It is a tricky proposition, rewarding necessary risk-taking without encouraging excessive risk taking. This is the fine line the Obama administration, and Congress will be walking in their attempt to legislate compensation practices in the financial services industry.
"I think it comes down to not overly rewarding the employee for either the short-term or the long term," said Jack Dolmat-Connell, CEO of the compensation consulting firm DolmatConnell & Partners, when asked whether it is possible to create a plan that rewards prudent risk. He adds, however, legislation may not be the best way to achieve this balance because lawmakers may not understand all the issues surrounding compensation.
Within a month, U.S. Representative Barney Frank (D-Mass.) is expected to introduce legislation to regulate executive pay in the industry. Frank's office declined to comment, but senior congressional sourcessaid possible elements of the legislation might include extending the timeframe of executive payouts, directly linking pay to a company's performance, clawbacks and giving investors a "say on pay" or an annual advisory vote on executive compensation.
The sources say the goal is not to cap compensation. Compensation levels, sources said, should be decided by boards and approved by shareholders via "say on pay." The goal is to create a structure that prevents the piling on of excessive risk, risk President Obama has blamed in the past for contributing to the current financial crisis. Back in February the President said as part of his administration's plan to overhaul regulation of the financial services industry, the White House would "examine the ways in which the means and manner of executive compensation have contributed to the reckless culture and quarter-by-quarter mentality" that hurt the financial system. The President said reforms would focus on executives being "rewarded for growth measured over years, not just days or weeks."
The Federal Reserve, which regulates the country's national banks said through a spokesperson, "The Federal Reserve intends to use its supervisory and regulatory authority to promote bank holding companies' conformity with executive and employee compensation practices that do not create incentives for behavior that puts the firm and financial system at risk. We are working on proposals in this area that may be issued in the next few months."
Some Wall Street firms are trying to get a jump on Washington. Morgan Stanley introduced a three-year clawback provision in its compensation plan for a "broad group of employees" this year. If the employees do something that results in a financial restatement, or significant financial or reputational losses for the company, Morgan Stanley can ask the employee to return a portion of their pay up to three years after it is awarded.
In a speech before the Council of Institutional Investors in April, Goldman Sachs CEO Lloyd Blankfein outlined elements of Goldman's compensation guidelines he believes should be applied to the industry. The guidelines include paying employees an annual salary plus deferred compensation with more of the compensation being paid in stock as total compensation increases, paying senior executives mostly in deferred compensation and allowing for clawbacks.
In an interview on CNBC, New York State Insurance Department Superintendent Eric Dinallo said he's worried new regulation on pay could make the U.S. less competitive.
"The idea that we're going to lead, that Wall Street is going to lead this country as it always has frankly out of these depths I think comes from our ability to innovate in financial services," he said. "And I would just caution that we not regulate pay to the point that we drive them into other industries or purely into hedge funds."