ABA Banking Journal - September 2009 - (Page 26)
COVER STORY/PAY IN THE SPOTLIGHT food chain, the more problematic that would be. This will have to change, says Borge, if much of For the person who runs a business unit, compenwhat’s being discussed in Congress and among regsation could be based on a portfolio approach—perulators goes through. formance of a group of assets or accounts, could be TARP rules: Shape of things to come? measured, with a risk factor included. Banks coming under TARP confront the potential “But it’s the exception, not the rule,” he says. shape of the future for banks in this context. Another problem is that risk doesn’t get defined or Treasury issued interim final rules restricting aspects identified. What do different people looking at a of executive compensation in mid-June. Over the bank define as risks? asks Brian Dunn, president of summer Treasury accepted comments on the rule. McLagan, a subsidiary of AON Corp., and CEO of ABA’s Sally Miller Global Compensation. “It’s a lot like pornography,” thinks TARP pay rules (In its comment, ABA pointed out that in many details, the interim final regulation oversteps the he adds, in that people can know it when they see it, will filter down. requirements of the Emergency Economic but may not be able to explain beforehand. “Risk is inherently subjective,” agrees Borge. “Risk is a forecast Stabilization Act of 2008 and the American Recovery and of what may happen in the future. It’s an unanswerable question. Reinvestment Act of 2009 that it implements.) Numerous provisions apply, but in the risk management conThere will be nobody who gets it right because you won’t know text, several stand out. when you get it right. But the journey will be valuable.” One is the requirement that TARP recipients maintain, or Compensation in a vacuum create, a board compensation committee consisting solely of Another key point enumerated by Secretary Geithner is align- independent directors. ment of compensation practices with sound risk management This committee is to meet, at least twice a year, to “review, practices. discuss, and evaluate employee compensation plans in light of Borge says that he understands the logic of this principle. any assessment of any risks these plans pose to the TARP “You don’t want the compensation committee off in a corner, recipients.” drawing up approaches to compensation, while somewhere in Further, the committee is to “discuss, evaluate, and review” the company, someone is doing something that no one knows senior executive officer (SEO) and employee plans “to ensure anything about,” he explains. that the SEO compensation plans do not encourage the SEOs to Not knowing what risks are being taken, and who is taking take unnecessary and excessive risks that threaten the value of them, leaves the bank flying blind, and leaves the compensation the TARP recipient.” committee more or less in the dark. Compensation committees are also required to provide an Typically, he adds, the compensation consultants who work annual narrative description of what actions were taken to limit with banks tend to work in something of a vacuum, designing unnecessary and excessive risk taking in SEO and other employplans based, traditionally, on peer tracking data. And “the risk ee compensation. And they must also certify that they have guys,” if the bank has any, are typically not asked about com- completed all required reviews. pensation schemes. Among the criticisms that ABA’s Sarah Miller, senior vice- Pillars of compensation as proposed by Secretary Geithner n early June, Treasury Secretary Timothy Geithner issued a statement on compensation. Its key points have been the starting position for much of the subsequent talk about risk and financial institution compensation. Geithner’s statement came after a meeting with top officials of the Federal Reserve Board, the Securities and Exchange Commission, and other experts. The group agreed to five points of compensation reform, three of which directly mention risk: • “Compensation should be structured to account for the time horizon of risks.” The ability of certain employees to “earn I immediate gains without their compensation reflecting the long-term risks they were taking for their companies and their shareholders” helped bring on the crisis. • “Compensation practices should be aligned with sound risk management.” “At many firms,” Geithner commented, “compensation design unintentionally encouraged excessive risk-taking, providing incentives that ultimately put the health of the company in danger. Meanwhile, risk managers too often lacked the stature or the authority necessary to impose a check on these activities.” • “We should reexamine whether golden parachutes and supplemental retirement packages align the interests of executives and shareholders.” Both compensation techniques have evolved away from their original purposes, and may no longer be encouraging performance in the interest of shareholders, Geithner warned. Much of what the statement said drew on an April 2 document issued by the Financial Stability Forum, an international group consisting of central bankers and banking and securities regulators and policy makers. The document is entitled, “Principles for Sound Compensation Practice.” To read it go to http://www.financialstabilityboard.org/. 26 SEPTEMBER 2009/ABA BANKING JOURNAL Subscribe at www.ababj.com
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