Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

In a new Concept Paper, the Securities Exchange Commission has announced that it is investigating whether the U.S. proxy system needs to be drastically updated. It has been nearly 30 years since the Commission last conducted a comprehensive review of the proxy voting infrastructure, and there have been significant changes since then in shareholder demographics and technology.   The SEC’s inquiry focuses on, among other things, proxy voting by institutional securities lenders and the role of proxy advisory companies.

Institutional investors often lend their securities, and these lent shares lose their vote until recalled by the lender. Without sufficient advance notice of the issues to be voted on, lenders may not be able to recall shares in time to vote on key matters like executive compensation. Thus, the Commission is trying to find out whether shareholders would be helped by requiring the agenda items at shareholder meetings to be identified earlier, so that lenders can make a decision to recall their shares and vote on issues important to them.

The SEC is concerned that proxy advisory firms may be subject to conflicts of interest or may fail to conduct adequate research to support their recommendations. To remedy these problems, it is proposing improving disclosure of potential conflicts of interest, enhancing regulatory oversight over the formation of voting recommendations, and requiring eventual public disclosure by proxy advisory firms of their voting recommendations in SEC filings.

Interested investors should take the opportunity to send the SEC their comments.

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On July 8, the European Parliament approved the world’s strictest rules on bankers’ bonuses. The rules apply to banks and investment firms, but not to hedge-fund managers.

The new rules ensure that bonuses provide less incentive for risky practices that increase executive compensation in the short term, at the expense of long term corporate financial stability.

Under the new regime, no more than 30% of bankers’ bonuses can consist of up-front cash, and, in the case of very large bonuses, no more than 20% can be cash. More importantly, about 70% of total bonus value would be deferred for up to three years and would paid in a new class of security called “contingent capital”.

Ordinarily, bonuses can be paid in the form of a note or “IOU” from the Company. Under the contingent capital scheme, however, in the event of financial difficulties, this debt is converted into equity, which, like stock, falls in value with declining company fortunes.

The new rules are likely to be formally adopted at a meeting of EU finance ministers this week, allowing them to come into effect at all banks operating in the European Union before this year’s bonus season. American policy-makers eager to prevent future financial crises would be wise to look closely at these overseas developments.

Contributed by Yoko Goto

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The G-20, an international group of banking policy makers, have elected to delay the adoption of a uniform set of banking regulations requiring member nation banks to hold more capital—measures necessary to forestall the kind of bank runs that recently brought down several finance sector giants.  This new set of banking regulations is designed to increase banks’ capital and liquid assets, improving their ability to absorb losses and to weather severe short-term market declines.  However, the G-20 avoided issuing a mandate that would have required uniform adoption of the new capital requirements by the end of 2012.  Instead, the G-20 committed to permitting countries to phase in the adoption of these new capital requirements. 

By permitting a transitional period for the adoption of a new set of capital requirements, the G-20 enabled member nation banks to hold different levels of capital and liquid assets.  This approach poses risks to investors everywhere.  As seen in the recent financial crisis, risk migrates to the path of least resistance.  In light of the G-20’s delay, banks can be expected to shift risk to offshore entities in countries that have yet to adopt the more stringent capital and liquid asset requirements prescribed by the G-20.  Until all countries fully implement the G-20’s capital requirements, investors are still exposed to significant losses as banks, instead of mitigating risk, shift exposure to countries with less onerous capital requirements.

Contributed by Craig Martin

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After a 20-hour marathon session, legislators reached agreement last Friday on a final version of a financial reform bill that, if enacted, will transform financial regulation in the U.S. It is expected that there will be enough support to for the bill to pass in both chambers later this week.

In some respects, the agreement is tougher on the banking industry than the bill drafted by the Treasury department last summer. Lawmakers agreed to a provision known as the “Volcker rule,” named after former Federal Reserve Chairman Paul Volcker, which restricts the ability of banks whose deposits are federally insured from trading for their own benefit. In order to win wider support for the legislation, Democrats agreed to allow financial companies to make limited investments in areas such as hedge funds and private-equity funds, although banks can invest no more than 3 percent of a fund’s capital and those investments could also total no more than 3 percent of a bank’s tangible equity. This would have a significant impact on many Wall Street firms such as Goldman Sachs and Morgan Stanley that have long engaged in amounts of trading for their own accounts.

