Slow Progress on a Provision to Rein-In Wall Street High Rollers

Imagine that you work for a company that pays you to gamble large sums of other people’s money in casinos. If you win for the “investors,” you get a big bonus. If you sometimes lose — well you still collect your salary. Something like that has been happening on Wall Street.

Executive pay has often been structured in a way that encourages risk-taking. Executives have been given stock options that paid if stocks reached a certain price. If they fell short, the “penalty” was simply to forego the extra money. Former SEC Chairman Mary Shapiro explained that many financial institutions had compensation arrangements that “paid employees enormous sums for short-term success, even if these same decisions result in significant long-term losses or failure for investors and taxpayers.” Multiple surveys have found that over 80% of financial market participants believe that compensation practices played a role in the excessive risk accumulation that led to the financial crisis.

The financial crisis brought huge long-term losses to the U.S. economy and took a big toll on individual lives. According to a study by the Dallas Federal Reserve, the crisis will cause a loss in U.S. G.D.P. of between 6 and 14 trillion dollars, between 2007 and 2023

At the top of the financial industry, executive compensation was jaw-dropping: The Financial Crisis Inquiry Commission reported that “In 2007 Lloyd Blankfein, CEO at Goldman Sachs, received $68.5 million; Richard Fuld, CEO of Lehman Brothers, and Jamie Dimon, CEO of JPMorgan Chase, received about $34 million and $28 million, respectively.” At a lower executive level, brokers and dealers averaged more than 7 million dollars in compensation. Much of this high executive pay was accounted for by bonuses and performance incentives. Yet one third of US bank tellers are reportedly on public assistance. Prosecutors say low pay is a factor in rising crime among tellers.

The Dodd-Frank Wall Street Reform and Consumer Protection Act includes numerous provisions to deal with excessive executive pay. A key one, Section 956(b), requires seven financial regulatory entities to propose rules prohibiting incentive pay that encourages inappropriate risks to financial institutions — banks, credit, unions, investment advisors and others. [1]

Dodd-Frank was signed into law in July of 2010. Anticipating regulatory foot-dragging, Congress required regulators to prescribe new rules within 9 months. Basic concepts for regulating compensation to avoid rewarding excessive risk had already been developed before Dodd-Frank was signed. Four agencies had published broad guidelines applying just to banking organizations (Dodd-Frank covers more financial institutions). It took until mid- April 2011 to produce a draft regulation to implement 956. That regulation emphasized broad principles similar to the banking regulation. It added some weak specifics — like a 50% deferral of executive pay for three years — that would do little to change existing Wall Street practices. The comment period ended May 31st 2011. Over Four years later no new draft has appeared!

What’s the hold up? 956 is aimed directly at the wallets of some of the most politically influential executives in the country. The financial industry commands formidable lobbying resources, employing high-ranking former government officials and deep pockets for lobbying Congress and federal agencies. But public impatience with powerful lobbies is only growing and appears as a theme in political campaigns on both sides of the partisan divide.

There is no shortage of ideas for real reform. As just one example, groups like Public Citizen and Americans for Financial Reform have advocated that instead of Stock options, which can pay off in the short term, executives should be paid in bonds that must be held to maturity and will not pay if a company becomes insolvent. After more than four years, it’s past time to produce a strong regulation!


[1] The seven regulators are Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Board of Directors of the Federal Deposit Insurance Corporation, the Director of the Office of Thrift Supervision, the National Credit Union Administration Board, the Securities and Exchange Commission, and the Federal Housing Finance Agency. Covered institutions include bank holding companies, broker dealers, investment advisors, Fannie Mae, Freddie Mac and any others that regulations determine should be included.