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S. HRG. 111–844 TARP AND EXECUTIVE COMPENSATION RESTRICTIONS HEARING BEFORE THE CONGRESSIONAL OVERSIGHT PANEL ONE HUNDRED ELEVENTH CONGRESS SECOND SESSION OCTOBER 21, 2010 Printed for the use of the Congressional Oversight Panel smartinez on DSKB9S0YB1PROD with HEARING ( VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00001 Fmt 6011 Sfmt 6011 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING TARP AND EXECUTIVE COMPENSATION RESTRICTIONS VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00002 Fmt 6019 Sfmt 6019 E:\HR\OC\A160.XXX A160 S. HRG. 111–844 TARP AND EXECUTIVE COMPENSATION RESTRICTIONS HEARING BEFORE THE CONGRESSIONAL OVERSIGHT PANEL ONE HUNDRED ELEVENTH CONGRESS SECOND SESSION OCTOBER 21, 2010 Printed for the use of the Congressional Oversight Panel ( U.S. GOVERNMENT PRINTING OFFICE WASHINGTON smartinez on DSKB9S0YB1PROD with HEARING 64–160 : 2010 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00003 Fmt 5011 Sfmt 5011 E:\HR\OC\A160.XXX A160 CONGRESSIONAL OVERSIGHT PANEL PANEL MEMBERS THE HONORABLE TED KAUFMAN, Chair KENNETH TROSKE J. MARK MCWATTERS RICHARD H. NEIMAN smartinez on DSKB9S0YB1PROD with HEARING DAMON SILVERS (II) VerDate Mar 15 2010 06:02 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 E:\HR\OC\A160.XXX A160 CONTENTS Page smartinez on DSKB9S0YB1PROD with HEARING Opening Statement of Hon. Ted Kaufman, U.S. Senator from Delaware .......... Statement of J. Mark McWatters, Attorney and Certified Public Accountant ... Statement of Damon Silvers, Director of Policy and Special Counsel, AFL– CIO 9 ..................................................................................................................... Statement of Kenneth Troske, William B. Sturgill Professor of Economics, University of Kentucky ........................................................................................ Statement of Richard Neiman, Superintendent of Banks, New York State Banking Department ........................................................................................... Statement of Kenneth R. Feinberg, Special Master for TARP Executive Compensation, June 2009 through September 2010 ................................................ Statement of Kevin Murphy, Kenneth L. Trefftz Chair in Finance, University of Southern California, Marshall School of Business ........................................ Statement of Fred Tung, Howard Zhang Faculty Research Scholar and Professor of Law, Boston University School of Law ................................................ Statement of Ted White, Strategic Advisor, Knight Vinke Asset Management; Cochair, Executive Remuneration Committee, International Corporate Governance Network .................................................................................................. Statement of Rose Marie Orens, Senior Partner, Compensation Advisory Partners, LLC .............................................................................................................. (III) VerDate Mar 15 2010 06:02 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00005 Fmt 5904 Sfmt 0483 E:\HR\OC\A160.XXX A160 1 5 10 14 18 21 41 69 70 81 smartinez on DSKB9S0YB1PROD with HEARING VerDate Mar 15 2010 06:02 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00006 Fmt 5904 Sfmt 0483 E:\HR\OC\A160.XXX A160 HEARING ON TARP AND EXECUTIVE COMPENSATION RESTRICTIONS THURSDAY, OCTOBER 21, 2010 U.S. CONGRESS, CONGRESSIONAL OVERSIGHT PANEL, Washington, DC. The panel met, pursuant to notice, at 11:00 a.m. in room SD– 538, Dirksen Senate Office Building, Senator Ted Kaufman, chairman of the panel, presiding. Present: Senator Ted Kaufman [presiding], Richard H. Neiman, Damon Silvers, J. Mark McWatters, and Kenneth R. Troske. smartinez on DSKB9S0YB1PROD with HEARING OPENING STATEMENT OF HON. TED KAUFMAN, U.S. SENATOR FROM DELAWARE The CHAIRMAN. This hearing of the Congressional Oversight Panel will now come to order. Good morning. My name’s Ted Kaufman. I’m the chairman of the Congressional Oversight Panel for the Troubled Asset Relief Program. This hearing is my first as the Panel’s chairman, so I want to begin by thanking my fellow panelists and recognize their tremendous work to date. And I’m deadly serious about that. I’ll tell you, they came into me the first day and they said, ‘‘Here, take a look at this.’’ Twenty-four reports. What, 12 hearings? It’s just—it is really remarkable what the Panel’s work can do. As we all know, the TARP has been among the most controversial government programs in recent memory; yet, month after month, this Panel has managed to cut through the noise and differing opinions to provide a perspective that is independent, factbased, and consensus-driven. I hope to help carry our work forward in exactly that spirit. We are here today to examine the executive compensation restrictions in the TARP. In 2008, Congress authorized $700 billion to bail out the financial system, but the money came with certain strings attached. As a condition of receiving taxpayer aid, the companies were required to align their executive pay practices with the public interest. No one can argue against the ‘‘public interest,’’ but in the context of executive pay, I think everyone would agree, it’s very difficult to define or measure. After all, a paycheck represents many things. It represents the source of a family’s livelihood. It represents an incentive to work hard and achieve results. It represents a tool for retaining workers. It represents the value that an employee adds to the workforce. It represents a cost to the employer’s bottom line. (1) VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 E:\HR\OC\A160.XXX A160 2 smartinez on DSKB9S0YB1PROD with HEARING In the case of bailed-out financial institutions, a paycheck represents a transfer of wealth from taxpayers to corporate executives. A paycheck that is too high is clearly out of step with the public interest. It risks rewarding executives whose mismanagement contributed to the financial crisis and potentially wasting taxpayer dollars. Yet, a paycheck that is too low creates problems, too. If a bailed-out bank cannot hold on to talented executives, it may struggle to stay afloat or to repay taxpayers. Even a paycheck that is neither too high nor too low may still create perverse incentives. A CEO paid $10 million in company stock may take reckless risks to drive it to $20 million. A company can rein in this problem by requiring executives to hold their stock for several years. Yet, even then, executives may refuse to consider measures, such as bankruptcy, that would strengthen the public interest but diminish shareholder profits. For all these reasons, executive pay is complicated and controversial, but it’s also of profound importance. If Treasury, acting on its authority and leading by its example, can get executive pay right, it could help to lay the foundation for long-term financial stability. Any mistakes, on the other hand, could contribute to the next financial collapse. Today, we will hear from witnesses—excellent witnesses—who have long practiced in navigating these turbulent waters. We thank you for your time and look forward to your testimony. And now I’d like to turn to other colleagues in the Panel for their statement. Mr. McWatters. