidance specifically provides that it
must. We don't deal just with senior executives. We deal with
any employee or group of employees who can increase materially
the risk to the organization.
And what we had in mind, another example, are mortgage
originators. Mortgage originators may not make very much money
themselves individually. On the other hand, it is important
that a firm understand the incentives it creates when it gives
bonuses to those folks. Is it encouraging them to just increase
volume without regard to risk or increase the volume without
regard to compliance with the law? There are lots of things
incentive compensation practices in the mid-2000's did that I
think we all regret now.
So one of the things we have been trying to do--and this is
an area where I think there needs to be a little more work by
banking organizations--is to identify those groups who are
lower paid employees but who do receive incentive compensation
and do, as a group, add risk to the organization.
Mr. Ellison. Are you in a position to hear from some of
those employees? Because I can tell you that some of them are a
little nervous about talking to me. I had to promise not to
identify their company. They told me about a lot of pressure
tactics they were under. Is this something you have been able
to do is to hear directly from them?
Mr. Alvarez. We do hear directly from some employees
through a variety of ways. We also are getting the actual
incentive compensation policies that apply to them so we have a
chance to look at the actual document.
The Chairman. If the gentleman will yield, that is a very
important point. We will work with our colleague to make sure
that we have channels whereby that kind of information can be
sent along in a way that would protect the individuals. We will
work with you. The time has expired. I thank the panel. This
has been useful. We have a work in progress here.
I will say there are some of these things initiated in the
House, some in the Senate. My own view, as was indicated by the
questions from my colleague from North Carolina, is that the
House pieces were somewhat better organized than the Senate
piece and that more work will have to be done on that, and we
will be working with you on it. We don't rule out the
possibility that it will have to be further amended.
I thank the panel.
I now call up Martin Baily and Darla Stuckey. Thank you.
And we will begin with the testimony from Martin Baily, who
is a senior fellow at the Brookings Institution, and was part
of the Squam Lake bipartisan group of economists who had
significant government service who met to discuss this, and Mr.
Baily is a former chairman of the Council of Economic Advisers.
Would someone please close the door, as you will never know
who will wander in here?
Mr. Baily?
STATEMENT OF MARTIN NEIL BAILY, SENIOR FELLOW, THE BROOKINGS
INSTITUTION
Mr. Baily. Thank you, Chairman Frank, Ranking Member
Bachus, and members of the committee. It is a great privilege
to be here.
In a sense, I guess, I am representing the Squam Lake
group. I do want to mention that I think they see themselves
primarily as a group of finance academics. There are a few of
us who have served in government. I was in the Clinton
Administration, as you mentioned. Fred Mishkin was at the
Federal Reserve. Matt Slaughter was in the Bush Administration.
But most of the group are actually finance academics, and they
got together in an attempt to see if there is anything from
finance theory and practice that could contribute to financial
sector reform.
It is also, as you said, a range of views. Sometimes, we
have had to be sort of dragged together to form a consensus,
and I do want to say one or two of the things that I will say
today may not represent the views of the whole group.
Let me get started then. I think the Dodd-Frank Act made
substantial steps forward towards improving regulations but,
obviously, left a fair amount to be done by the regulators. So
I think it is very appropriate. I applaud you for holding
meetings such as this.
Some of this, as was mentioned earlier, has to be done at
the international level, and historically, the international
level hasn't been a great forum. The Basel process has not been
either timely or effective. There is some sense, I think, that
the financial crisis lit a fire under them, and they are doing
a better job now, but that is something certainly we have to
monitor.
Now, the two recommendations from the Squam Lake group that
relate to compensation are, first, to discourage any regulation
of the level of the compensation, and we have had already quite
a bit of discussion of that, and that is in line with the Dodd-
Frank Act. So I don't know I need to say a lot about it.
I think if I were to make one comment it is that we do
indeed have a very wide and widening income distribution in our
economy, but it is a much more fundamental problem than just
the financial sector. It has to do with, are we providing the
right skills to people; do we have the right tax system, and so
on. So I don't think that was a matter for financial
regulation. I agree with you, the decision you have made about
the level.
