By Bartlett Naylor
May, 2021 marks ten years since regulators missed the deadline that Congress mandated to bridle runaway Wall Street pay, a central cause for the 2008 financial crash. The mandate is one of 400 rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, approved in 2010. Most of the mandated rules didn’t come with implementation dates—unlike the requirement to limit risky excessive pay—a sign of the importance of this rule. And the federal banking agencies responsible for implementing Dodd-Frank’s 400 rules managed to complete most of them, although it took years. Yet despite the law, despite the mandatory May 2011 deadline, the banker pay reform rule remains unfinished.
Much has transpired in the ten years since this rule should have been implemented. Barack Obama completed his first and second terms. The House of Representatives impeached Donald Trump twice. World population increased by nearly one billion people and the United States grew by about 20 million people. The United Kingdom withdrew from the European Union. For $3.84 in 2011, you could buy a share of Tesla stock, which now sells for around $500.
What hasn’t changed in ten years, though, is that the regulators charged with ensuring that Wall Street bankers don’t pay themselves to risk their institutions and the wider economy have not obliged the law.
The rule in Dodd-Frank, specifically, is Section 956. It provides for basic banker pay reform. In its operational phrase, it directs “the appropriate Federal regulators [to] jointly prescribe regulations or guidelines that prohibit any types of incentive-based payment arrangement . . . that . . . encourages inappropriate risks.”
“Inappropriate risk” is an elegant phrase under which ambitious reforms are possible. Leading to the 2008 crash, bankers engaged in wholesale fraud based on their compensation packages. Wholesale fraud is certainly “inappropriate.” For this, 49 financial institutions have paid various government entities and private plaintiffs nearly $190 billion in fines and settlements, according to an one analysis. Whatever those compensation packages were that led to this fraud, they must be radically changed under a responsible implementation of Section 956. And it’s also notable who paid that $190 billion for wrongdoing: it wasn’t the culpable bankers; it was their shareholders.
A responsible rule implementing Section 956 must ensure that bankers pay for future malfeasance. One way to do this is through deferral of current compensation by senior bankers that would be sequestered in a fund. Should the bank be fined for misconduct, that fund would be used. This enlists all senior bankers to police one another, since one or a few wayward senior bankers would jeopardize the pay of the entire C-suite. Consider it akin to a whistleblower bounty in reverse. The idea surfaced with then-president of the New York Federal Reserve, William Dudley. Public Citizen promoted this concept in our appeals to regulators as they began consideration of a Sec. 956 rule five years ago.
In ten years, Wall Street has continued to demonstrate the need for sounder pay packages. JP Morgan, which boasted the best management among the mega-banks during the ’08 crisis, suffered billions of dollars in losses in what’s known as the London Whale trade, an episode tied to an effort to boost executive compensation. Wells Fargo established unreachable sales quotas for consumer accounts because growth in this area fueled the stock price and, in turn, stock-based executive compensation. Following a bribery scandal at Goldman Sachs with its Malaysian business, the board clawed back millions in bonuses. Credit Suisse finds it must change executive compensation in the wake of nearly $5 billion in losses from its relationship with Archegos Capital Management.
If regulators had established good rules by May 2011 as Congress had mandated, some of these episodes might have been averted.
Ideally, a strong rule under Section 956 for bankers can be a model for executive compensation in all industries. Surely, executives should not secure a bonus for misconduct, yet aPublic Citizen found just that in a report that examined corporate misconduct and its intersection with compensation . Recently, the Institute for Policy Studies surveyed CEO compensation at Fortune 500 firms with the lowest median-paid workers. (Another Dodd-Frank rule requires all publicly traded firms to list the pay of the median-paid worker as compared to the top exec.) Author Sarah Anderson found that more than half of the firms bent their own performance rules, generating more bonuses to executives even as they laid off workers during the pandemic.
Why regulators have failed to finalize the Sec. 956 rule is unclear. Public Citizen has explored several hypotheses previously. The most obvious candidate is that many regulators must agree on the rule, including the Securities and Exchange Commission (SEC), the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, and the Federal Housing Finance Agency. President Biden will appoint the heads of most of these regulators, but not the Federal Reserve, where terms last 14 years.
Fortunately, Biden appointees and White House officials with whom Public Citizen have communicated know about Section 956. They know about the 10 years-past missed deadline. Even industry-funded groups believe the time has come to reform risky pay practices. Opined one industry trade newsletter, “the Archegos collapse may push [SEC Chair Gary] Gensler to prioritize unfinished rulemaking under Dodd-Frank, including Section 956 that covers the amount of risk-taking that financial services companies are permitted to incentivize through compensation.”
Another May should not pass without this reform being implemented.