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 E:\HR\OC\A160.XXX A160 Insert offset folio 10 here 64160A.001 smartinez on DSKB9S0YB1PROD with HEARING 3 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 E:\HR\OC\A160.XXX A160 Insert offset folio 11 here 64160A.002 smartinez on DSKB9S0YB1PROD with HEARING 4 5 smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF J. MARK McWATTERS, ATTORNEY AND CERTIFIED PUBLIC ACCOUNTANT Mr. MCWATTERS. Good morning, and thank you, Senator, and welcome to the panel. The CHAIRMAN. Thank you. Mr. MCWATTERS. Over the past 2 years, Members of Congress, policy wonks and academics, and private-sector participants have debated the existence of any linkage between the compensation structures employed by TARP recipients and other institutions and the financial contagion that erupted in the last quarter of 2008. Some contend that the cause-and-effect relationship exists between the structure of an employee’s compensation package and the amount of risk the employee’s willing to undertake on behalf of his or her employer. I refer to this as the ‘‘show me the money’’ theory. Under this theory, some mortgage lenders, for example, may have originated residential mortgage loans without conducting prudent due diligence investigations of the borrowers. Likewise, some TARP recipients and other institutions may have packaged mortgage loans and securitization vehicles, without having properly vetted the underlying collateral, and sold the securitized tranches to investors who, themselves, may have elected to forgo any meaningful investigation of the legal and financial integrity of the transactions. Other commentators, however, reject the ‘‘show me the money’’ theory and argue that the financial crisis of 2008 and beyond was not spawned by misdirected compensation policies, but instead arose from the failure of mortgage originators and securitization sponsors and investors to appreciate the magnitude of the risk inherent in the mortgage lending and pooling of loans into opaque securitization products. I refer to this as the ‘‘white heart, empty head’’ theory. Under this approach, directors, officers, and employees of TARP recipients and other institutions, from the perspective of pure self-interest, would not have knowingly taken any action that could have resulted in the loss of their employment, the material devaluation of their incentive stock options and grants, or the bankruptcy, takeover, or liquidation of their firms. That is, these individuals possess no desire for self-immolation, and they discharged their duties accordingly. As in other instances, the solution to our inquiry may not reside solely within the domain of either theory or hybrid of the two. Although the ‘‘white heart, empty head’’ theory has a certain visceral appeal—and it is significant to note that relatively few investment professionals accurately foresaw the impending financial tsunami— those who dismiss the ‘‘show me the money’’ theory, however, may be disappointed as we discover more about how the sausage was actually made in the residential mortgage securitization factories. In the final analysis, I suspect that both theories may help explain the genesis of the recent financial crisis. The compensation packages offered by some TARP recipients no doubt encouraged a certain amount of excessive and unnecessary risktaking, the consequences of which, unfortunately, were not fully appreciated by the TARP recipients themselves, their Federal and State regulators, or the capital markets. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00011 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 6 smartinez on DSKB9S0YB1PROD with HEARING The most challenging work remains ahead, however, as we struggle with the remaining fundamental inquiry: How does an employer structure a compensation program so as to identify and minimize unnecessary and excessive risktaking while encouraging managers to assume sufficient risk so as to assure the long-term profitability of their employer? Thank you, and I look forward to our discussion. The CHAIRMAN. Mr. Silvers. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00012 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00013 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert graphic folio 15 64160A.003 smartinez on DSKB9S0YB1PROD with HEARING 7 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert graphic folio 16 64160A.004 smartinez on DSKB9S0YB1PROD with HEARING 8 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00015 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert graphic folio 17 64160A.005 smartinez on DSKB9S0YB1PROD with HEARING 9 10 smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF DAMON SILVERS, DIRECTOR OF POLICY AND SPECIAL COUNSEL, AFL–CIO Mr. SILVERS. Thank you, Mr. Chairman. Good morning. Let me first say what a pleasure and honor it is to be with our new chairman, Senator Ted Kaufman. Secondly, I would like to express my appreciation to all our witnesses, and in particular to Kenneth Feinberg, for appearing before us today, for being open to our views in the course of his work, and for his strenuous efforts in so many difficult circumstances on behalf of the American public. Now, TARP is a program which uses public funds to subsidize private businesses and, in the process, extends to those private businesses implicit, and in some cases explicit, guarantees. Now, while there is extensive debate about executive pay in private companies subject to market discipline, that debate is of limited relevance to companies that have capital at below-market cost or have escaped bankruptcy due to the generosity of the American public. So, we are here to ask, today, What compensation practices at TARP recipient institutions were and are in the public interest? I believe there are three dimensions to this question. The first is: Compensation practices under TARP should have contributed, and should contribute, to a sense among the American public that TARP’s purpose was public-spirited and not designed or managed to maintain the incomes or assets of the executives of the businesses that caused the financial crisis. This issue is critical to the very legitimacy of our national government and our capacity, as a Nation, to address the ongoing economic crisis and to engage in national economic policymaking in the future. Now, in this context, I am particularly curious about the somewhat peculiar conclusion drawn by the special master, that billions of dollars of executive pay was, quote, ‘‘not appropriate,’’ but was nonetheless in the public interest. I look forward to learning how that could be. Second, compensation practices under TARP should have led to economic and career consequences for executives of failed firms. There was and is a profound public interest in mitigating the moral hazard created when executives of too-big-to-fail institutions learn that, in the words of the New York attorney general, ‘‘Heads, I win; tails, you lose.’’ Unfortunately, one of the effects of TARP appears to have been to perpetuate the accumulation of wealth by the very people and institutions that seem to have been responsible for our Nation’s economic catastrophe. Last week, the Wall Street Journal reported that overall compensation at six of the largest TARP recipients, including Bank of America and Citigroup that were recipients of exceptional aid, was higher in 2009 and in 2010 than it had been in 2007, and, during the 4-year period of the continuing financial crisis, amounted to over $430 billion; this, during a period when the real wages of Americans fell and returns to long-term investors in these very firms were catastrophic. Now, finally and thirdly, compensation practices under TARP should be aligned with the public’s interest both as investor and as implicit guarantor, both of individual firms and of the financial system as a whole. In pursuing this goal, TARP has faced a problem VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00016 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 11 smartinez on DSKB9S0YB1PROD with HEARING of equity prices in a number of TARP recipients that were so low as to be, effectively, options. Executives with equity-based compensation thus faced little real downside exposure and every reason to not restructure bank balance sheets, as my fellow panelists have alluded to. This situation would seem to encourage reckless risktaking, like, say, pursuing foreclosures without having the proper documents by means of faked affidavits. So, I hope, today, that we can learn how TARP measures up against these objectives and what approaches to executive pay make the most sense, in light of them. Thank you. The CHAIRMAN. Mr.