Do regulators still need to issue an exec comp rule?

WASHINGTON — A regulatory plan to create new restrictions on banks’ executive compensation practices appears dead — but changes since the financial crisis may have made the proposal largely obsolete anyway.

In updated regulatory agendas published late Thursday, four of the six agencies responsible for completing the joint rulemaking left the regulation off their agendas.

That was a clear sign, some observers said, that the agencies had conceded defeat on the issue, and there was likely no recourse to resurrect the rule.

“My sense is the proposed executive compensation rule is in deep, deep hibernation,” said Margaret Tahyar, a partner at Davis Polk. “It's extremely challenging, verging on the impossible, to force a regulator to act.”

Fed Chair Janet Yellen
Janet Yellen, chair of the U.S. Federal Reserve, speaks during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington, D.C., U.S., on Wednesday, March 15, 2017. The Federal Reserve raised its benchmark lending rate a quarter point and continued to project two more increases this year, signaling more vigilance as inflation approaches its target. Photographer: Andrew Harrer/Bloomberg

But it’s unclear how much it was even needed, however. Regulators have already implemented several changes, and the market has demanded even more.

The Federal Reserve, for example, has pushed large banks to reduce the maximum payout on stock options to 125% and to defer compensation over a longer period of time. Institutional investors and activist shareholders have moved the industry toward adopting provisions like clawbacks and deferred compensation since the crisis, she said.

"The fact that this has stalled doesn't mean that the Federal Reserve and regulators will sit back and say there's nothing to do now," said Susan O'Donnell, a partner at Meridian Compensation Partners, which consults with banks and other financial firms on compensation practices. "Clawbacks and forfeitures are standard practice among banks, so you don't need a rule to do that. Certain practices have become best practices and momentum has continued, so it's not like everybody is going back to before the financial crisis."

Yet some worry about the precedent being set.

Aaron Klein, a fellow at the Brookings Institution and policy director at the Center on Regulation and Markets, said that regardless of whether the industry has improved its practices, the law is the law. Regulators' intent to ignore it is not unlike the Fed’s decision to delay requirements to issue a rule related to the issuance of subprime mortgages, he said, and could have similarly disastrous results.

“It is not the regulators’ job to decide which law to follow,” Klein said. “One of the problems with the current regulatory structure is there’s often no effective mechanism to hold regulators accountable when they have failed to promulgate a rule under the law.”

The Dodd-Frank Act requires six agencies to issue rules forbidding incentive-based compensation structures that are either “excessive” or “could lead to material financial loss to the covered financial institution.” The final rule was meant to be completed within nine months of the law's enactment, which was signed exactly seven years ago on Friday.

The agencies struggled with how to enact that mandate, however, issuing an initial plan in 2011 but failing to finalize it for years afterward. The regulation was reproposed in April 2016, and stipulated different requirements for firms with different sizes, with the most stringent requirements being placed on the largest firms.

On Thursday, four of the six agencies — the Securities and Exchange Commission, the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and Commodity Futures Trading Commission — left the proposal off their agendas. Only the Federal Reserve Board and National Credit Union Administration left any mention of it on their to-do list.

The Fed may still have it in its sights. Fed Chair Janet Yellen said in December that the regulation was part of a secular improvement in incentive-based compensation standards across the financial industry, but emphasized that regulators should not become complacent on the issue.

"There have been many ways in which there have been many compliance failures at banking organizations," Yellen said. "This is something that is important. The failings in a number of institutions certainly suggest there is room for improvement."

Some consumer advocates suggested they might take the issue to court to force the agencies to act.

Marcus Stanley, policy director at Americans for Financial Reform, acknowledged that establishing standing to sue regulators may be difficult, they may try anyway.

“It’s an inherently unbalanced playing field, where regulated entities can sue based on the most far-fetched interpretation of some detail of a rule, but if an agency is just flat-out not completing a rule it’s difficult for us to get standing,” Stanley said. “But we’re certainly going to look at whether that’s possible.”

One way regulators could prevent that is to promulgate a new version of the executive compensation plan, one that largely codifies the status quo, said Tim McTaggart, a partner at Stinson Leonard Street and former Fed official.

“Doing nothing where there’s an obligation to produce a rule is always a risk for an agency,” McTaggart said. “Whether they go through an exercise to produce a rule — kind of a rule for a rule’s sake — it’s a course of action that’s defensible.”

But Stanley warned that regulators may come to regret dropping the rule. He pointed to Wells Fargo’s phony-accounts scandal late last year as proof that the market has not solved the executive compensation problem.

“The Wells thing was very relevant, because these guys got giant bonuses that were directly related to ripping off customers — it showed, I think, the need for this rule,” Stanley said. “Obviously [the administration] is willing to do unpopular stuff, so we’ll see whether that changes.

The agencies’ apparent intention to ignore the rule comes as little surprise to Karen Shaw Petrou, managing partner at Federal Financial Analytics. She noted that the regulation was difficult to promulgate even under the Obama administration, and said the election of Donald Trump as president made its demise a foregone conclusion.

“In November we said this was one rule that was dead on arrival, and I haven’t thought much about it since,” Petrou said. “It wasn’t liked on all sides. It was too lax for those focused on retribution, and too stringent for the industry.”

Many experts said there are principled reasons to be opposed to the 2016 version regardless of who is in office. Some thought the plan went too far, particularly provisions that could claw back compensation for executives who cause corporate embarrassment.

"The rules never really got a full debate, so I don't think it's a bad thing that they have been killed, because I think the pendulum has swung too far," said Alan Johnson, managing director of Johnson Associates, a compensation consulting firm. "But there will be some blowback on this."

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