The final version of the financial reform bill also includes a provision restricting banks’ derivative trading. However, it is not as strict as Senator Blanche Lincoln’s proposal which would have required banks and their parent companies to segregate much of the derivatives trading business. The agreed-upon version of the bill would allow banks to trade in derivatives to hedge their own risk, but would forbid banks from speculating in highly risky credit default swaps and other exotic instruments. As an additional safeguard, the Commodity Futures Trading Commission would be given greater oversight of derivative trading.

Contributed by Yoko Goto

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In 2009, the Financial Accounting Standards Board (“FASB”) caved to immense pressure from financial sector lobbyists when it eliminated a requirement that companies disclose market-related losses on asset values.  In the furor that followed, scholars and institutional investors pointed out that these changes are likely to set the stage for a repeat of the market catastrophe of 2007-2008. FASB now appears to agree, and is showing the backbone necessary to do something about it.   

On May 26, 2010, FASB issued an Exposure Draft of a proposed Accounting Standards Update (“ASU”), Accounting for Financial Instruments, that improves the accounting for financial instruments by updating rules for classifying, measuring and recognizing impairments for financial instruments. The ASU is designed to provide greater transparency in financial statements reporting financial instruments. 

Under the proposed accounting standard, almost all financial instruments, including loans, would be reported at fair value. For example, a bank’s portfolio of loans previously classified as held-to-maturity or held-for-investment and reported at amortized cost would now be reported at fair value with any fair value adjustments recorded in other comprehensive income on the balance sheet. 

Most likely to be affected by the rule change are traditional banks, which have large loan portfolios that under current accounting rules are reported at amortized cost, net of impairments for credit losses. Under the FASB’s proposed rule, the traditional banks would value their loan portfolios using fair market value, reporting the loans at amortized cost and fair value on the balance sheet and recording any fair value adjustments in other comprehensive income in the equity section of the balance sheet.  

These traditional banks are also likely to be affected by a related proposed amendment concerning the threshold for recognizing credit impairments. Under the proposed guidance, FASB would eliminate the rule that credit impairments need only be recorded when they are probable. The “probable” threshold under current accounting rules results in delayed recognition of credit losses. Instead, the new rule would require banks to record a credit impairment charge in net income when the bank doesn’t expect to collect all contractual amounts due under a loan. With a lowered threshold for credit losses, entities will provide more timely information about expected credit losses on financial assets.

In the near term, FASB’s Exposure Draft is open to comment from the public. However, if the ASU were to be approved, the financial landscape of banks will forever change. Under the new rules, banks will be required to fair value large portfolios of loans that were once carried at cost on their balance sheets. Further, FASB’s proposed amendments will make it difficult for banks to ignore impairments caused by credit losses in loan portfolios. As the financial crisis still shadows the financial markets, the FASB’s new push for transparency will be welcomed by many investors.

Contributed by Craig Martin

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 On May 20, the Senate approved a bill that, if enacted, would represent the most sweeping regulatory overhaul since the Great Depression. Among other things, the Senate bill would:

• Establish a new council of “systemic” risk regulators to monitor growing risks in the financial system.
• Empower the Federal Reserve to supervise the largest, most complex financial companies to ensure that the government understands the risks and complexities of firms that could pose a systemic risk.
• Give the Securities Exchange Commission the authority to grant shareholders proxy access to nominate directors.
• Establish a new self-regulating organization for credit rating agencies designed to eliminate conflicts of interest in the issuer-pay model. The SEC would appoint members of the regulatory body which would assign rating agencies to provide initial credit ratings of financial instruments.

The Senate bill differs significantly in some ways from the House version of the Wall Street reform legislation. While both bills contain provisions calling for the creation of a new consumer protection agency, in the House version the agency would be substantially independent, while the Senate version would put the agency under the umbrella of the Federal Reserve, an institution not famous for its concern for consumer rights.

With respect to regulating the massive over-the-counter derivatives market, however, it is the Senate bill that calls for stricter rules—perhaps because it passed in the wake of the recent Goldman Sachs imbroglio   Both bills give regulators new powers to oversee the derivatives market and to force most derivative contracts to be traded through third party “clearing houses.” However, the Senate bill would make it more difficult for companies to seek exemption from the new rules.

Investors and taxpayers alike should stay tuned to what happens in the process of reconciling the two bills: the results may shape the U.S. markets for generations to come.