Our recommendation is that the regulators should look at
the structure of compensation to make sure that it is aligned
with the interests, not only of shareholders in the institution
but also of taxpayers who may get called upon to bail out this
institution, and I know we have put in place various steps so
that we should not have to bail out financial institutions, but
we don't know what is going to happen in the future, and I
think it is an important tool in the arsenal to make sure that
we have the right compensation structure to reduce that
possibility.
We want to make sure that when executives are making
decisions about the risks they are taking in their own
institutions, they are not sort of in the back of their minds
thinking, if things go wrong, I can get supported by the
taxpayer, either in the form of the FDIC or somewhat in the way
that happened, unfortunately, in the crisis.
A major goal of capital market reform should be to force
financial firms to bear the full cost of their own actions, and
as I said, we propose several mechanisms and there are such in
the Dodd-Frank Act to do that, but compensation is a useful
tool.
Systemically important financial institutions should
withhold a significant share of each senior manager's total
annual compensation for several years. The withheld
compensation should not take the form of stock or stock
options. Rather, each holdback should be for a fixed dollar
amount, and employees would forfeit their holdbacks if the
government goes bankrupt--excuse me, if the firm goes bankrupt
or receives extraordinary government assistance. So we want to
make a very direct link between taxpayer interest and incentive
on the senior managers of the company. We want to hold them
accountable for the possible failure of their company.
Now, I talk in my written testimony a little bit about what
is currently in the Dodd-Frank Act versus our proposal. I talk
a little bit about what regulators are doing. We have heard
about that already here. I talk a little bit about what has
been proposed in the U.K. financial services authority because,
as was noted earlier, it is a good idea to have harmonization,
and obviously, London is the other main financial center. This
should be more broad than London, but that is obviously the
biggest alternative to New York as a financial sector.
So let me just draw my conclusions. I am running out of
time already. Here I will express my one concern about whether
the Squam Lake--
The Chairman. We understand. Take another couple of
minutes. We have only a few people. So take another couple of
minutes.
Mr. Baily. You shouldn't encourage me to blab on, but I
will finish quickly.
My only concern with the Squam Lake recommendation is
whether or not it goes quite far enough, deep enough down the
organization. If you have a large organization and an
international organization and you are a trader and you see the
benefits to you in terms of your bonus of taking on certain
kinds of risks, I think the notion of worrying about taxpayers
or if the firm might actually go broke and have to be put in
receivership with the FDIC or something, that may seem a little
bit too remote.
So the way in which I myself would go a bit further--and it
is along the lines of the testimony that was given earlier--is
that each company should work with its regulator, the Federal
Reserve or the FDIC or the SEC, to describe what their
compensation structure is, how it lines up with their own
internal risk management structure, and that they are, in fact,
providing the right holdbacks for traders and for other folks
within the company to make sure that we don't go to the edge of
the precipice; in other words, that we build in incentives for
traders that might take big, risky bets but that wouldn't
necessarily drive the company into bankruptcy but would pose
additional risks on the system.
But I do stress that not everyone at Squam Lake agrees with
that. There was a good bit of concern among members of the
Squam Lake group that we don't want to overregulate this. And I
agree with that. We want to maintain incentives for
performance, for innovation, all the things which help this be
a dynamic sector.
I will stop there. Thank you, Mr. Chairman.
[The prepared statement of Mr. Baily can be found on page
49 of the appendix.]
The Chairman. Thank you.
Next is Darla Stuckey, who is the senior vice president for
policy & advocacy for the Society of Corporate Secretaries and
Governance Professionals.
Ms. Stuckey.
STATEMENT OF DARLA C. STUCKEY, SENIOR VICE PRESIDENT, POLICY &
ADVOCACY, SOCIETY OF CORPORATE SECRETARIES AND GOVERNANCE
PROFESSIONALS
Ms. Stuckey. Thank you, Chairman Frank, and Ranking Member
Bachus.
I am here today on behalf of the Society of Corporate
Secretaries & Governance Professionals. Our members include
corporate secretaries, securities lawyers, compliance officers,
and even some executive compensation plan administrators. They
work in companies of every size and every State and in every
industry. I would love to talk more about us, but if you would
like to know more, please go to governanceprofessionals.org.