—Dr. Troske. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00017 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert graphic folio 21 here 64160A.006 smartinez on DSKB9S0YB1PROD with HEARING 12 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00019 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert graphic folio 22 here 64160A.007 smartinez on DSKB9S0YB1PROD with HEARING 13 14 smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF KENNETH TROSKE, WILLIAM B. STURGILL PROFESSOR OF ECONOMICS, UNIVERSITY OF KENTUCKY Dr. TROSKE. Thank you, Senator Kaufman. I would like—also like to start by thanking all of the witnesses for appearing before our panel today. I recognize that all of you are very busy people with a number of other responsibilities, so I appreciate you taking your time to travel here and to help us with our oversight responsibilities. As we are all aware, the issue before us today—examining the government’s efforts to regulate how firms compensate executives, particularly firms who have received bailout money—remains one of the more controversial issues to arise out of the recent financial crisis. Taxpayers remain incensed about the large bonuses received by executives at firms that received enormous government bailouts. Much of the recent discussion of executive compensation on these issues has focused on several issues about executives: Should executives of bailed-out financial firms receive bonuses? Do bonuses cause managers to focus on short-term gains as opposed to the long-term growth of a company? And have boards of directors of large financial firms been captured by management so that they simply rubberstamp managerial decisions instead of engaging in the appropriate amount of oversight? While I recognize that there can be instances in which the way firms compensate executives is not always perfectly in line with the interests of shareholders, I believe that, in a free market, these problems can and will be corrected. However, in my opinion, the fact that for the past 40 years the Federal Government has made it clear that it would use taxpayer money to insure large financial firms against failure creates a distortion that actually exacerbates the problems mentioned above—mentioned previously. In other words, the financial sector is not a free market, and if we could simply return it to a free market—that is, if we could simply get rid of all of the government guarantee that has created too-big-tofail firms—then many, if not most, of these problems would largely disappear or would no longer be of concern to taxpayers. It also means that by focusing on these ancillary problems, we fail to fix the true problem that is producing so much anger. In regard to the specific issue of executive compensation, recent research from the Federal Reserve Bank of Minneapolis shows that, in almost every setting, shareholders of firms will choose to pay workers in an efficient manner. The one exception to this rule is when the government provides an implicit or explicit guarantee of the firm’s debt and does not charge the firm for this guarantee. In this case, shareholders will choose to incentivize workers in ways that encourage them to take an excessive amount of risk. After all, if the risky investment pays off, shareholders reap all the rewards, but if the investment bankrupts the company, then it is the taxpayers who are left holding the bag. One obvious solution to this problem is to simply let firms fail, in the too-big-to-fail phenomena, or at least charge firms for the insurance that they’re being provided by the taxpayers. Regardless of what one thinks is the optimal solution, I think we can all agree that these issues remain important, and I am interested in hearing what the witnesses have to tell us about the chal- VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00020 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 15 smartinez on DSKB9S0YB1PROD with HEARING lenges involved in having the government regulate how firms pay their employees. So, once again, I would like to thank all of the witnesses for agreeing to appear before our panel today. Finally, I would like to extend a special welcome to our new chair, Senator Kaufman. For me, having Senator Kaufman join us is especially exciting, since I am no longer the newest member of the Congressional Oversight Panel. And, Senator, I want to assure you that I empathize with what you have been going through during the past few weeks, trying to catch up on all of the fine work that the Panel has completed. However, burdensome as your work has been, I want you to know that you’re getting off easier than me, since the first hearing I participated in was the Panel’s marathon hearing on AIG which lasted for 6 hours. The CHAIRMAN. Oh, God. Dr. TROSKE. I am fairly confident that our hearing today will be much shorter. The CHAIRMAN. Thank you. Superintendent Neiman. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00021 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00022 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 27 here 64160A.008 smartinez on DSKB9S0YB1PROD with HEARING 16 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00023 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 28 here 64160A.009 smartinez on DSKB9S0YB1PROD with HEARING 17 18 smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF RICHARD NEIMAN, SUPERINTENDENT OF BANKS, NEW YORK STATE BANKING DEPARTMENT Mr. NEIMAN. Thank you. I, also, want to start by welcoming Senator Kaufman. I’m thrilled that you have been able to join us, and I want to congratulate Majority Leader Reid for such an exceptional appointment. When I first started as a bank regulator, almost 4 years ago in New York, one of the first things that became clear was that the misaligned compensation incentives in the mortgage origination process, particularly of those around mortgage brokers, was harming consumers and poisoning the mortgage market. As my colleagues on the Panel and our witnesses know, too many new homeowners were steered into inappropriate subprime products because of the higher profits those products provided to loan originators. Worse, such misaligned compensation incentives permeated throughout the entire securitization process as the default risk of these products was consistently offloaded onto others. The entire financial system is rife with potential for similar conflicts between short-term profits and long-term sustainability. I hope to focus, this morning, on the best ways we have, collectively, learned to align risk with compensation so that we do not again need another TARP, or possibly yet another special master position, for Mr. Feinberg. [Laughter.] The guidance issued by the Federal regulators, in June, takes a principle-based approach to assuring that insured institutions and their holding companies appropriately balance risks and rewards and do not encourage imprudent risk taking. I hope to draw on Mr. Feinberg’s experience with TARP, and the other witnesses’ experience, to explore the pros and cons of a rulesbased versus principle-based approach to compensation. It seems to me that it is clearly difficult to draw effective rules for all situations before the fact, but, at the same time, the enforcement of principles requires vigilance and discretion. An additional area worth considering is if compensation and misaligned pay incentives are not just a concern for those generating revenue within institutions. The independence and incentives