Contributed by Yoko Goto

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On Friday April 16th, the Securities and Exchange Commission (SEC) filed a civil complaint against Goldman Sachs and one of its vice-presidents, Fabrice Tourre, for allegedly defrauding investors by failing to disclose vital information about a financial product linked to subprime mortgages. Goldman’s shares tumbled, dragging the markets down with it.

The instrument in question, structured and marketed by Goldman, was a synthetic collateralized debt obligation (CDO), whose performance was tied to that of residential mortgage-backed securities. Goldman told its investors, who included some European banks, that the securities underlying the CDO had been selected by an independent third party, ACA Management. The SEC alleges that Goldman failed to disclose that another firm, Paulson & Co, a big hedge-fund manager, in fact had a hand in choosing what went into the CDO.

This was a crucial omission, since Paulson & Co—run by John Paulson, who made billions in 2007-08 betting against the housing market—had taken a short position against the CDO; in other words, the firm would profit if the instrument performed poorly. 

According to the SEC's complaint, Paulson shorted the portfolio it helped to select by purchasing insurance against the default of certain layers through derivatives called credit-default swaps (CDSs) it entered into with Goldman. The SEC argues that these derivatives gave the hedge fund an incentive to select mortgage securities that would bomb. And bomb they did. The deal closed in April 2007; by the end of January 2008, 99% of the portfolio had been downgraded by credit-rating agencies.

Goldman called the charges “completely unfounded in law and fact” and said it would contest them vigorously. Paulson & Co, which has not been charged, issued a statement saying that ACA, as the third-party collateral manager, had sole authority over the selection of securities in the CDO. In a more detailed response issued later, Goldman insisted that extensive information about the portfolio had been provided to the buyers, who were sophisticated investors aware of the risks.

It may seem surprising that Paulson is not named as a defendant in the SEC's complaint. However, the decision not to name Paulson as a defendant was likely influenced, at least in part, by the Supreme Court's recent landmark decision in Stoneridge Investment Partners, LLP v. Scientific-Atlanta, et al. (2008). The Stoneridge holding restricts plaintiffs from alleging 1934 Exchange Act fraud claims against "non-speaking" participants in schemes to defraud investors. Rather, investors may only sue those who issued statements or otherwise took direct action that the investors had relied upon in buying or selling stock. Thus, under Stoneridge, the SEC could not bring securities fraud allegations under Section 10(b) against Paulson without demonstrating that Goldman's investors directly relied on false statements or misleading conduct by Paulson.  

Given the public and official outrage over Paulson's involvement in the Tourre scandal, recent legislative efforts to overturn Stoneridge seem timely and well taken. 

Contributed by David Sack

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On April 7, 2010, the Securities and Exchange Commission (SEC) began presenting its case against Jon-Paul Rorech, a Deutsche Bank bond salesman and Renato Negrin, a former trader at hedge fund Millennium Partners LP, for insider trading. However, this is not a run-of-the-mill insider trading case. This case is significant because it is the first case the SEC has brought to trial involving insider trading of credit default swaps (CDS), and its outcome could help clarify whether the securities laws reach the murky world of credit default swaps.

Credit default swaps are financial instruments that serve to protect against a default by a particular bond or security. They are essentially a form of insurance against defaults on a company’s debt. Unlike traditional insurance, however, the market for credit default swaps is largely unregulated. Many noted economists consider unregulated CDS trading to be one of the major contributing factors to the financial crisis.

The SEC alleges that Rorech illegally tipped off Negrin about a bond offering from Dutch media company VNU Group, which controls Nielsen Media, the television ratings service. Based on that information, Negrin bought credit default swaps that rose in value when the deal was made public, eventually earning him a $1.2 million profit. 

The defense argues that because credit default swaps are not defined as securities according to securities regulations and are not traded on any exchange, they are more like private contracts between financial players. Therefore, they are not subject to SEC enforcement under the insider trading provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.

The SEC in turn argues that credit default swaps, even though they are not considered securities in the traditional sense, clearly meet the definition of “security-based swap agreements” established by the Gramm-Leach-Bliley Act. Therefore credit default swaps fall within the purview of the SEC.

The decision in this case could very well determine whether credit default swaps, the derivatives blamed for much of the economic meltdown, are subject to the SEC’s anti-fraud actions.

Contributed by Vicky Ku

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Last week, the SEC proposed new rules that would require issuers, instead of credit rating agencies, to vouch for the soundness of their asset-backed securities. The types of securities that would be affected by these regulations are bundles of loans that generate profits through regular payments, such as residential mortgages, student loans and commercial loans.

