Federal Reserve supervisors are telling about two dozen of the largest US banks they must do more to end pay practices that encourage excessive risk-taking and are ordering boards to step up scrutiny of incentives, according to three people briefed on the discussions.
Fed officials met in recent weeks with executives and board members and told them to submit plans for repairing deficiencies in how they monitor pay, the people said. The banks also must ensure that managers of individual business units aren’t given too much discretion over employee compensation. Firms in the Fed’s review programme include Citigroup Inc, Goldman Sachs Group Inc, JPMorgan Chase & Co, and Bank of America Corp.
“The Fed review could de-motivate banks to take excessive risks,” said Mark Borges, a compensation consultant at Compensia Inc in Corte Madera, California. “Banks are front and center as an example where the compensation arrangements are tied directly to activities that create levels of risk they may not be equipped to manage.”
The Fed released guidelines in October aimed at ensuring that policies at the largest US banks tie pay to long-term performance and don’t create incentives for the kinds of investments that prompted bailouts of financial firms such as Citigroup and Bank of America. The central bank’s actions run parallel to efforts by US lawmakers, the Obama administration and world leaders to overhaul policies usually set by corporate boards and management.
“At the largest financial institutions there are thousands of employees with many kinds of incentive compensation arrangements,” Fed Governor Daniel Tarullo said in an email to Bloomberg. “It is going to take an ongoing effort to get satisfactory risk-management structures and risk-appropriate compensation arrangements in place.”
Tarullo is leading an overhaul of the central bank’s supervision and led the drafting of the compensation guidelines.
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The Fed, which is working on the reviews with regulators from the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency, also wants to make sure banks are taking into account how much employees expose the firms to liquidity and reputational risks.
Fed supervisors are questioning whether the firms’ boards of directors are adequately monitoring pay-related risks, said the people, who declined to be identified because the talks aren’t public. Fed officials are asking compensation committees to look into pay packages beyond the five senior executives whose compensation is disclosed in Securities and Exchange Commission filings.
Examiners also want banks to run tests of pay related risks using hypothetical scenarios that could occur if the firms’ results or economic conditions were to worsen, one of them said.
“You had compensation practices across the financial system designed in a way that people were able to benefit from the upside without being exposed to sufficient risk of loss on the downside,” Treasury Secretary Timothy F Geithner said on April 13 in a speech in Washington. “That is an untenable balance and it’s something that has to change over time.”
Fed officials declined to name which banks it is reviewing. Spokesmen for Goldman Sachs, Bank of America, JPMorgan, Citigroup and Morgan Stanley declined to comment.
In a speech in November, Tarullo said some firms leading up to the financial crisis tied pay to the number of loans an employee makes or a trader’s revenue “without sufficient regard for the risks associated with those activities.”
Some Wall Street banks have taken steps to rein in pay in response to government scrutiny and public outrage over bonuses.
Goldman Sachs said in December that year-end bonuses for 30 executives, including Chief Executive Officer Lloyd Blankfein, will be in restricted stock they can’t sell for five years. The New York-based bank, facing a fraud lawsuit from the SEC, has been criticized by lawmakers including House Financial Services Committee Chairman Barney Frank for allocating more than $16 billion to pay employees after receiving a bailout by taxpayers.
Goldman Sachs said on April 20 that first-quarter earnings jumped 91 per cent to $3.46 billion, or $5.59 a share, surpassing analysts’ estimates. The firm’s shares doubled last year as profit soared to a record.
Morgan Stanley Chairman John Mack, who also held the CEO title last year, declined to take a bonus for the third straight year, citing “this unprecedented environment.” The New York- based firm beat analysts’ estimates, reporting first-quarter net income yesterday of $1.78 billion, or 99 cents a share, compared with a loss of $177 million, or 57 cents, in the first quarter of 2009.
Citigroup CEO Vikram Pandit last year said he was taking $1 million annually in base pay and declined any incentive compensation. JP Morgan’s Jamie Dimon took a $1 million salary and no bonus or stock awards last year and Kenneth Lewis, who retired as Bank of America’s chief executive in December, received no salary, stock or option awards.
In November, Blankfein, Mack and Dimon met with Federal Reserve Bank of New York President William Dudley to discuss the guidelines issued the previous month, people familiar with the matter said at the time.
Kenneth Feinberg, the Obama administration’s special master on compensation, and members of his staff have met with Fed officials in the past several weeks and “talked about what the principles should be governing compensation,” Feinberg said in an April 19 interview.
Feinberg requires that the five companies whose pay he oversees, including American International Group Inc, eliminate cash guarantees and reward executives mainly with long-term stock. Group of 20 leaders have agreed to similar principles.
In March, Feinberg, 64, told those companies to cut cash compensation to their top executives by 33 per cent. Total pay this year, including cash will fall by about 15 per cent for 119 executives at AIG, General Motors Co, GMAC Inc, Chrysler Group LLC and Chrysler Financial Corp. Both Bank of America and Citigroup were under Feinberg’s supervision until they repaid taxpayer funds in December.