You have asked for our views on the effects of the
implementation of the compensation-related provisions of Dodd-
Frank, particularly as they affect risk taking and particularly
in the financial services area. Without taking a position on
the impact of the Act specific to financial services companies
only, since all companies are covered by Dodd-Frank, we do
believe that the governance changes under Dodd-Frank, along
with the SEC rules implemented since the crisis of 2008,
generally will help companies manage and oversee risk and
further corporate accountability.
Our members who are financial services companies simply
request that the SEC, the Fed, and the FSA coordinate their
compensation rulemaking and do so soon.
You also asked for our views on what the Federal regulators
should consider, so I now turn to three of the executive comp
provisions, and I apologize if you have spoken about these in
the first panel at length, but I will talk about say-on-pay, a
little bit on pay ratio, and clawbacks, as well as I would like
to talk--
The Chairman. No apology. We want your opinion. The fact
that the other people talked about it makes your opinion even
more important. So, please, go ahead.
Ms. Stuckey. Okay. Thank you. I also would like your
indulgence to talk a minute or two about the whistleblower
provision in Dodd-Frank, which is not specifically executive
comp related, but is very important.
First, say-on-pay and say-when-on-pay. You know what say-
on-pay is, the shareholder vote on executive comp. It is
effective for meetings after January 21, 2011. Our only concern
with this is that the SEC's schedule as submitted may be too
late. We urge the SEC to propose these rules soon in October,
so the rules will be out in early January so we can hit the
January 2011 target. Given the short timeframe that we have, we
suggest they implement rules similar to the TARP companies.
They have had it for the last 2 years. Our members would use
that as a model and get that done.
The Act also requires companies to give shareholders a vote
on how frequently--this is what we call--how frequently they
should get say-on-pay, we call say-when-on-pay. I guess the SEC
calls it say-on-pay frequency.
With respect to say-when-on-pay, SEC rulemaking should
provide boards a choice this year whether to offer a resolution
with their own single recommendation, for example, 2 years; or
to give a multiple choice resolution where the shareholders
could pick: A, B or C; 1, 2 or 3 years. We believe that this
has to be driven by boards and managements. They are in the
best position to recommend the frequency to ensure that the
timing of the vote is aligned with respect to compensation
programs, many of which are driven in 3-year increments. The
shareholders will be able to express their views.
Finally, on this one, the SEC should clarify that a
shareholder proposal seeking an alternative 1-, 2-, or 3-year
scheme would be excluded from a proxy statement. This would
avoid unnecessary uncertainty or a conflict with the company's
resolution, and we don't think it was your intent to have say-
when-on-pay votes every year in the 6-year period.
Pay-ratio disclosure, I heard some of the colloquy. As you
know, it does, by construction, apply to all employees. We
would hope that all employees becomes all U.S. employees for
U.S. companies and all U.S. full-time employees. We realize
this rule won't be implemented until next summer or looked at
until next summer, but we think that we need technical
clarifications during this time, and we believe that the
clarifications should be driven by intent and practical
reality, which you have already heard. We don't believe that it
was Congress' intent to include workers all over the globe to
compare to U.S. CEO's, and in addition, it is quite, quite
burdensome.
One other thing that would help immensely with this and
that we believe the statute should be clarified to provide is
that total comp means total direct comp. That is cash: that is
base salary, cash bonuses, equity comp, but not pension
accruals, 401(k) matches, and other noncash items.
Clawbacks: The Act also requires companies to implement
policies to recapture incentive comp that would not otherwise
have been received in the event of a restatement. This clawback
provision is mandatory, provides no board discretion, covers
all present and former executive officers, does not require
misconduct, and has a 3-year look back; it goes well beyond
existing law and practice today. Our biggest concern with this
is that boards must have some discretion in this area to
implement a clawback. At the least, it must be allowed to
determine if recoupment would cost more than the expected
recovery amount is worth; that is, whether you have to pursue
litigation to get it back, the likelihood of recovery, whether
it violates any employment contract, and there are also some
State law concerns, that it would violate State law provisions.
Surely Congress didn't intend to require clawbacks even
where the recovery is less than the cost to recover it. For
this reason alone, it is very simple: Boards must be given some
discretion. So we urge the SEC to do that in its rulemaking,
and at this point, I would recommend to you there is a letter
from the Center on Executive Compensation attached to my
testimony.
