Yesterday, the House Committee on Financial Services held a hearing entitled, “Compensation in the Financial Industry – Government Prospective.” The hearing follows the Committee’s January hearing on the same subject and specifically focused on executive compensation for TARP recipients in the financial industry.

The Committee heard testimony from the following witnesses:

  • Scott Alvarez, General Counsel, Board of Governors of the Federal Reserve System
  • Edward DeMarco, Acting Director, Federal Housing Finance Agency
  • Kenneth Feinberg, Special Master for TARP Executive Compensation, U.S. Department of the Treasury

Several members of the Committee gave opening remarks, including Representative Brad Sherman (D-CA) and others who expressed support for government intervention as necessary protection for taxpayers from excessive compensation packages given to executives of failed or failing companies. In contrast, Representative Spencer Bacchus (R-AL), for example, spoke about the dangers of government control over the inner workings of private companies, including compensation practice decisions. Mr. Bacchus stated that such decisions should be made intra-company by the shareholders who bear the risk and not by “ineffective bureaucrats.”

Mr. Alvarez focused on the Federal Reserve’s proposed guidance and supervisory initiatives that are intended to move the banking industry forward in developing and implementing incentive compensation practices consistent with prudent risk management and safety and soundness. This includes:

  • Making employees bear the risks as well as reaping the rewards of the business.
  • Integrating the compensation function with risk management and internal controls.
  • Requiring companies, and in particular boards of directors, to strike a better balance between risk and profit.

The Federal Reserve has two initiatives to achieve these goals, including in depth horizontal reviews of the compensation practices across larger banking institutions and regular review of the compensation practices of community banks through the normal periodic regulatory examination process.

Mr. DeMarco spoke about the Federal Housing Finance Agency’s experience with compensation determinations at Fannie Mae and Freddie Mac and, in particular, the tension between needing to attract and retain talent while minimizing taxpayer losses. He summarized the actions taken with regard to compensation in the two GSEs, and the lessons learned about the difficulty in attracting and retaining talent when there is both an uncertain economic environment and an uncertain future for the two enterprises specifically.

Mr. Feinberg summarized a few broad determinations that he has made during the ongoing process of evaluating and setting compensation for a limited number of individuals at each of General Motors, GMAC, Chrysler, Chrysler Financial and AIG, including:

  • Guaranteed income should not be permitted: the compensation, other than base cash salary, of key officials should depend on long-term performance.
  • Base cash salaries should very rarely exceed $500,000 and in most cases should be far less that that.
  • Excessive compensation should be subject to a clawback based on any material misstatements.

Mr. Feinberg stated that his task under the law is to achieve a balance between limiting excessive compensation to protect the public’s investment while allowing for sufficient compensation to maximize the public’s investment. He makes this determination based on a number of variables such as risk, taxpayer return, appropriate allocation, performance-based compensation, comparable structures and payments and employee contribution to TARP recipient value. The law under which Mr. Feinberg has authority is unique because it is limited in scope to five companies, he has no authority to restructure old retention contracts, and he has the unusual challenge of calculating individual compensation.