Loopholes Sap Potency of Pay Limits

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FEBRUARY 6, 2009
Loopholes Sap Potency of Pay Limits
By MARK MAREMONT and JOANN S. LUBLIN

President Barack Obama's crackdown on Wall Street pay contains loopholes, and may have limited impact in restraining compensation, according to some executive-pay consultants and management attorneys.

Some compensation professionals already are pointing out potential holes in the rules, including tactics such as changing executives' titles or rearranging pay packages. Just as past attempts by the government to restrict executive pay largely backfired, these people warn, the new curbs also may have unintended consequences.

The plan, announced Wednesday, includes a $500,000 cap on annual compensation for senior executives of companies that receive future "exceptional" government aid. Additional compensation would have to be paid in restricted stock or similar long-term incentive arrangements, which the executives could cash in only after the government is repaid, with interest.

Other recipients of future federal bailout money would have to place tougher limits on severance packages and disclose luxurious perks, such as the use of company jets. Annual compensation above $500,000 at these companies would be subject to a nonbinding shareholder vote.

"The mix of transparency and accountability is powerful and strikes the right balance to allow banks to continue operating effectively while operating under common-sense guidelines that rein in excessive compensation," a Treasury Department official said Thursday.

Many applauded the moves as a useful step to curb Wall Street compensation practices that may have led to excessive risk-taking. But some critics identified weaknesses, suggesting the restrictions be retroactively applied to companies that already have received federal bailout cash. They noted that the most stringent restrictions likely would affect only a few firms; others could avoid some of the curbs by putting extra pay to a shareholder vote.

Some said the plan doesn't limit total compensation, because it allows companies to boost awards of restricted stock.

"I am fearful that companies will look at this as an opportunity to grant more restricted shares and stock options to executives who already have an abundant amount of equity," said Jesse Brill, a securities and compensation lawyer who is chairman of CompensationStandards.com, an advisory Web site. He would prefer barring executives from cashing in stock until age 65 or two years past retirement to encourage long-term decision making.

Michael Kesner, head of compensation consulting at Deloitte Consulting LLP, worries the plan allows executives to claim restricted-stock awards once the company pays back the government, and doesn't require companies to tie those awards to operating results or share-price gains, as many companies now do.

"They're actually saying we don't care about performance," Mr. Kesner said.

Others said the preliminary restrictions released by the Treasury Department are overly vague. For example, the $500,000 annual pay limit applies only to "senior executives." James F. Reda, a New York compensation consultant, said companies could give certain executives lower titles or assign them to head subsidiaries.

"Now you're going to have executives ask not to be called a senior executive," said Steven Hall, a New York pay consultant. He warned that companies can't get too "cute," because they will embarrass themselves before a hostile public and government. "Being cute ain't going to work in the future," he said.

There also isn't a clear definition of what constitutes a luxury perk. Companies could grant executives benefits such as medical exams, tax gross-ups and personal tax advice, said Sarah Anderson, an executive-pay analyst at the Institute for Policy Studies, a liberal think tank in Washington. Gross-up payments from companies reimburse senior executives for taxes the executives owe on company-provided perks and other benefits.

The Treasury official said the department plans to issue more detailed regulations, likely in a few weeks. He said each company's perk guidelines will be vetted and posted publicly.

David Yermack, a finance professor at New York University's Stern School of Business, said the initial guidelines don't address many aspects of executive pay, such as deferred compensation and pension arrangements.

Mr. Yermack also said it isn't clear if companies would be allowed to boost executives' pay by repricing existing stock options. Such a repricing could be worth millions of dollars in potential compensation.

Perhaps the broadest impact from President Obama's plan will stem from its endorsement of advisory shareholder votes on executive-pay provisions. Such "say-on-pay" votes have long been sought by corporate-governance advocates, but only a small number of companies have implemented such votes.

Some bankers and compensation consultants said they worry the plan will prompt an exodus of talent from companies with regulated pay to other firms. But Alan Levine, an executive-compensation attorney at Morrison Cohen LLP in New York, said there will be plenty of qualified people willing to run big banks at annual salaries of $500,000.

"I think there's some guy at Citigroup who says, 'I don't care if I'm only making a half-million dollars, I'm going to lead this bank to recovery, and when we get out of this cloud, you're going to pay me.'"

—Phred Dvorak contributed to this article.

Write to Mark Maremont at mark.maremont@wsj.com and Joann S. Lublin at joann.lublin@wsj.com

Printed in The Wall Street Journal, page C1