The Chairman. Letter from whom?
Ms. Stuckey. The Center on Executive Compensation. It is
attached to my written testimony.
The Chairman. Center for?
Ms. Stuckey. Executive Compensation.
Finally, I will turn now to the whistleblower bounty
provision, and I appreciate your indulgence.
It is in every company's best interest to have a robust
compliance program, but the SEC and the U.S. Sentencing
Commission strongly support effective in-house compliance
programs that can prevent and detect criminal conduct or other
wrongdoing.
Section 922 of Dodd-Frank states that the SEC shall pay an
award to whistleblowers in cash between 10 and 30 percent of
any money they receive over $1 million that either they
collect, the U.S. Attorney collects, any other SRO or any State
Attorney General, as a result of the whistleblower's
assistance. Importantly, the bounty depends on whether the
informant provides original information to the SEC. That is, if
an employee is aware of a potential violation and wants to
report an issue, he now has to choose whether to raise it to
the company or with the SEC.
Employees have long been trained to raise issues first with
their superior, alternatively with an ombuds or an ethics
hotline or even to the chair of the company's audit committee.
Under the new whistleblower provisions, an employee will
now have a significant financial incentive to bypass raising
the issue with the company at all for fear of losing the
bounty, because if he raises to the company first, the company
might beat him or her to the SEC.
And if you believe the New York Post, the threat is real.
Yesterday, the Post reported that when the new movie, ``Wall
Street: Money Never Sleeps'' opens Friday, today, moviegoers
will see an advertisement prior to the movie recruiting
whistleblowers who know of misconduct at their companies. The
ad will inform people of the potential riches that can come
with being a whistleblower, letting them know that they can
make money and also do a good thing. The ads also tell people
that they can remain anonymous, and it also provides them with
the address of the new whistleblower Web site, SECsnitch.com.
We don't believe this was the intended result of this
provision, having employees bypass their companies. It is
contrary to long-established public policy, and it also
undercuts the well-established internal compliance programs put
in place after SOX that companies have spent so much money on.
We suggest that the statute grant bounties but not on the
condition that the whistleblower bypasses the company.
Finally, we believe the SEC should refer to the defense and
health care industries, which have long had to deal with false
claims cases and have experience in this area.
I encourage you to review my written testimony, and I think
my time is up. I thank you.
[The prepared statement of Ms. Stuckey can be found on page
86 of the appendix.]
The Chairman. I thank both of the witnesses for their
testimony.
Let me say to Ms. Stuckey, as I did when the gentleman from
North Carolina raised it, the provisions about all
compensation, the comparisons, did originate in the Senate. We
have some questions about it. I guess it would seem clearly
there would be a consensus that it shouldn't be every single
employee. Now, I don't know whether it was drafted with enough
flexibility to allow that, but if necessary, we would have to
step in. I think that is clearly the case, and that was not one
of the issues that we thought most important.
So that would be our general sense would be to--we will be
urging the SEC to narrow that, if possible, and if not, then we
would do it statutorily if we have to, which clearly is
necessary in that regard.
Mr. Baily, you did note that with regard to how deep into
the company we get, you had your own views they were not
universally shared by the Squam Lake group. One question, is
the Squam Lake group a one-time group? Are you guys going to
hang out some more, or what can we expect from Squam Lake?
Mr. Baily. We are going to hang out more. There is some new
stuff that is going on to look at, the GSEs, Fannie Mae and
Freddie Mac and a couple of other things. One or two members of
the group have made a graceful exit, but we are still in
business.
The Chairman. With regard to the GSEs, I would advise you
not to waste your time to advise us on the post-GSE regime.
There will be no more GSE's. I think that is fairly clear. We
will obviously be open to what would be replacing them, and
that will be very important. The gentleman from Alabama.
Mr. Bachus. Thank you, and Mr. Chairman, I want to
associate myself with Ms. Stuckey's remarks about the SEC
getting their rules on say-on-pay out as soon as they can
because businesses need to make decisions, and it would be very
helpful. It would give certainty, which is always, I think, a
good thing.
