Wall Street pay changes ‘glacial’ amid year of outrage

Wall Street It’s a typical December on Wall Street. Bankers are paying out big fat bonuses.

And they’re on course to pay out almost as much as they did in 2007, at the peak of the credit boom, when the financial sector wasn’t propped up with hundreds of billions of dollars in government money.

The six largest U.S. banks, Citigroup Inc., Bank of America, J.P. Morgan Chase, Goldman Sachs, Wells Fargo and Morgan Stanley, are on track to hand out as much as $149 billion for bonuses, all benefits and other compensation for 2009, according to the run rate projected by the New York State Comptroller’s Office.

As the most controversial year for compensation on Wall Street comes to a close, progress on executive pay issues seems to be moving at a glacial pace despite the underlying fever for reform.

“It’s shocking how little change there’s been,” said William Cohan, a former investment banker and author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street,” which chronicles the collapse and bailout of Bear Stearns.

“We had an opportunity to realign incentives and get real skin in the game,” he added. “But that has not happened.”

However, there are early signs of a shift in pay policies at some financial institutions like Goldman as they try to quell public outrage and head off more draconian government restrictions on the sector’s main tool for recruiting and retaining talent.

“Some decisions are being made one step ahead of the posse, but that’s how positive change is made in many cases,” said Michael Oxley, former Republican chairman of the House Financial Services Committee who helped create the Sarbanes-Oxley Act to crack down on corporate fraud earlier this decade. “This is a glacial kind of movement but clearly movement has been made.”

A national furor erupted earlier this year after American International Group paid more than $160 million to retain employees of a derivatives unit that pushed the giant insurer and the financial system to the brink of collapse. Some recipients agreed to pay the money back, but the episode sparked a debate about compensation across corporate America.

The government pumped more than $200 billion of taxpayer money into AIG and the nation’s largest banks through the Troubled Asset Relief Program, or TARP. But strict limits on compensation came with that support.

The Treasury Department appointed Kenneth Feinberg as pay czar, giving him authority over the pay of top employees at the seven institutions that got the most government support, including AIG, Citi and Bank of America.

As executives realized the extent of government control over their compensation, there was a stampede to raise new capital and repay the government, led by Goldman which exited TARP in June.

However, the Federal Reserve has weighed in with permanent guidelines on how banks must stop incentives that encourage employees to take too much risk. And the threat of legislation limiting compensation further still hangs over the sector.

Earlier this month, the U.K. imposed a 50 percent tax on bank bonuses over 25,000 pounds and France has followed with a similar tax.

Soon after the British bonus tax was announced, Goldman said its 30-person management committee will be getting bonuses for 2009 in the form of “shares at risk” instead of cash. The shares cannot be sold for five years.

The five-year holding period includes a bulked-up provision that lets Goldman take the shares back if employees conduct “materially improper risk analysis” or fail to sufficiently voice concerns about risks, the firm said.

Shareholders will also get an advisory vote on Goldman’s compensation principals and the pay of its top executive officers at future annual meetings, the firm added.

“This is very significant,” said Bob McCormick, chief policy officer at corporate governance advisory firm Glass Lewis. “The big concern is that these firms pay big cash bonuses based on unsustainable returns and investments. Goldman’s solution is the most progressive.”

“Goldman tends to be a leader, so this will encourage others to follow suit,” he added.

The shift to more share-based compensation is already happening elsewhere. Citi, Bank of America and Wells Fargo said recently they plan to issue almost $5 billion in new shares to pay some year-end bonuses in stock rather than cash.

However, some critics say Goldman’s changes don’t amount to much and won’t be enough to change risky behavior in the industry to prevent it threatening the financial system again.

Former Goldman partner Roy Smith called the bonus plan “a concession to public outrage,” while noting top executives at the firm were already paid 50 percent to 60 percent of their annual bonus in stock.

“The current goal of the compensation vigilantes ? more equity, less cash, long vesting and potential claw back of losses ? is not a threat to most of the business franchises of the investment banks,” said Brad Hintz, a Bernstein Research analyst who used to be treasurer at Morgan Stanley and chief financial officer at Lehman Brothers.