of those whose job it is to manage risk and assure legal compliance is arguably just as important. The mindset that considers risk managers as merely a cost of doing business is one we can no longer afford. I am pleased that the Panel is exploring this topic of executive compensation. And I do very much appreciate Mr. Feinberg’s attendance with us today, as well as the other experts. Compensation issues are an unfinished business in building a more resilient financial sector, and this is an important hearing for our Panel. Thank you. The CHAIRMAN. Thank you. I’m pleased to welcome our first witness, Kenneth Feinberg, who served as special master for TARP Executive Compensation from June 2009 to December 2010 and who has demonstrated his support for tough assignments and for—as a great public servant. And Ken and I go way back when we both were—he was involved with Senator Kennedy and I was involved with Senator Biden, primarily VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00024 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 19 smartinez on DSKB9S0YB1PROD with HEARING on the Judiciary Committee. So, I want to thank you for your service and I want to thank you for joining us. We ask that you keep your oral testimony to 3 minutes so there will be adequate time for questioning, but, as you well know, your written statement will be printed in the official record for the hearing. Please proceed. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00025 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 32 here 64160A.010 smartinez on DSKB9S0YB1PROD with HEARING 20 21 smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF KENNETH R. FEINBERG, SPECIAL MASTER FOR TARP EXECUTIVE COMPENSATION, JUNE 2009 THROUGH SEPTEMBER 2010 Mr. FEINBERG. Thank you. It is an honor to be here, Mr. Chairman. It’s been about 30 years since we first met, and it’s great to be back here again, with you on that side and I’m the witness this time. I want to emphasize I’m the ‘‘former’’ special master. The acting special master, Patricia Geoghegan, is right here, along with deputy special master Kirk Slawson. He is still on the front lines doing this. I also note the presence of Professor Murphy, who was of great assistance to us as a consultant during our work. I just want to emphasize a couple of points. This whole issue of causation was sort of preempted by Congress, when it came to my role. Congress delegated, to the Secretary of the Treasury, who delegated to me, the legal responsibility for linking executive compensation to regulation. Professor Murphy and others can talk about whether it’s a good idea for government to get involved in this. I’ve emphasized, repeatedly, that my role was very limited to just seven top recipients. That’s all the statute conveyed to me. Even as to those seven, my role in actually regulating pay was limited to the top 25 officials, as a mandatory matter. I had other voluntary discretionary regulatory authority, limited somewhat by the statute and by the regulations. So, in effect, to some extent—to some extent—my role is a sideshow, as the New York Times pointed out, because if you really want to get answers to questions of causation, linkage, executive pay, what is appropriate regulation, look to the Federal Reserve, the SEC, the FDIC, the G20, the new Dodd-Frank legislation that’s now the law of the land. My role was rather limited. Now, within that context, we did find some prescriptions that we invoked and implemented tying pay to performance. Very limited guaranteed compensation. Cash. Very limited guaranteed cash compensation. Tie the rest of an executive’s compensation to stock in the company for which she or he works. Do not allow that stock to be easily transferred too early. Compel the executive to keep that compensation in the form of equity. Nontransferable, except over a period as long as 4 years, a third after 2 years, a third transferable after 3, a third transferable after 4. The law required the statute immediate vesting of that compensation, but we decided, in a move that I think was important, that the long-term compensation of any individual top official in these seven companies should be deferred, as much as possible, so that the long-term success or failure of that company will be tied to the long-term compensation of the executive. I think it’s sort of elementary. I’m not sure everybody agrees with me on this, but this is what we concluded. We wanted to try and minimize risk. We wanted to maximize taxpayer return. We wanted to make sure that there was an appropriate allocation between cash and equity. We wanted compensation tied to performance. We wanted to look to the compensation of these seven companies and see how competitive our pay packages would be, relative to other companies that are in the market- VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00027 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 22 smartinez on DSKB9S0YB1PROD with HEARING place that we had no authority to regulate. And, finally, we wanted to make sure that, as I say, the top officials were paid based on what they contributed to the overall performance of the company and its shareholders. Finally—— The CHAIRMAN. Can you wrap up? Mr. FEINBERG [continuing]. Finally, two quick points. We heard, over and over again, that if we didn’t provide competitive pay packages, those top officials would leave and go elsewhere. And we were told by these companies, they would go elsewhere, they might even go to China. Everybody was going to go to China to work if these companies lost these officials. They’re still there. Eighty-five percent of the specific individuals whose pay, by statute, we regulated are still there. The second final point is in response to panelist Silvers. Why did the special master conclude, at the end of his tenure, that—as to officials at 17 top recipients—not just the 7, but as to 17 top recipients—why did I conclude, at the end of my tenure, that, although certain compensation practices led to compensation that was inappropriate and not justified—why didn’t I demand—even though I had no enforcement authority—why didn’t I demand that that money be returned to the taxpayer? Answer? The CHAIRMAN. No, let’s hold the answer, when Mr. Silvers asks the question, because you’re—— Mr. FEINBERG. I’m done. The CHAIRMAN [continuing]. Out of time. Mr. FEINBERG. Thank you, Mr. Chairman. You wield a tough gavel. The CHAIRMAN. Oh, yeah, right. [Laughter.] [The prepared statement of Mr. Feinberg follows:] VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00028 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00029 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 37 here 64160A.011 smartinez on DSKB9S0YB1PROD with HEARING 23 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00030 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 38 here 64160A.012 smartinez on DSKB9S0YB1PROD with HEARING 24 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00031 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 39 here 64160A.013 smartinez on DSKB9S0YB1PROD with HEARING 25 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00032 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 40 here 64160A.014 smartinez on DSKB9S0YB1PROD with HEARING 26 smartinez on DSKB9S0YB1PROD with HEARING 27 The CHAIRMAN. How did you—overall, how did you evaluate your success? I know it was kind of inside, and it was internal, but how did you judge your success as special master? Mr. FEINBERG. I think, I would view, if I must say so—Ms. Geoghegan might have a different view, but I don’t think so—I think we did exactly what the statute, Congress, and the Treasury regulations asked us to do. We were confined by those legal regulations in the statute. And I think, overall, in a very limited way— seven companies we did exactly