Let me go back to the question of Ms. Stuckey, for purposes
of the median pay ratio disclosure, you said that it ought to
apply only with U.S.-based full-time employees, and I tend to
agree with you on that, but because this covers all--I am not
sure anybody said this. This is not just financial companies;
953 applies to all public companies, which in itself, we have
talked about financial companies getting in trouble and the
safety net. But would you go ahead and just explain for the
record why you believe only U.S. employees.
Ms. Stuckey. Sure, I would be happy to. I don't believe--it
sort of caught our group by surprise and I understand that
there is some appeal and there have been statistics quoted by
the media in the past about average worker pay to CEO pay, and
I am not sure how correct those are. So I can understand why
someone would want to know what the average worker makes.
We don't really think that institutional shareholders
particularly care about this number, but companies are willing
to implement Congress' intent, and it could be hugely
burdensome. And without sounding like I am whining, if you are
a multinational company and you have 100,00 employees in 20 or
30 or 40 countries, there are lots of pitfalls. There are
cross-border issues, like exchange rates. There are privacy
laws in France, for example, that might not even allow you to
do this, all kinds of things. So if you are willing to work to
make this only U.S. employees, a lot of corporate secretaries
and human resource professionals will breathe easier. So this
is a situation where we don't think the cost would outweigh the
benefit of what the number is.
And the reason why we don't think that the pension number
should be included is the pension number certainly is known for
the CEO and the top five folks, but in order to find the median
employee, it is very different than finding an average. You
have to do an actuarial pension calculation for each of your
8,000 people, say, in the pension plan, and that is for a
medium-sized energy company in the Midwest that I spoke to.
To do a pension calculation for 8,000 people and line them
up in a row and pick the middle guy or gal, that is a huge
burden. So we would urge you not to include that at all, but
even if you wanted to include that, to allow the calculation to
be done without that, find the middle person, then add the
pension back in and then do the ratio, if you understand what I
mean.
Mr. Bachus. I do and let me say this. I agree with you that
this would be a very burdensome problem.
Mr. Baily, do you have any comment on it?
Mr. Baily. I am quite concerned about the level of poverty
in the United States. I am quite concerned about the fact that
ordinary workers have not done very well in the last few years.
I don't see how publishing that ratio helps anybody very much.
So I am not a big fan of that.
The Chairman. If the gentleman would yield, I would note
again, that was a Senate provision, and I think our inclination
is to see to what extent it can be lessened as a burden, and if
not, we would be able to work to try and change that next year.
Mr. Bachus. I think that is very helpful, and I think there
is somewhat of a consensus building.
Ms. Stuckey, what are some of the other potential hurdles
or pitfalls to public companies complying with the Dodd-Frank
compensation provision?
Ms. Stuckey. I can mention one that I cut out in the
interest of time, and that would be the pay versus performance
disclosure. There is a new provision that the SEC provide rules
on this, and I think companies are anxious about this because
they want the rule to be written flexibly enough to explain,
whether it be in draft form or not, how compensation actually
paid is tied to performance.
The current compensation structure of the current chart is
not easy to understand. And they want to be able to tell--
boards and comp committees want to be able to tell their story,
to explain which point in time relates to which compensation,
and that some compensation may be granted in year one. It may
be a reward for a past year's performance. It may be incentive
for a future year's performance. Some compensation is based on
just 3-year straight line performance pay based on net income.
But they want to be able to show that at the bottom level,
and you may not want to hear this, but at the bottom level,
they want to be able to show that their executives are vested,
just like the shareholders, and when the share price falls,
they hurt, too. So their options become underwater, and the
comp number that maybe the media reports isn't really what they
got. So we want the SEC to write rules flexibly enough so that
companies can tell that story.
Mr. Bachus. Okay. Thank you.
Mr. Baily, do you have any comment on that?
Mr. Baily. No, I don't have any further comment on it.
Mr. Bachus. Thank you.
Thank you, Mr. Chairman.
The Chairman. I would note again that the provision just
being discussed is another United States Senate provision. So
we will be approaching with some--we will take a fresh look at
it.
The gentleman from Florida.
Mr. Posey. Thank you, Mr. Chairman.
Mr. Baily, did I hear you correctly that before employing
employees who should or could be subject to executive
compensation requirements, that they should work with the FDIC,
the SEC or whoever ahead of time before they make arrangements
to employ these people, that they should work with them, they
should go to a bureaucrat and get their plans approved or get
some kind of warm and fuzzy from them?
