When financial regulators earlier in the year issued a third proposal on Dodd-Frank incentive-based compensation arrangements for financial institutions, two of the six agencies that were congressionally mandated to write the rule jointly were curiously missing: the Federal Reserve and the Securities and Exchange Commission (SEC). And at least for the securities regulator, it had a valid reason: the Fed’s inaction.
“It has to be a joint rule. And once the Federal Reserve told us that—and they have told us at staff level, they have told us at the chair level—they were not yet ready to move on it, I thought it was best to just…,” SEC Chair Gary Gensler said during a House Financial Services Committee hearing on September 24, 2024, in response to a question by Representative Nydia Velazquez (D-NY) who believes the agencies should have written it a long time ago since they were given an April 2011 deadline.
And frustrated by the lack of progress, Velazquez interjected before Gensler finished answering: “Sir, you said that you are taking this job seriously. It has been 14 years. Do you think we deserve better?”
Dodd-Frank, which Congress passed in 2010 in response to the 2008 financial crisis, included Section 956, which is intended to reign in reckless behavior on Wall Street caused by imprudent incentive compensation packages for bankers. And investor advocates have urged regulators over the years to adopt the rule, but strong banking industry opposition to the rule has led to the prolonged delay. Sec. 956 of PL111-203
Had regulators adopted the proposed rule as issued in March 2011, financial firms would have been banned from giving out pay packages that encourage excessive risk-taking. Firms would have to file annual reports describing the financial incentives, including narrative descriptions of pay packages and the firm’s compensation policies and procedures.
The original proposing release cited arrangements that “rewarded employees—including non-executive personnel like traders with large position limits, underwriters, and loan officers—for increasing an institution’s revenue or short-term profit without sufficient recognition of the risks the employees’ activities posed to the institutions, and therefore potentially to the broader financial system.”
And Gensler responded to the congresswoman that “the American public definitely deserves that we do this, and I am supportive and have asked staff to work on it. But I understand the Federal Reserve is not willing at this time to move forward.”
The SEC “will not slow the Federal Reserve down; we will be ready whenever they are ready,” Gensler added, saying that the agency has collaborated and talked to all the other five agencies. “And we can only actually propose something if joint. And so we need the Federal Reserve. If they are ready, we will be ready.”
The four agencies that issued the third round of proposals are: the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Federal Housing Finance Agency in May and the National Credit Union Administration in July. And this may have to do with economic analysis.
During the September 24 hearing when four other SEC commissioners testified, Commissioner Jaime Lizarraga said that “the other agencies, unlike us, don’t have to conduct economic analysis like we do. So, that also adds another layer” of complexity.
When: Unknown
It is unclear when or if the central bank will move forward on this rulemaking, especially as some critics say that the current Fed may be too sympathetic to banks.
Chair Jerome Powell, for example, has expressed skepticism about the need for the rule.
“I would like to understand the problem we’re solving, and then I would like to see a proposal that addresses that problem,” he said in congressional testimony in March. Powell was first appointed by President Trump, and President Biden reappointed him to head up the Fed.
However, a Fed spokesperson in early May reportedly said that the central bank is committed to working with other agencies on a joint rule but needs to take into account updated information that reflects current industry practices.
But now with the SEC testimony, there is no question the Fed is to blame for regulatory inaction, said Bartlett Collins Naylor, financial policy advocate with Public Citizen.
“Powell is blocking banker pay reform,” Naylor told Thomson Reuters on October 4. “He said as much in his own congressional testimony. Now both SEC Chair Gensler and Commissioner Lizárraga affirm that the holdup is the Fed. Meanwhile, misconduct incentivized by badly structured pay continues on Wall Street. The most recent conspicuous examples are the failures of regional banks” last year.
The Fed did not respond to a request for comment.
It is unclear when the rule will be adopted as the effort underway is yet another proposal.
The second proposal was issued in 2016. Changes that financial companies made to their compensation practices since the 2011 proposal was released had persuaded the regulators to modify the proposal. The requirements would apply to banks, broker-dealers, credit unions, and investment advisers with $1 billion or more in assets.
For Velazquez, it is unclear why a third proposal is even needed.
“It’s hard to comprehend why this rule has been delayed for so long or why it requires such an extensive analysis that it has yet to be finalized,” Representative Velazquez told Thomson Reuters in an emailed statement on October 4. “The longer the delay, the greater the risk for yet another scandal related to excessive risk taking tied to incentive-based executive pay structures. It’s past time for federal regulators to get this done.”
Meanwhile, to prompt regulators to act with urgency, Public Citizen in September 2022 issued a report called Inappropriate: Banker Scams Continue as Washington Fails to Reform Pay as Mandated by 2010 Law.
“The 2008 financial crash stemmed from numerous causes, and risk-taking by bankers in pursuit of incentive-based compensation figured as one of the most conspicuous triggers,” the report states. “Bankers committed massive frauds selling flawed mortgages, ultimately sending the economy into a Great Recession.”
The report said that there might be an excuse for the government’s inaction if the rule were no longer relevant or urgent, but they emphasized that that is not the case, citing well-known examples of inappropriate risk-taking and fraud.
“In 2022 alone, numerous cases link compensation to fraud and investor abuse by banks, including examples such as: a fake account scam at U.S. Bank; abuse in student loans by Navient; investor abuse by Allianz, Schwab, First Republic Bank, and Credit Suisse; and maintaining insufficient anti-money laundering controls by USAA Federal Savings Bank and Wells Fargo,” the report notes. “This ongoing litany of inappropriate action by executives in search of enrichment clearly demonstrates the urgency of why regulators must take swift action to finalize this pay reform rule.”
This article originally appeared in the October 7, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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