what we were trying to do. And frankly, Mr. Chairman, we now see other Federal agencies adopting many of the prescriptions I’ve mentioned in their own effort to rein in executive pay. The CHAIRMAN. Well, you stated that 85 percent of the people are still there. Are there other numbers you use? In other words, at the end of the thing, you looked at it, and you said, ‘‘There are some numbers here, some metrics that I feel good about or I feel bad about’’? Mr. FEINBERG. Well, that’s the most important. I also look at the metrics that demonstrate that we did—if you look at the statistics, we substantially reduced what we thought was inappropriate largesse on the part of these top 25 officials. I think the executive pay that we set, mostly consensual with the companies, demonstrates a drop in that overall executive pay, something that I think was important to do. The CHAIRMAN. Well, how much of it, do you think, though, people stay because they thought, when you were gone, it was going to go back to what it was before? Mr. FEINBERG. Oh, I think there’s something to that. Now, whether or not that will happen, I don’t know. The CHAIRMAN. Oh. Mr. FEINBERG. I draw two conclusions from that question. One, it’s a bit premature to say whether companies will go back to business as usual. I’ve only left a couple of months ago. The 2010 prescriptions and pay prescriptions, we’ll watch, I think, and this panel and the Congress will watch and see. Second thing I would say is, don’t paint with too broad a brush. I think what I’ve learned is, you’ve got to look at each individual company and see how that company reacts to criticism, when it comes to pay. I don’t think you can just assume all companies adopt these prescriptions, all companies don’t adopt these prescriptions. You got to go case by case by case. The CHAIRMAN. But you do have some views about whether, in fact, that worked. You do have views about specifically what happened, and—in terms of the metrics, in terms of the math—of what happened, case by case. And the other thing that you were looking for, you were looking for long-term effect. Mr. FEINBERG. That’s right. The CHAIRMAN. So, it isn’t just—looking at the seven companies really will not tell us what happened with that, right? Mr. FEINBERG. That’s right. The CHAIRMAN. We’re looking for something broader than that, right? Mr. FEINBERG. That’s right. And the two ways you’ll find out about a broader impact is, one, what the agencies are doing with VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00033 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 28 a much broader cohort of companies than what I would—dealt with; and, secondly, it’ll be interesting, in the next few years, to see whether companies that weren’t under my jurisdiction voluntarily, on their own, adopted the prescriptions. Many did, right now. We’ll see, over the next few years, whether they adhere to those prescriptions. The CHAIRMAN. Right. And you used—you kept track of what the pay was before you got involved, and when you got involved. Do you have that? Can we have a chance to view—— Mr. FEINBERG. Final report. The CHAIRMAN. Final report. Mr. FEINBERG. If you look at our final report and the accompanying materials that are submitted that are part of the public record, you will see: what the companies submitted; how we responded; how we engaged that data and companies, anecdotally and empirically; and how we disagreed with those companies. The CHAIRMAN. Okay. Mr. McWatters. Mr. MCWATTERS. Thank you. Mr. Feinberg, you were charged with the interpretation and implementation of certain statutory and regulatory provisions regarding executive compensation. What’s your assessment of those statutory and regulatory provisions? Mr. FEINBERG. I think that it—they worked. It was a very limited role. I doubt that Congress or the Treasury want any expansion of that role. I think, in the limited area that I was asked to regulate, we did it, we did it pursuant to law, we did it effectively. I do not hear, anywhere, in Congress or in this administration, suggesting that the degree of micro management that I was obligated to be engaged in should be replicated or expanded. Mr. MCWATTERS. Okay. If you were presented with the opportunity—asked to draw these provisions again, de novo, how would they differ? Mr. FEINBERG. Well, clearly we would want to change some of the language of the statute that prevented—that required that compensation, in an annual year, vest immediately—the so-called Dodd Amendment. I think that the problem we ran into is that, for the top 25 officials, vesting was required immediately, cash bonuses were severely curtailed—cash compensation was severely curtailed. I think that we would want to tinker with the—some of those incentives—or, some of those requirements. But, I think, overall, those were the major areas of tinkering. Mr. MCWATTERS. Okay. I’ll ask the same question I asked in my opening statement. And, again, in answering the question, don’t be constrained by the current rules, okay? This is just, again, de novo question. And that is: How does an employer structure a compensation program so as to identify risk, but also minimize any unnecessary and excessive risk, but still permitting the executive to take sufficient risk so the company prospers? How do you balance that? Mr. FEINBERG. Very, very difficult. My first answer is a hedge by saying: every company has a culture and a environment that is different. I’m not sure you can answer that very legitimate question by saying that GM and automobile companies should invoke the VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00034 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 29 same prescriptions as AIG or Bank of America. I think they’re very different. But, I would say that the fundamental conclusion we drew is that you want to set up a compensation package that provides competitive cash to that employee, but in a limited amount—a competitive amount—we said, under $500,000 annually—and that the appropriate balance should be struck by giving the remaining compensation in a given year in stock in that company, but over a relatively lengthy period of time so that you are undercutting any incentive for quick turnaround, quick flip, making the stock, in effect, cash. And, instead, you’ve got to hold a—as nontransferable, a good share of that stock, over as long as 4 years. Mr. MCWATTERS. Okay, thank you. My time’s up. The CHAIRMAN. Mr. Silvers. Mr. SILVERS. Mr. Feinberg, before I let you continue in what you were about to say before, let me express my view that I think that your work has undoubtedly significantly improved compensation practices in the financial sector and in the specific companies that you were—that you had authority over. Mr. FEINBERG. You’re setting me up, Mr. Silvers. [Laughter.] Mr. SILVERS. I am, indeed, but I’m trying to be nice first. And I want to express the absolute sincerity of my—of what I’ve just said, before I get to the tougher part of it. Now, I’d like you to tell me why you found, in your final report, that a significant amount of the compensation paid to the 17 firms you referred to who were TARP recipients that were paying, I believe, over half a million dollars to their executives—why you found a significant amount of that compensation during the period after the enactment of TARP, during a 4-month period after the enactment of TARP, to be inappropriate. Why was that? Mr. FEINBERG. It was inappropriate because they were taking taxpayer money and feathering their own nest. Mr. SILVERS. Well, that’s an extraordinarily helpful lead-in to where you left off, because what I want to know is, not the question of how much or should you have clawed it back—all right?