Senator Gary Peters, a Democrat from Michigan, urged financial regulators to quickly finish writing a crucial Dodd-Frank rule related to incentive compensation for bankers in light of apparent shoddy risk management at Silicon Valley Bank. The financial institution suffered from a stunning collapse about two weeks ago when there was a massive run on deposit. Banking agencies quickly stepped in to try to prevent a wider financial meltdown.
“Section 956 of Dodd-Frank was intended to require financial regulators to quickly and collaboratively issue rules requiring financial institutions to disclose any incentive-based executive compensation arrangements that encourage excessive risk-taking at financial institutions or that may lead to financial loss,” Senator Peters wrote in a March 22, 2023, letter to the heads of federal agencies.
The provision in the financial reform law—which was enacted in July 2010 in response to the 2008 financial crisis—is intended to rein in reckless behavior in the financial industry that could put the broader economy at risk as it did 15 years ago when millions lost jobs, retirement savings and homes.
Congress gave regulators a May 2011 deadline to adopt the rule. But after more than 12 years, regulators have not advanced the rulemaking largely because of intense lobbying by the financial industry—to the consternation of reform advocates. In pressing for reform, consumer and investor protection advocates said that flawed compensation plans made bankers and other financial services professionals take excessive and reckless risks in pursuit of big payouts in the leadup to the crisis. More than ever today, advocates believe it is time for regulators to act.
“The recent bank failure of Silicon Valley Bank and reported bonuses issued to its leadership further underscore the urgency and importance of this rule’s implementation,” Peters wrote.
While various factors may have been at play that led to its demise, such as the bank’s susceptibility to runs when economic conditions deteriorate; a large portion of customers who were mainly in the tech sector had deposits of more than the FDIC-insured $250,000 limit. But the Federal Reserve had concerns about the bank’s risk management starting from 2019, issuing citations that it did not have appropriate internal controls to manage risks for a large institution that has more than $100 billion in assets. The bank has been growing rapidly with assets at $70 billion in 2019 to $114 billion a year later. Then in 2021, Silicon Valley Bank had assets of about $209 billion.
Before its collapse, Silicon Valley Bank was the 16th largest bank and the second largest failure in history. The largest failure was Washington Mutual in the 2008 financial crisis.
But Silicon Valley Chief Executive Officer Gregory Becker earned $9.9 million last year. Federal agencies also quickly had to take over Signature Bank, to try to stabilize the banking system. Signature Bank founder and CEO Joseph DePaolo, made $8.6 million in 2022.
“Given how incentive-based compensation can continue to lead to certain financial institutions and professionals taking excessive and reckless risks, implementation of this long-delayed rule is an important reform to ensure reckless financial risks and financial mismanagement do not put our banking system at risk,” wrote the senator. In 2008, Peters was a member of the House of Representatives, serving on the Financial Services Committee. And he served on the conference committee that finalized Dodd-Frank.
“Addressing commonsense financial regulation is essential to supporting families in Michigan and across the U.S., growing our economy, and creating jobs,” Peters wrote. “Please consider advancing regulations as swiftly and collaboratively as possible.”
Financial regulators over the years had attempted to write the rule twice, first issuing a proposal in 2011 then a revised proposal in 2016. Each time, financial institutions aggressively pushed back in their comment letters and in their lobbying. So far, they have succeeded as regulators put the rulemaking item on the back burner.
This is a joint rulemaking effort by the Securities and Exchange Commission, Office of the Comptroller of the Currency, the Federal Reserve, FDIC, Federal Housing Finance Agency and National Credit Union Administration.
But had regulators adopted the proposed rule as issued 12 years ago, 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 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.”
In 2016, changes that financial companies made to their compensation practices since the 2011 proposal was released 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.
However, the most recent regulatory agendas, which were unveiled earlier this year, show no indication that Section 956 will be implemented any time soon.
“We have received the letter and plan to respond,” a Federal Reserve spokesperson said. The FDIC declined to comment. A spokesperson said that the OCC does not comment on congressional correspondence. “We are reviewing the letter; no further comment at this time,” an NCUA spokesperson said. FHFA said it does not have a comment at this time. The SEC did not respond to a request for comment.
In the meantime, Public Citizen had been trying to prompt regulators to act with urgency well before Silicon Valley Bank’s collapse. For example, in September last year, the reform advocacy group 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 noted that there might be an excuse for the government’s inaction if the rule were no longer relevant or urgent, but it emphasized that that is not the case, citing well-known examples of inappropriate risk-taking and fraud, including JP Morgan’s $6 billion loss in flawed derivatives bets known as the London Whale, which was a plan to boost senior executive pay. Wells Fargo had quotas on its sales reps to increase consumer accounts, leading them to create fake accounts and boost senior executive pay linked to account growth metrics.
“Bad bank behavior follows bad compensation structure, a lesson we must apparently re-learn at the cost of financial crisis. Ideally, policy makers will now escape the grip of Washington’s 3000+ bank lobbyists and liberate a law approved in 2010 to reform this needlessly perennial mess,” Bartlett Naylor, financial policy advocate for Public Citizen, said on March 22 of the most recent bank failures.
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