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Dodd-Frank Strikes Again with Wall Street Compensation Rule

Last month's proposed rule on Incentive-Based Pay, the "London-Whale Sized Regulation," is open for comment until July 22. This proposal carries large implications for financial sector operations and also represents a overall trend in Dodd-Frank regulations.

According to NCUA vice-chairman Rick Metsger, the regulation stemmed from a Congressional mandate:

"Congress mandated action in this area because there were financial institutions which failed as a result of excessive risk-taking that was encouraged by incentive-based compensation arrangements which rewarded senior officials based on the volume of business they generated, regardless of whether the institution subsequently made or lost money on that business."

Metsger’s statement is inaccurate for a number of reasons, starting with how this regulation originated. Congress asked for guidelines on pay. They did not mandate action. Regulators responded with a 279-page rule to be voted on by six regulatory agencies: the SEC, the FDIC, the Federal Reserve, the Federal Housing Finance Agency, the National Credit Union Administration.

Here is a breakdown of the proposal:

  1. Over $250 Billion: Strict regulations would be imposed on banks with over $250 billion in assets. There are a dozen banks in the United States that fall within these categories. Executives at these firms would be subjected to a four-year deferment period for 60 percent of their incentive-based pay.

  2. $50 – $250 Billion: Executives at banks with less than $250 billion would be subjected to a three-year deferment period for 50 percent of their incentive based-pay.

  3. “Perceived Harm” Clause: Additionally, pay for executives at firms with over $50 billion in assets can be clawed back for seven years for “misconduct that resulted in significant financial or reputational harm” to the institution.

  4. “Significant Risk Takers”: The rules apply to not only top-level executives, but also to anyone regulators deem a “significant risk taker.”

These restrictions come in spite of a preexisting decline in Wall Street pay.

Wall Street bonuses have decreased significantly over the past year. A 2015 report by Johnson Associates expected bonuses to drop by 15%. Last month, Q1 2016 employee earnings at Goldman Sachs were down 40%. In FY2015, Deutsche Bank cut its overall bonus pool by 17% and Credit Suisse cut its bonus pool for traders by 36%.

Banks are already subject to super-imposed regulations from overlapping regulatory agencies.

This proposal adds an extra, extendable layer of regulations to pre-existing FDIC regulations. In fact, the FDIC Incentive Compensation rule has nearly identical language to the newly proposed regulation. The main difference between the two is the amount of flexibility given in its enforcement.

Adding to the confusion, it is unclear which regulatory agency will make discretionary decisions and which agency will enforce the rules. This would be particularly problematic when determining relation between an employee decision and a financial or a perceived reputational loss. Like many regulations, it is unclear what role the government will have and how consistent this role will be.

The Wall Street pay regulation represents a larger overall trend in Dodd-Frank. In many recent Dodd-Frank rules, federal regulators serve as “super-directors” over the Board of Directors, telling them that they have a better way of running the company. In this case, the government is going into private-sector companies and determining how their employees are paid.

The private-sector firms subject to this regulation includes companies and asset managers that are not covered by FDIC insurance so the government is imposing regulation without a backstop. In other words, these are not protected by the government, yet federal regulators still tell restrict their operations.

Regulators are incapable of “running” the vast number of companies subject to Dodd-Frank regulations. They do not have the resources nor do they have the expertise.

Dodd-Frank regulations should not have the authority to second-guess the decisions made by corporate directors. Tell federal regulators to keep their hands out of the private sector by submitting a comment on this regulation.