— but, How do you reconcile that finding with your statutory obligation around the notion of the public interest? Mr. FEINBERG. Well, it’s a very close question, I admit. I debated this for many, many weeks. And I concluded, for the following couple of reasons, that it would be inappropriate to claw back the— or seek to claw back the money. First, 90 percent of that money that was inappropriately paid to those executives on those 17–90 percent of it was paid to companies, like Citigroup, that had already repaid the taxpayer every dime of TARP. We—— Mr. SILVERS. Now—— Mr. FEINBERG. We found—— Mr. SILVERS. Mr. Feinberg, Citigroup has not repaid every dime of TARP—— Mr. FEINBERG. Under my jurisdiction—they were out from under my jurisdiction—they had repaid—— Mr. SILVERS. But, they have not repaid every dime of TARP, as we sit here today. Mr. FEINBERG. That is correct. But, under my statutory—— VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00035 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 30 Mr. SILVERS. I—— Mr. FEINBERG [continuing]. Jurisdiction over Citigroup—— Mr. SILVERS. I—yes. No, I understand that. But, the public-interest mandate was not confined to special aid. Mr. FEINBERG. I understand. I—— Mr. SILVERS. It seems—Mr. Feinberg, it seems to me that what you were really—what you really did—and I would like you to deny—if it’s not true, if I have—misunderstand what you were doing, then tell me—but, what you really did was, you concluded that—I—it can’t be true that feathering your own nest, when you’re a—when you’re holding the public’s money, is in the public’s interest. That can’t be true. It seems to me, what you just said is the key thing, that you felt that it was not in the public’s interest to have an accurate finding here, because it would trigger a process of recapture that you felt was not in the public interest to trigger. Mr. FEINBERG. You—— Mr. SILVERS. Is that—— Mr. FEINBERG. You say it well. You say it well. But, let me go on and remind me you, as you well know, better than anybody, I also recognized I had no authority to force that money back. All I could do under the statute was seek, beseech, request, urge. I couldn’t guarantee that that money would be repaid, in any event. Mr. SILVERS. Right. Mr. FEINBERG. And, my final point, at the time that that money was inappropriately paid to those executives, as you well know, they violated no law at the time, they hadn’t violated any regulation at the time. I thought it was overkill. Mr. SILVERS. But, that wasn’t your standard. Your standard was not, ‘‘Did they break the law?’’ Your standard was ‘‘the public interest.’’ And I understand that you made a judgment about what was in the public interest, in terms of the consequences; but, that was also not your mandate. Your mandate was—and I think you’ve determined it—I think the irony here is that, in your own way, you have determined that that compensation violated the public interest. And, it was Congress’s determination that, if it did, it should be—every effort should be made, within the fact that you didn’t have the power, to claw it back. Mr. FEINBERG. Don’t—— Mr. SILVERS. My time is expired. Mr. FEINBERG. Don’t pooh-pooh that fact, that I didn’t have the power to claw it back. The CHAIRMAN. Dr. Troske. Dr. TROSKE. Thank you. Mr. Feinberg, I thought you made a very good point about the limited role that you had—Congress—and it’s something that we should all keep in mind. Having said that, you’ve got a lot—gained a lot of experience in this issue, so, you know, we would like to draw on some of your broader experience. One question I have is, in some such—you—as you correctly said, you’re supposed to look at what would be competitive and, you know, what are comparable firms and what you’d expect these executives to get paid. Of course, many of these executives that you were dealing with were executives that—at firms that, in the absence of a government bailout, would have been bankrupt. And I VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00036 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 31 don’t think CEOs of bankrupt firms get paid a lot. So, I mean, did you take that into account? Is that something that you considered when—you thought, What would these people have been paid, had they been out looking for a job, having been just the CEO of a firm that they drove into bankruptcy? Mr. FEINBERG. Yes, we looked at any and all of these variables to try and come up with a pay package that we thought was appropriate, in light of competitive pressures. Dr. TROSKE: Okay. You mentioned that 85 percent of executives were still there. What would we have expected? I mean, what was the—I guess, in some sense, I’m trying to get a sense of what a competitive pay package would have been. And you would expect a normal amount of turnover at these firms. Did you investigate what turnover was like before they implemented TARP and sort of—in some sense, maybe you paid them too much; maybe the turnover—you know, saying that 85 percent of them are still there, I— that seems like a high number to me. So, can you—do you have a sense of what that is? Did you do any looking at that? Mr. FEINBERG. Yes, we looked at that. I must say, I always viewed this whole issue of pay as only one variable as to why people stay where they are. This argument that was presented to us, that pay, and pay alone, is ‘‘the’’ variable that will determine whether we’re competitive or not, I found it dubious at the time, and I still find it dubious, and I think that the statistics bear me out on this. People stay at jobs for a lot of reasons, only one of which—important, but one of many reasons—is their pay. Dr. TROSKE. As a college professor who probably—you get paid more, as a consultant—I’m certainly going to agree with you, because I—and you’re right that that is a common finding, is that pay is not the sole determinant of whether people are happy and stay at their job. Talk a little bit about AIG. I guess it’s—it was reported, or at least I’ve read reports in the New York Times, that AIG received some sort of special consideration, in terms of the value, you know, that they were not—their compensation—the executives—they were not based on the value of their—the stock—AIG stock—but of some derivative of that stock. Is that the case? And, if so, why? Mr. FEINBERG. I don’t believe that is the case. That was the case—that was proposed. Dr. TROSKE. Okay. Mr. FEINBERG. And we tried to work something out, in conjunction with AIG’s suggestion that the stock—the common stock wasn’t worth enough to appropriately compensate top officials. But, we worked out a compromise with the Federal Reserve, with AIG, with the Office of Financial Stability. It turned out, at the end of the day—I believe—that, at the end of the day, AIG did agree that its common stock, under our formula, would be appropriately used as a compensation device. Dr. TROSKE. Your 500—again, your $500,000, you know, seemingly, line in the sand of—that’s what they should get as cash— I—you said that you tried to come up with a competitive amount. How did you come up—where did the $500,000 come from? Mr. FEINBERG. First, it wasn’t a line in the sand. We allowed variations from the 500,000. And, in some cases, there were quite VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00037 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 32 a few variations from the 500,000. We concluded, based on the packages that were submitted to us, based on evidence that we took on our own, anecdotally—empirical evidence that we got on our own—and also based on our sense of what Congress and Treasury intended in their statute and regulations—at the end of the day, we exercised our discretion and came up with that number, based on these variables. Dr. TROSKE. Thank you. The CHAIRMAN. Superintendent Neiman. Mr. NEIMAN. Yes, thank you. Just, really, following up on that, because, you know, it’s clear