While current rules require that such asset-backed securities be rated “investment grade” by a nationally recognized statistical rating organization, the 667 page proposal would require asset-backed securities issuers to (1) certify that the assets will likely produce the type of return described in the prospectus; (2) keep at least a 5% stake in the asset backed securities; (3) provide investors with a way to confirm that the assets conform to the issuer’s representations and warranties; and (4) update the SEC with Exchange Act reports on an ongoing basis (as opposed to only updating the SEC with Exchange Act reports after the first year, as these issuers are currently allowed to do).

Credit rating agencies generated large fees in the years leading up to the recent financial crisis when they offered AAA ratings to catastrophically risky bundles of home loans made to unqualified buyers. These ratings failed to give investors sufficient notice of the true risk associated with many asset backed securities, a phenomenon that played a significant role in the financial sector collapse. The SEC has stated that the rule changes, which would also seek to regulate expedited “shelf offerings,” are intended to “eliminate the appearance of an imprimatur” that might result from a rating issued by a government-approved agency.

There is no question that proposed regulations' intent "to better protect investors in the securitization market" is a laudable one.  However, some might suggest that the proposed rules serve mainly to distance the government from the acts of the credit rating agencies, without addressing the conflicts of interest that give rise to flawed ratings in the first place.

Contributed by Carol Villegas

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Before the ink has even dried on the new healthcare legislation, new progress is being made on an equally bold push for reform of the financial services sector. On March 22 a bill promising sweeping new changes on Wall Street emerged from the Senate Banking Committee and will soon be introduced to the full Senate.

The bill, sponsored by Connecticut Senator Chris Dodd, takes a multi-pronged approach to reform. The bill would revamp governance of public companies, giving shareholders advisory votes on executive pay and the ability to nominate directors through company-issued proxy ballots.

The bill would also substantially expand government oversight of banks, hedge funds and the derivatives market. The Securities and Exchange Commission would gain the authority to regulate parts of the derivatives market, including security-based swaps, and would be empowered to strictly oversee hedge funds. The bill would also give the Commission the right to self-fund, allowing it to set its own budget and collect filing fees from the public companies and investment firms that it supervises.

The legislation would create a nine-member council, led by the Treasury, which would watch for systemic risks and direct the Federal Reserve’s supervision of the nation’s largest and most interconnected financial institutions. The Federal Reserve would be charged with supervising not only banks but any institution that would “pose risks to the financial stability.”

One of the most significant changes proposed by Dodd’s bill is a provision allowing regulators to implement the so-called “Volcker rule,” named for Paul A. Volcker, the former Federal Reserve chairman. The rule would prohibit deposit-taking banks from investing in or owning hedge funds or private equity funds, and engaging in proprietary trading—making trades unrelated to their clients’ interest.

The scope of the bill has already precipitated a frenzy of lobbying from Wall Street and banking industry titans. Investors should pay close attention to the progress of the legislation, as it’s sure to be another wild ride.

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The Obama administration has renewed a push to toughen regulations on banks that are “too big to fail.” The proposal, dubbed the “Volcker Rule” after the former Federal Reserve Chairman Paul Volcker, would limit the scope and size of banks and other financial institutions by ensuring that no bank will engage in “proprietary trading” -- that is, trading operations unrelated to serving customers.

Proprietary trading places bank capital at risk through speculation. Although such trading is engaged in by only a handful—probably four or five—of American mega-sized commercial banks, the commercial banking sector could take a dangerous hit if these bets go wrong. 

Proponents of the Volcker Rule argue that such a prohibition is essential to ensure the stability of the commercial banking sector and to protect banking customers from undue risk undertaken by corporate management. It would also discourage banks from engaging in insider trading using inside information and data gleaned from their customer relationships.

The proposed Volcker Rule has been met with strong resistance in Congress. Critics argue that the objective of the proposal could be achieved under a provision in the House bill adopted last year which let regulators ban speculative trading by banks if it is deemed too risky. They also contend that it will be hard for regulators to differentiate between transactions that a bank makes for its clients from those made in its own account.

One thing that is clear is that if “too big to fail” banks expect an implicit guarantee of taxpayer support, they should be prepared for much greater regulatory review of the risks they undertake.

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Eyes On Wall Street welcomes Lynn E. Turner, the former Chief Accountant of the U.S. Securities & Exchange Commission. Mr. Turner offers Eyes readers some trenchant insight on controversial new rules for fair value accounting, and their long term implications for investors.

