Following up on Bank Director’s Bank Executive & Board Compensation conference last week, we asked attorneys for their opinions on the latest rules on compensation risk and whether they really found them necessary or helpful. In a word? No. Although the exact impact remains to be seen, many feel that these new rules will actually hurt more than they help.
Will the new federal rules on compensation risk make the banking industry safer?
In the context of banks that are too big to fail and too big to govern, the rules will have only a marginal impact. Clearly Jamie Dimon was as surprised as anyone when the London whale caused the bank a multibillion dollar portfolio trading loss, but to say that compensation rules lead to reckless speculation is to miss the point. The losses suffered by J.P. Morgan Chase & Co. were not a result of misplaced compensation incentives, but a lack of sufficient controls over activities which are culturally risk intensive. It is doubtful that the London whale would have avoided speculative trades if his contract penalized his poor performance or risk taking. Performance-based compensation trends and regulatory restrictions on incentive based compensation are in conflict. It is ironic that during a time when incentive-based compensation is on the rise, and scrutiny over peer comparisons and total shareholder returns is increasing, regulators would blame compensation arrangements as a cause of the crisis.
—Doug Faucette, Locke Lorde LLP
Not really. Changes in substance, if any, will occur on the outside edges, the extremes if you will, of prior bank compensation practices, which will impact very few community institutions. Compensation practices for community banks have never amounted to a threat to the industry or the insurance fund. For most institutions, there will be tweaks and changes that will occur to show responsiveness to the regulatory concerns, probably as much in the lower ranks (e.g., with respect to loan origination pay) as in the executive suite. Every institution is required to conduct a risk assessment of their incentive compensation programs, and this should be documented at the board level. We would recommend that every institution institute a clawback policy for executive compensation. This is a good citizenship move, makes sense from all angles, and is easy to implement. We also expect to see more incentive compensation paid in the form of restricted stock for public companies.
—John Gorman, Luse Gorman Pomerenk & Schick, PC
The interagency rules implementing Section 956 of Dodd-Frank limiting compensation in banks larger than $1 billion in assets are not finalized yet. It remains to be seen whether these rules will change the product mix offered by banks going forward under the guise of restricting compensation. It also remains to be seen whether there will be “trickle-down” of these rules to banks with assets of less than $1 billion. Another unintended consequence might be if the rules restrict compensation to an extent that some of the best and brightest minds leave the banking industry for greener pastures. Does that actually make the banking industry safer?
—John Podvin, Haynes and Boone, LLP
Fundamentally, this is less about safety than it is a criticism of board level supervision of executive pay levels. At least, compensation consultants are happy.
—Mark Nuccio, Ropes & Gray LLP
The regulation of incentive-based compensation practices is a key aspect of the Dodd-Frank Act. It is based on the view that executive and senior manager compensation practices at financial institutions during the years leading up to the financial crisis failed to properly align compensation with appropriate risk-taking, and may have led to practices and activities that were inconsistent with the long-term health of financial institutions. The financial regulatory agencies proposed incentive compensation standards and disclosure requirements 18 months ago, and these rules are expected to be adopted in final form in the relatively near term. To the extent that these rules encourage financial institutions’ directors and senior management to pay closer attention to the risk incentives created by compensation practices and activities, and take appropriate action to better reward behaviors that emphasize the longer-term health of a financial firm while discouraging activities that do not accomplish this objective, the new rules should assist in reducing inappropriate risk in financial firms.
—Charles Horn, Morrison Foerster LLP