The main problem is that Goldman’s new bonus plan only applies to the firm’s top 30 executives. The firm has yet to decide on bonuses for the rest of its 31,000 or so employees. Many will still get some of their annual bonus in cash, although the awards will probably be more skewed towards stock than in previous years.

“The rank and file, who actually do the trading and design the products, are still getting paid in cash and getting big bonuses to take short-term risks with shareholder and creditor money,” Cohan said.

It’s wrong to just focus on Goldman, because this is an industry-wide problem, he added.

“There’s one unifying theme to all of the crises that have occurred in financial markets over the past 25 years,” Cohan explained. “It’s the compensation system where bankers and traders are rewarded for taking short-term risks with other people’s money. That hasn’t changed one iota.”

Despite trying to take the lead on Wall Street compensation, Goldman could still run into a perception problem with the American public.

“I think they are trying to do what is right,” said Jeff Vistithpanich, principal at Johnson & Associates, a financial services consulting firm. But, “If you say 1/8Goldman Chief Executive3/8 Lloyd Blankfein is getting $50 million in stock, all people are going to do is focus on the $50 million.”

One problem with the all-stock bonus approach is that some top Wall Street executives have already amassed vast wealth from previous boom years. Blankfein got a $68 million bonus for 2007 and $26.8 million of that was in cash.

“The top guys have probably already pulled out more cash than they could ever use in their lifetime,” leaving them with little “skin in the game,” Cohan said.

Cohan reckons investment banks should be run more like private partnerships again, with the entire net worth of top partners on the line each year.

Cohan suggested a new class of security be added to investment banks’ capital structure that equals the entire net worth of the top 100 people at the firms. If big losses hit, this security would be completely wiped out before shareholders and creditors, he explained.

Executives would be much more attentive to risk if they knew they might lose everything if big bets go sour, Cohan said.

Regulators and the government in the U.S. have taken a far gentler approach, unveiling guidelines and hoping that companies adopt the suggestions.

Now that most large banks have exited TARP, they’re free from government compensation restrictions and oversight by the pay czar. However, Treasury hopes Feinberg’s decisions on pay at companies still in the program, like AIG, will influence other companies.

“The Special Master has said that we believe his determinations have served as a constructive model for companies that are looking to reduce risky bonuses,” a Treasury spokeswoman wrote in an e-mail to MarketWatch.

But Mark Borges, a principal at consulting firm Compensia who used to work on compensation issues at the Securities and Exchange Commission, reckons Feinberg’s toughest rulings will be shunned by other companies.

“Anything that smacks of a limit is probably not going to spread beyond the group of companies that have to comply with the government’s guidance,” he said. “Institutions are reluctant to do things in this area unless they’re forced to.”

The pay czar limited cash salaries of executives at companies that got lots of government support through TARP to $500,000 a year, except in “exceptional circumstances.”

“There’s no way other companies are going to do that,” Borges said. “They don’t want any limit on the amount that an executive can be paid.”

Feinberg also froze “gold-plated” retirement and severance payments for executives of major TARP recipients. Other companies will keep offering these benefits “because they feel that they need to have these things to remain competitive,” Borges said.

Feinberg also completely rejected guaranteed cash bonuses because they separate pay from performance.

“I don’t think you’ll see companies give those up either,” Borges predicted. These controversial benefits are useful for trying to attract talented executives or stop them from leaving, he explained.

Still, other compensation standards imposed by TARP legislation and the Pay Czar may spread across the broader corporate community over time, Borges said.

All companies are already required to look at compensation policies to see whether they increase risk. They’ve also been adopting clawbacks and this should accelerate, Borges said.

Longer holding periods for stock compensation are also catching on and more use of stock rather than cash to pay executives will also spread, he added.

The pay czar also limited the value of annual perquisites to $25,000.

“Companies have been trying to rein in perks for some time,” Borges said. “The pay czar’s limit could provide the cover companies need to control these.”

(c) 2009, MarketWatch.com Inc. Source: McClatchy-Tribune Information Services.