FDIC Proposes Limits on Banker Pay


The federal government says excessive pay at financial institutions was one of the main causes of the recent economic crisis. It now wants to make sure bank executives and traders take less risk, by insisting they defer a large part of their compensation.

The Federal Deposit Insurance Corp. (FDIC) issued the proposed rules after a meeting on Monday. They would require top executives at major banks to defer at least 50% of their incentive compensation for three years. The proposals were part of the Dodd-Frank financial regulation bill passed last July.

Holding Big Banks to a Higher Standard

Traders who can put banks at material risk would also be required to defer a big chunk of their pay, and under a new rule they could lose that pay if the banks subsequently suffer a loss as a result of their transactions. Analysts say that part of the rule could open up a hornet's nest on Wall Street.

"Who is going to do the God-like thing and figure this out for thousands and thousands of people and tens of thousands of trades," says Alan Johnson, who heads Johnson Associates, a Wall Street compensation firm. "The problem is that half of this is about risk, and some significant portion is about politics. They have mangled it [to] where it will be a nightmare to try to actually enforce or keep track of."

The new rules also require senior executives at major banks -- with more than $50 billion in assets -- to be held to a higher standard, requiring their compensation be paid out over a long period. The idea is to make sure those executives have not subjected their institutions to unnecessary risk, although how that will be defined wasn't entirely clear. Such deferrals of 50% or more of compensation are already common on Wall Street.

"This proposed rule will help address a key safety and soundness issue which contributed to the recent financial crisis – that poorly designed compensation structures can misalign incentives and induce excessive risk-taking within financial organizations," said Sheila Bair, chairman of the FDIC, in a statement.

Delaying Payments for Traders

According to the proposed rules, which the public can comment on for 45 days, payouts for traders are to be delayed significantly beyond the period in which they earn the money. "The amounts paid are adjusted for actual losses or other aspects of performance that become clear during the deferral period," the proposal says, suggesting a form of "claw-back" rarely used on Wall Street -- because it would be so difficult to enforce legally.

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Indeed, Johnson maintains that enforcing such a rule is almost impossible. For example, he says, a trader might make a loss on one trade but profit on nine others -- and those trades change in value over time until they are closed out. In addition, the company may hedge the value of the trade, so one trader's loss might actually result in a profit for the firm.

And what happens if a trader urged the company to sell a position, but it doesn't and that position loses money? Would the trader still have to lose his compensation?

"This will now encourage traders to hide the risk," Johnson says. "You're going to move that trade to somebody else, you're going to make sure that the bad stuff is not under your name." Other traders might also insist their firms close trades at the end of the year, so they don't have to keep the risk hanging over their compensation.

The proposed rules bring the U.S. into line with other countries that have also adopted bank executive compensation restrictions. Some have even set limits on the amount of compensation that can be paid, but the Obama Administration appears to have rejected those limits.