Mr. Baily. Maybe I misstated or maybe I am misunderstanding
your question. I think there is a process going on now where
the regulators that are approving the risk-management
structures within companies so that they are meeting risk-
management standards are asking them to explain what their
policy is on compensation.
It is not that I want them to say, this is the amount going
to each employee and we are going to approve that going to each
employee. No, I don't think that is a good idea at all, but
what is their policy and does it meet the requirements for risk
management, both in terms of their own desire to reduce risk
within their institution and to make sure that they are not
putting taxpayers in risk should something happen to the
company?
Mr. Posey. Did I understand correctly--and I will look at
the transcript--but you suggested they should go to the FDIC,
the SEC or someone beforehand to make sure that their plans are
going to be compliant in advance, like there is some latitude
given to the bureaucrat to make this judgment call, and they
would have some type of influence on the committee who is
setting the compensation outside of clear and unambiguous rules
that apply to everyone that should be easily understood by the
sector of this country that provides jobs and produces and
gives us a GDP that we enjoy, that regulates a lifestyle that
we had, that we are going to have those people go to a
bureaucrat and get an opinion or try and get some kind of feel
good signal in advance before they cut a deal?
I hope that is not what you said and that is not what the
transcript will say because I find that appalling. I find that
is probably the quickest way to destroy the economic system we
are trying to get to recover, but that would probably do more
damage than anything else when you have that kind of intrusion,
unclear, very ambiguous, could be arbitrary, could be
capricious, affecting private companies', public companies',
opportunity to do business.
I would think that you would say, here are the rules, if
you don't go outside that box, you are okay. If you go outside
that box, you are in trouble. Or maybe that you will establish,
instead of a zillion different rules, say here's the new
fiduciary standard, you have this fiduciary standard to your
stockholders, and it would be a jury in question whether or not
you break that fiduciary standard, and if you do break it, the
consequences are severe.
Thank you, Mr. Chairman.
Mr. Baily. I certainly did not wish to create arbitrary and
capricious rules or to create a system in which you have to
have necessarily warm-and-fuzzy relationships with bureaucrats.
So I, too, will look back at the transcript and make sure that
I was saying something that I want to stand by.
I do understand very much the need to have incentives and
opportunities and that businesses be allowed to run their
operations, as long as the policies they are following--and
there should be clear rules about this, I agree with you again
on that--so that within the rules, they are not imposing
excessive risk on taxpayers.
Mr. Posey. The biggest disincentive in the world is for you
to have to clear your decisions with a government bureaucrat on
any level. I just think the suggestion that you need some kind
of government approval after you have made your decision,
inside the box of the guidelines that are established, that
should be clear, unambiguous is just staggering to the
imagination.
Mr. Baily. I take your point.
The Chairman. The gentleman from North Carolina.
Mr. McHenry. Thank you, Mr. Chairman, and I certainly
appreciate the testimony.
And Mr. Baily, your discussion began with, I think, a key
point, which is income distribution deals with a lot larger set
of issues like skills, education, training, the ramifications
of the Tax Code, really the provisional incentives the Tax Code
puts in place, and I appreciate you mentioning that at the
beginning, because I think the one key thing that we can do as
a matter of governmental policy is make sure that there is a
skill base out there so that we can have a very diverse, very
active economy, and appreciate you starting with that, and that
is something that is of issue to me and my constituents at
home.
The question here today, the reason why we are even having
this discussion is really at the heart, and I know the chairman
has had this interest in executive comp for long before the
financial meltdown. But the reason why we are talking about
systemic risk and executive comp, well, compensation
structures, is largely because of the Federal Government's
actions to prevent a complete and utter meltdown of the
financial marketplace. Is that basically your view, Mr. Baily?
Mr. Baily. I am sorry, could you just repeat the last
sentence?
Mr. McHenry. Basically, the reason why systemic risk is the
discussion is because the Federal Government had to bail out
firms, right?
Mr. Baily. Yes.
Mr. McHenry. Then you look at the overall structure, and
you said, of course, you got paid millions if you did ``X,'' if
you failed, and you got paid billions if you succeeded, so of
course, the incentive is to not worry about failure; somebody
else will pay for it.
