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Mandate Banker Pay Reform

With a few word changes, banker pay reform could change Wall Street culture

By Bartlett Naylor

As six federal financial regulatory agencies work on a banker pay reform regulation in what could bring the most consequential change to industry culture in decades, debate hinges on a few words. And the recent hearings about the failures of  Silicon Valley Bank (SVB) and other regional behemoths should leave no doubt about what those words should be.

Bankers at all levels caused the 2008 financial crash because their pay structures incentivized risky, even fraudulent conduct. All studies of this crash affirm the central role of compensation in that international disaster. In response, Congress approved the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, featuring pay reform in a critical section—Section 956.  Signaling the importance of this banker pay reform, Congress set a deadline for regulators to translate the statute into concrete regulation: May 2011. (Only a handful of the massive law’s statutes came with deadlines.) Regulators failed to meet this deadline but did put out an almost excellent proposal in 2016. This proposal required that a portion of all senior banker incentive compensation be deferred into a collective fund. If there’s misconduct and the bank must pay a fine, or if the bank fails, then this fund is used to pay penalties, or to cover uninsured depositors and other creditors.  The reckless banker and the responsible banker both sacrifice pay. This deferral fund effectively deputizes every banker to police every other banker at the firm lest reckless banking threatens their own paycheck. What makes this only “almost” excellent is that the 2016 proposal leaves it to the bank’s board to decide whether to use this deferral fund.

In theory, boards should oversee management rigorously in the service of shareholders who officially elect them. In reality, boards are often recruited, selected and then controlled by management. After all, if it was a true election, there would be multiple candidates running for each slot, as there are in political elections. Board members who ask too many inconvenient questions are asked to leave. Staying and remaining docile can be lucrative. At SVB, board pay ranged from $241,000 to $461,000  for the board chair.  The board met 11 times in 2022, although one of those lasted two days. Looking at the hourly rate for those 12 days (and it’s not clear the meetings lasted a whole day), that’s a pay range of $2,718/hr to $4,802/hr. Who wants to ask tough questions and risk that gig?

In 2022, SVB management led by CEO Greg Becker made a reckless bet that the Federal Reserve would not raise interest rates.  This astonishing gamble proved problematic even in the second quarter of 2022, as the value of SVB’s large portfolio of long-term, low-interest bearing Treasury bonds had declined by $7 billion. That’s about half of the bank’s capital (or assets minus liabilities). By the third quarter, that portfolio loss swelled to $22 billion, more than wiping out the bank’s capital on paper. Worse, the bank sold an insurance contract it had to hedge against adverse interest rate changes.

How did the SVB’s board chastise the CEO for these fatal mistakes? It awarded him a bonus.

And it’s not just the SVB board that hands out unearned bonuses. In 2021, the JP Morgan board tripled CEO Jamie Dimon’s pay to $84 million. Shareholders revolted, and in a protest vote, rejected it in a non-binding referendum.

For that matter, as shareholder representatives, board directors are the wrong people to decide whether to dock manager pay. Shareholders benefit from a rising stock price. To increase the stock price, the bank must take greater risks. But banks must exercise caution. And most of the money that banks deploy doesn’t come from shareholders; most money comes from depositors and bond holders. Board directors are not voted into office by depositors or bondholders.

Regulators working on the current draft to implement Sec. 956 must take heed of this flaw in the 2016 proposal. They must not make forfeiture of the deferral fund dependent on boards. The regulators must make this forfeiture mandatory.  Without mandatory forfeiture, we’ll will likely still just be handing out bonuses for failure.

As Public Citizen has documented, banker misconduct has persisted since the 2008 crash, with JP Morgan’s London Whale loss, the fake account scandal at Wells Fargo, bribery scandals at Goldman Sachs and Credit Suisse, and many other examples. The failures of Silicon Valley Bank, First Republic, Silvergate and Signature correctly focus lawmaker and regulator attention to the central role of bad compensation structures in bank misconduct.

With only a  few word changes in the 2016 proposal, bankers in the future will know that their paycheck is in jeopardy if they gamble with interest rates, as did SVB; or tolerate the rampant fraud that led to the 2008 financial crash; or look away when one of their colleagues bribes Malaysian government officials, as did those at Goldman Sachs.