Eyes:     Many investors may not be familiar with fair value accounting. Can you give us a thumbnail sketch of what it involves?

Turner:     In its simplest form, fair value accounting is nothing more than having a company report its investments in terms of what they are worth today rather than what they paid for them when they bought them in past years or even decades.

Eyes:     Why should investors care about the way investments are accounted for?

Turner:     Well, as an investor you’re always interested in how management is stewarding the assets that you’ve given them to use. One good measure of how they’ve done with those assets and dollars is looking at the value that management has subsequently created. And looking at the value of those investments today, rather than some time ago, gives you a much clearer indication as to whether management has wisely invested the assets and got a return on the investments or instead has losses that they might like to hide and not be held accountable for.

Eyes:     Why did fair value accounting come to be so controversial during the financial crisis of 2007 and 2008?

Turner:     You know, I’ve been around for about three decades now and the whole debate over fair value accounting is nothing new. It was a major debate during the first half of the Seventies, when we had the ’72-’73 bear market; it was a major debated item during the savings and loan and banking crisis in the late ‘80s and early 1990s; and again it’s returned as a hot item in the subprime financial crisis. So it’s nothing really new. The arguments are always the same: the bankers say in the down times that they shouldn’t be made to take their losses, or it will destroy their businesses. But in the good times, they always come back and ask to use fair value accounting and take the write-ups. 

The reality is that these financial institutions, some of which have been dismally managed, don’t want to have accountability for the poor management decisions that they’ve made when they’ve invested the assets, the money from investors.

Eyes:     And that’s why the financial sector now has so much antipathy for fair value accounting?

Turner:     Well, the crisis was created when banks made a lot of bad home loans that were never going to be repaid.. We know that for a fact now. When the loans defaulted a lot of homes came on the market that couldn’t be resold, or had to be resold at much lower prices than what they’d been bought for or what people felt they were worth. 

As a result, investments in those loans and those mortgages declined in value significantly. The financial industry, which had packaged and sold the loans and had a significant amount of these assets on their own balance sheets, really didn’t want the public to learn about the magnitude of those losses. The public would be upset that they were sold bad investments by the finance companies. In turn the companies didn’t have enough capital to reverse or to sustain those losses and would become financially unstable requiring taxpayer and government support. 

Eyes:      The financial sector has had some recent success in undermining the fair value accounting rules in both the E.U. and the U.S. Can you describe those changes?

Turner:     What the Financial Accounting Standards Board (“FASB”) in the U.S. and International Accounting Standards Board (“IASB”) in the E.U. have done, interestingly enough, is somewhat interconnected. Initially, the European Commission and the President of the E.U., Sarkozy, put tremendous pressure in October of 2008 on the IASB to relax its rules and give greater latitude to financial institutions in how they go about figuring fair value, and in particular what type of assets they’ve got to apply fair value to. In part in response to what the E.U. did, earlier this year, under pressure from the US Congress, the FASB relaxed some of the accounting rules to give greater latitude in how you would calculate those fair values. These changes allow the banks to manipulate what they report as fair values. As one person said, under the new rules it’s really not “mark to market,” it’s “mark to magic.”

under the new rules it’s really not “mark to market,”
it's “mark to magic.”

Eyes:     Now, what do you make of the argument that fair value accounting just doesn’t work when there isn’t a market on which you can assess the value of some of these mortgage-backed assets?

Lynn Turner:     Well, first of all, the vast majority of these assets do have a market, so it’s not as big an issue as what some people make it out to be. For those where there isn’t a market – that is, those investments aren’t traded day in or day out – you can still make an assessment, and accounting rules allow you to make an assessment, of what the cash flows are going to be coming off those investments, and ultimately what someone else is going to be willing to pay you for that. Smart managers should have made that exact assessment when they initially decided to purchase them in the first place and put them on their balance sheet. 

Eyes:     There’s certainly been a lot of debate earlier this year, and then maybe ongoing next year, about legislative proposals that might undercut the independence of standards boards like the FASB. How important is it that these boards remain independent?

Turner:     It is very important that both the Financial Accounting Standards Board and the International Accounting Standards Board be able to go through a due process that allows them to develop standards that will in fact provide investors with the very high quality information they need to make sound investment decisions. When members of Congress here in the US, or when the European Central Bank or Parliament put tremendous pressure on either of these two bodies to serve special interests like the financial lobby instead of investors, then there’s hundreds of millions of investors that get short changed. 