My concern is this: We write a regulation, and to Ms.
Stuckey's point, you have three or four different regulators,
they write three or four similar regulations but just
dissimilar enough, that you can't really please everyone, and
then they stay on the books. And in the end, the marketplace
figures out a way, with the force of money and the power of
money and the power of ideas in order to make more money as
individuals, and they get around it. So basically, it is great.
Congress feels good. We have stuck it to these folks that were
making all this money, and we feel good, and in the end, it
nets out with nothing. Is that a concern that you have, Mr.
Baily?
Mr. Baily. Yes, it is a concern.
Now, as we discussed a little bit in the earlier panel, one
response to that is that many of these companies, and I think
maybe that is a little also in answer to the earlier question,
a lot of these companies are themselves reforming their own
compensation structures, so they are not saying, oh, no, we
don't want to do that. Some of them actually did it before the
crisis. Some of the better companies and more enlightened
companies had pretty good compensation structures, and they did
withhold bonuses over several years, and in most cases, those
companies fared better over this crisis than the ones that did
not.
So I don't think we are pushing this down the throats of
most companies. We are trying to do things that, by and large,
they are doing on their own.
The only thing that we added I think in the Squam Lake
Report was to make sure we don't just end up with systems that
kind of align the employees with the shareholders, meanwhile
forgetting that taxpayers could be on the hook. And so we want
to make sure that at the level of incentive, particularly to
the CEO, but to senior management, that they know that some of
their pay is on the line if taxpayers have to get involved and
so we can help avoid some of these bailouts that we had.
Mr. McHenry. Would you agree that the best way for this to
actually happen is not through a government regulation but
through a corporation's reform within?
Mr. Baily. I think there is an interest in--we do have
supervision and regulation of our financial institutions. So I
don't think we can just leave it to the companies themselves to
do it. I think we have to make sure that it is being done in a
way that protects us as taxpayers rather than just leaving it
to--
Mr. McHenry. Beyond financial firms.
Mr. Baily. Oh, beyond financial firms?
Mr. McHenry. I think that is an answer.
Mr. Baily. I can certainly come back with a response, but
if these are not companies that are going to get bailed out or
receive government interest, by and large, they should do their
own thing without the interference of the government.
Mr. McHenry. Okay. And certainly it would be in the
shareholders' interests to ensure, such as say-on-pay, can have
their say-so and take their capital away from firms that don't
have the right incentive structure where the CEO and the
executives aren't truly aligned with the interests of
shareholders, and the marketplace can make that choice. And
that is what many of us are saying. It is not that we certainly
support certain compensation amounts. It is that we believe in
the individual ownership of that company rather than government
regulation.
And finally, Mr. Chairman, I appreciate your indulgence,
but to Ms. Stuckey's point about total direct compensation
versus an individual who has worked for a company for 30 or 40
years and started at the retail, checking people out, has
worked their way up and is number two in line to the CEO and,
after 40 years, has a lot of deferred compensation, and it
appears that he has a lot more direct compensation from the
firm than he truly does. And I appreciate your interest, and I
have folks in my district who have that very issue that it
certainly overstates what they believe is really worthwhile to
disclose.
Ms. Stuckey. I would agree, and I just, if you have 1
minute, I can give you a couple of other things, questions that
have actually been raised by people attempting to gather the
information: What do we do with 401(k) matches? What about mid-
year employees or part-timers? People who have come on with an
acquisition? What about severance? What about people who are
downsizing, given their huge severance package because they
have been there 30 years and maybe you have accelerated their
vesting, what do we do about that? What do you do about
overtime and shift differential payments of hourly workers? And
then, of course, there is the overseas currency, nonmonetary
components, like apparently in overseas countries, many people
get cars. Sometimes they even get food. There are a lot of
things that might have to be valued. So that is the sort of
nuts and bolts stuff that we are concerned about.
Mr. McHenry. Thank you.
Thank you, Mr. Chairman.
The Chairman. I thank the witnesses. This will be an
ongoing process, and this has been useful, and we will continue
to work on it. The hearing is adjourned.
[Whereupon, at 11:55 a.m., the hearing was adjourned.]
A P P E N D I X
September 24, 2010