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London Whale-Sized Regulations on Wall Street Pay

Financial regulators released a 279-page proposal that would set parameters around how and when Wall Street Executives make their money. The proposal, mandated by the Dodd-Frank Act, is a five-year project spanning across six regulatory agencies.

The rules, if finalized, would require firms to defer over half of executive’s incentive-based pay over a period of four years. The proposal places companies in several tiers according to the value of their assets under management.

The mandatory deferment periods would extend beyond the industry standard of three years, potentially delaying executive pay for up to seven years. Seven years is also the amount of time banks with over one billion would have to keep records of incentive-based pay. The regulations would apply to not only large banks, but also credit unions, broker-dealers, registered investment advisers, and firms, both public and private that have more than one billion in assets. The rules apply to not only top-level executives but also to anyone regulators deem a “significant risk taker.”

Regulatory agencies, despite their lack of industry knowledge, would be given far-reaching regulatory authority. The proposal allows regulators to identify “significant risk takers” who are employed below the executive level. There are many qualifications for this categorization, one of which is being at the top five-percent of the company pay scale.

In writing this proposal, regulators must have forgotten the 2012 “London Whale” trading scandal in which faulty derivative bets made by a low-level employee of the chief investment officer at JP Morgan Chase resulted in a $6.2 billion loss.

Discretionary authority may also be used to determine whether an employee’s decision led to “negative externalities.” These “negative externalities” are vaguely defined in terms such as “damage”, “hurt”, and “loss.” Often, it is difficult to determine the extent to which an individual fiduciary decision affected a financial loss due to external market factors.

Additionally, the proposal not only targets the alleged instigator of a financial loss but also punishes employees that cause “reputational loss.” This incredibly broad, undefined standard could easily result in unfair deferment practices.

The firm, as well as the employee, would subject to vast regulatory discretion. The proposal allows regulators to switch any firm’s level tier, regardless of assets, if they decide that’s practices are risky or complex.

Regulators conveniently fail to point out that bonuses only constitute a small percentage of incentive-based pay in the financial sector. Incentive-based includes not only performance-based bonuses, but also commission, profit sharing, options, dividends, and tailored company incentives.

Incentive-based pay is often a large part of the financial service industry’s employee compensation packages. NCUA Vice Chairman Rick Metsger, when pointing out that commodities and mortgage traders have been paid more incentive-based pay in one year than the CEO, either disregarded or is entirely unfamiliar with this industry aspect. These brokers have a largely commission-based pay structure.

Regulator’s ignorance of financial sector operations is unsurprising considering that they are trying to enforce rules that curb risk on an industry that is based on taking risks.

FreedomWorks Foundation will continue it's coverage of the proposed rules on incentive-based pay and other instances of Dodd-Frank regulatory overreach. The proposed rules are open for comment until July 22.