In the long run, good investment decisions can’t be made without good information. And unfortunately both the European Central Bank, the European Parliament and the US Congress throughout this year – and it will continue into next year – will continue to try to break the arms of these standards setters to provide standards that are more favorable to the banks, which will do destructive damage to the US capital markets and investors.

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Senator Christopher J. Dodd (D-Conn.), Chairman of the Senate Banking Committee, has proposed a bill that would, if enacted, result in a sweeping overhaul of the U.S. financial system. Dodd unveiled a plan that would, among other things, consolidate bank regulators, create a consumer financial protection agency and impose new restraints on exotic financial instruments and credit rating agencies. In unveiling the bill, Dodd said, "I could have tried to draft something that was, sort of, already a compromise… But I think you make a huge mistake by doing that. You're given very few moments in history to make this kind of difference, and we're trying to do that."

If enacted, Dodd’s legislation would:

• Create a Consumer Financial Protection Agency which would focus on protecting American consumers from fraud and abuse, and on ensuring that consumers be given clear information on loans and other financial products from credit card companies, mortgage brokers and banks. This proposed agency would consolidate consumer protection responsibilities currently handled by the Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, the National Credit Union Administration and the Federal Trade Commission.
• Create a Financial Institutions Regulatory Administration which would eliminate the alphabet soup of multiple bank regulators, and would ensure that the FDIC and the Federal Reserve do their jobs.
• Address systemic risks posed by derivatives. Over-the-counter derivatives would be more closely regulated by the SEC and CFTC to close regulatory loopholes. Derivative trading would be required to go through central clearing and exchange trading to encourage transparency and accountability. 
• Require advisors to hedge funds and other pools of cash worth over $100 million to register with the SEC and to disclose financial data needed to monitor systemic risk and protect investors. 
• Establish a new Office of Credit Rating Agencies at the SEC which would strengthen regulation of credit rating agencies. This new office would have its own compliance staff and the authority to fine agencies. The bill would also give investors a private right of action against ratings agencies for knowing or reckless misconduct.
• Create the Agency for Financial Stability, an independent agency responsible for identifying, monitoring, and addressing systemic risks posed by large, complex companies as well as products and activities that can spread risk across firms. The Agency would draft strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.

The Dodd proposal faces some hurdles. Administration officials, House leaders and some Republicans have criticized parts of the plan as untenable. Edward, L. Yingling, President of the American Bankers Association, said the proposal "would tear apart the existing regulatory structure only to create a new one that would produce conflicts among regulators."  However, Treasury Secretary Timothy F. Geithner said that the legislation "moves us one step closer toward comprehensive financial reform."  Dodd has said he plans to move the bill through the banking committee quickly.

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On October 22 Wall Street received a double whammy with the release of plans by the Federal Reserve and the Treasury Department to aggressively regulate pay practices at banks. While both approaches capitalize on public wrath erupting over the announcement of record-setting year-end bonuses at top financial firms, they differ significantly in scope and effect. 

The Federal Reserve’s new compensation proposal, outlined in its October 22 press release, has the broadest sweep, covering thousands of banks, including U.S. subsidiaries of foreign institutions. While the proposed rules would not directly regulate pay, they would include demands that firms take into account losses incurred by employees, make pay tied to longer-term performance, and pay out over longer stretches of time. The only real teeth in this regulation, however, is the Fed’s right to veto compensation plans it does not like, and to require that management come up with better approaches. 

The Treasury plan is more limited in scope, but has a much more immediate impact. The plan, outlined in an October 22 press release titled The Special Master for TARP Executive Compensation Issues First Rulings, applies only to the beneficiaries of bailout funds under the TARP program. It attempts to better align pay with longer-term performance, but takes a more direct approach than the Fed. Treasury official Kenneth Feinberg, the Obama administration’s “pay czar,” slashed cash compensation, increased stock awards, and insisted that stock compensation be held for two to four years. Salaries paid to the highest-earning executives at seven companies getting exceptional federal aid will also be capped at $500K, while the group’s total pay level, annualized, will be 50% lower than last year.

Not surprisingly, the financial services industry is not happy with either approach. Although the sector benefited from last year’s massive infusion of taxpayer capital, banks are bridling at the suggestion that regulators—and the taxpayers they protect—should have any role in reforming the institutions that they helped save.

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