there’s—a fundamental question and debate on executive comp is: What is the proper role of government insuring that incentive comp arrangements don’t encourage excessive risktaking? And, as I mentioned in my opening statement and you referenced in yours, there’s a lot of work already being done by Federal bank regulators. The guidance put out by the bank regulators, as you know, in June, took a principle-based approach. I’d be interested in your experience. And, you certainly set out, in your opening, that—the six principles that guided you. Do you see the proper role for government in a principle-based or in a rule-setting framework, or a combination of the two? Mr. FEINBERG. Combination of the two. The one thing I had to do, that nobody else had to do, of course, was actually put pencil to paper and come up with the dollars. And coming up with the dollars, I would have thought, at the outset of this assignment, it wouldn’t have been—there wouldn’t have been much interest. Only 175 people I’m dealing with, here. Turns out that principles plus rulemaking—that’s fine; but asking government to then translate that into, ‘‘You will make 1 million or 800,000 or 5 million,’’ that is government intervention, which I think should be very, very limited and should not be expanded upon. Mr. NEIMAN. So, what are the specific pay issues that are more susceptible to principle-based versus rules? I mean, you said one clear rule, with respect to the 500,000, and now we’re hearing it’s— it clearly wasn’t a line in the sand. Are there other specific pay issues that you think a rule-based is appropriate? Mr. FEINBERG. Very important that compensation be spread and not be guaranteed and be tied to the overall performance of the company where the official works. We made sure—I think perhaps our most important prescription—and Professor Murphy and others can comment on this—is, we concluded that compensation should be in the form of stock, but stock which cannot be transferred. It may vest, by law, but it should not be transferable, except over a lengthy period of time, so that long-term performance of the company will determine the total pay package of the corporate official. Mr. NEIMAN. So, that, let me understand, is a principle as opposed to—— Mr. FEINBERG. A rule. Mr. NEIMAN [continuing]. A rule of mandating a—— Mr. FEINBERG. Right. Mr. NEIMAN [continuing]. Specific vesting period. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00038 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 33 Mr. FEINBERG. A rule might be: you should transfer, over a lengthy period of time. The principle is: a third, a third, a third— 2 years, 3 years, 4 years. Mr. NEIMAN. So, now, what—we hear one of the—some—many of the commentators to the Fed’s guidance said, principle-based are— give rise to vagueness, ambiguity with respect to compliance. And I think it’s also clearly tied to enforcement. What is the enforcement regime on a principle-based? Mr. FEINBERG. I’m—I’d want to debate the Federal Reserve more on that. It seems to me that what we found is that the rule delegated to the special master the ability to provide more detailed principles that would be used to effectuate the rule. The danger, I think, with pay is that you’ll come up with vanilla rules: Pay should be performance-based. Well, I mean, who will disagree with that? But, what’s the underlying detail behind that rule that is a principle that will be adopted? And I think—I’d debate—maybe it’s semantic, but I think it’s an important difference. Mr. NEIMAN. Before my time runs out, I would like your view on the guidance put out by the Federal bank regulators as getting at the issue of misaligned incentives. Mr. FEINBERG. Again, it remains to be seen. I want to—to me, the only test here, with these rules put out by the agencies, What impact do they have in practice? And I think it’s too early to comment, other than to say that vigorous enforcement—your point, Mr. Neiman—vigorous enforcement, I think, will determine the effectiveness of these rules or principles. Mr. NEIMAN. Thank you. The CHAIRMAN. Useful—when you talk about a ‘‘useful model’’ and ‘‘for reasonable pay,’’ do you think your work has led to more— an idea of what ‘‘reasonable pay’’ is? Mr. FEINBERG. Yes, I do. The CHAIRMAN. And what were the main elements of it? Mr. FEINBERG. The main elements, as I said—and I think the agencies are adopting some of what we prescribed the main elements of pay should be, without mentioning numbers: Low guaranteed base-cash salary; the remaining compensation in X stock, in that company, which cannot be transferred, except over a lengthy period of time; and, I should point out, more effective corporate— corporate regulation of golden parachutes, perks, end-of-career severance payments and pension plans. I think our final report pretty much lays out the blueprint that we think is a pretty good model. The CHAIRMAN. Can you comment on—and this goes beyond your—you know, specifically this thing, but I think it has real impact, especially when you’re talking about a reasonable model. My experience has been, over the years, that using stock as an incentive—and the price of stock has—you know, sometimes it works, sometimes it doesn’t. I mean, you’re executive, you got a good market going, Dow Jones goes up 3,000 points, you’re king, and you’re making a fortune, and you had nothing at all to do with that; you just happened to be there when the wind was blowing. And then, conversely, what we see, time and time again, when the market turns down, the compensation committees say, ‘‘Well, wait a minute, we didn’t cause the downturn. We shouldn’t be taking the VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00039 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 34 hit on that. Our company’s doing just what it was doing the last 3 years.’’ And therefore, they don’t get the reduction in compensation. Can you comment on that? Mr. FEINBERG. Well, that’s the argument. My response will be a couple of things. Two points. One, there’s got to be some diversity in compensation. I agree with that. The CHAIRMAN. Right. Mr. FEINBERG. It can’t be all stock. It can’t be all cash. We went back and forth on this discussion. Frankly, we concluded that if the market improves and corporate officials get a windfall because the stock soared: win-win. I mean, if the corporate—if the corporation benefits to that extent, so its shareholders benefit, hopefully the country benefits, that’s the free market. That’s all right. The CHAIRMAN. Except that, in order to do that, then when it goes down, they should take the hit for that. Mr. FEINBERG. They should take the hit. The CHAIRMAN. And you do agree that, in most cases, they don’t. And then, for this—in many, many cases—— Mr. FEINBERG. I—— The CHAIRMAN [continuing]. The compensation committee meets, and they say, ‘‘Well, you know, it wasn’t our fault, let’s—we’re not going to reduce that. We’ll give more stock or we’ll change the stock options, or whatever.’’ Mr. FEINBERG. That’s right. Now, that’s a corporate governance issue, too. The CHAIRMAN. No, no, I got it. I understand it. But, I’m saying—but, I’m just to get—again, I understand it’s a corporate governance issue, but when you’re dealing with the issue of, you know, what is reasonable pay, then that’s clear—you know, a clear concern. Mr. FEINBERG. Mr. Chairman, I agree completely that, in a vacuum, what I’m suggesting as principles might work just fine. But, if you’re not going to have enforcement, and you’re not going to have the type of corporate—internal corporate regulation to make the principles meaningful—— The CHAIRMAN. Right. Mr. FEINBERG [continuing]. It’s all about enforcement in the corporate culture. The CHAIRMAN. But, it would be fair to say that, in a reasonable model—a reasonable pay model, it would be incentives—stock can be one of those incentives, but it should be taken into account that stock is not the only determinant of whether an executive does a good job. Mr. FEINBERG. Absolutely. The CHAIRMAN. Good. And I know you said that the school’s not out yet on how Wall Street’s going to pay, but I think—again, it’s always risky to refer to newspapers, but the Wall Street Journal says, ‘‘Wall Street pay is on a pace to reach a record high in 2010.’’ William Cohan, writing in the New York Times, October 7, 2010, said, ‘‘The incentives on Wall Street have not been changed one iota.’’ Now, if that, in fact, is the case, how do you feel about your tenure and the ability to actually change cultures? VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00040 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 35 Mr. FEINBERG. Hey, if that’s the fact, and it’s broad brush across Wall Street and includes not only Bank of America and Citigroup, companies that were under my jurisdiction, but also includes Goldman, who professed to follow the prescriptions last year that we had imposed, voluntarily, then I think that our work has not been successful and it’s not being followed and it is a problem. The CHAIRMAN. Thank you. Mr. FEINBERG. But, I think that, if that’s the case, there are other agencies that profess to rein in executive pay, like the SEC and the Federal Reserve—I think that the mandate falls to them to pick up the slack. The CHAIRMAN. Although, I really do think everyone agrees that it would be better if we didn’t turn to that. It would be better if we could come up a reasonable pay package, if we did have incentives, if we did have a model, if people did go ahead and control it. And it’s very disturbing, if, in fact, given the opportunity to do this, that—an opportunity that, as bad as this financial crisis is, people don’t take advantage of it, you’ve got to wonder about where the answer is. Mr. FEINBERG. Right. I think that’s right. The CHAIRMAN. Mr. McWatters. Mr. MCWATTERS. Thank you, Senator. Mr. Feinberg, if a company pays a portion of the compensation in the form of stock—okay?—at a point when the stock prices are at historic lows, will executives have an incentive to engage in risky behavior, due to the potential for large upside gains and the limited downside loss? Mr. FEINBERG. Well, that—we had to debate that. That’s the argument. Now, we concluded that the way to minimize that likelihood—two ways: One, diverse pay packages that include cash, to a certain extent. And, secondly, have that stock transferable only over a relatively lengthy period, so that whatever short-term gain that corporate official might try and be incentivized to do—over the long-term life of that company, we thought it less likely that that type of risky behavior would be maximized, because over the longterm, especially with corporate governance in place, we thought that that would make it more likely that the long-term interest of the company would be aligned with the corporate official. Mr. MCWATTERS. Sure. I mean, if you talk to employees of Merrill, Lehman, Bear—Citi, I think, is trading around $4 a share— B of A, and a number of others, who had incentive stock—a lot of incentive stock, coming into the fall of 2008, and—I can’t say they were all wiped out, but they lost a lot. But, nonetheless, they created this mess with those compensation programs in place. So, if we now have these new and improved compensation programs that are dependent upon long-term incentive comp, aren’t we, in effect, copying what was in existence in ’05, with the exception, perhaps, of a meaningful clawback? Mr. FEINBERG. I’m not sure about that. I tend not to agree with that. I tend to look at Lehman and the debacle of the last few years—and I’m not an expert on this, I have a statute to enforce— but, to what extent would those executive pay packages, the cause of that debacle, as opposed to capitalization requirements and other institutional flaws in these companies—I think that, by requiring VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00041 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 36 that compensation in the form of stock be transferable only over a number of years, you minimize, somewhat, the likelihood of that type of risktaking. May be wrong about that, but that’s the conclusion we reached. Mr. MCWATTERS. No, I understand. As I said in my opening statements, I’m not necessarily wedded to the idea of compensation packages causing the problem. In other words, the ‘‘show me the money’’ theory, as I called it, I’m not confident that works. But, a lot of people are. And so, they’re proposing deferred comp, incentive comp as a way to solve the problem. But, my fear is—I mean, we may be solving the wrong problem, or at least not solving the correct problem. Mr. FEINBERG. Yeah. What is the alternative? We concluded that, if you really want to promote risky behavior, tell a corporate official that he or she is guaranteed 5 million in cash—win, lose, or draw, in terms of the future performance of the company. And we concluded that that, as a relative matter, would be more risky, in terms of the company’s long-term growth and success, than the method that we adopted. Mr. MCWATTERS. See, I would think to the contrary. I would think, ‘‘If someone’s going to pay me $5 million cash a year, I want to keep this gig going.’’ That’s a good one. It’s hard to come by, unless you can play first base for the Yankees or something like that, which I can’t. So, I’m just not sure. Okay, my time’s up. The CHAIRMAN. Mr. Silvers. Mr. SILVERS. Yeah. Mr. Feinberg, I’m—in a way, I want to continue Mr. McWatters’s line of questioning, but in a somewhat—maybe from a somewhat— a little different angle. Although, let me just take one case study, in what Mr. McWatters is talking about, that haunts me, which is: Angelo Mozilo. All right? $400 million-plus in comp taken out of Countrywide during, essentially, one leg of the business cycle. The up leg. All right? Securities fraud settlement, giant headlines. So, he paid—he had to pay back, I think, 67 million of the 400. What’s the externalities of that little adventure? Seven million foreclosed families, a destroyed—apparently, a deeply damaged property-loss system that’s been a foundation of our economy for 300 years. The—all of them—all of the work of this panel and the TARP and all that sort of thing—seems to have been substantially—Countrywide seems to have been a substantial contributor to it. And the net of that circumstance is—well, let’s say he had to pay his lawyers $30 million. The net of that circumstance is a pretax income of $300 million to Mr. Mozilo. That would appear to speak very strongly to executive pay as a contributing factor, would it not? Mr. FEINBERG. Oh, I think so. I mean, it gets to the point—you’re using a summa cum laude example. Don’t forget that, as to the 175 officials that we dealt with—— Mr. SILVERS. Right. Mr. FEINBERG [continuing]. We did—by statute, legally obligated—we did cap everybody’s packages. All of the compensation. I don’t think that we approved—I could be wrong; Patricia would know—but, I don’t think we approved anybody’s pay package— maybe one or two people—that were $10 million. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00042 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 37 Mr. SILVERS. The Mozilo example, though, goes to the time horizons issue. Right? If you—you’ve got pay set up so you can take out $400 million—right?—in one leg of the business cycle. The incentives are obvious. I want to come, then, to the—to, sort of, the big question here. We, as a—we—this panel has found, repeatedly, that TARP functions as an implicit guarantee of the major financial institutions. And it’s my opinion that there’s kind of a linger—it’s kind of always been an implicit guarantee of the very largest financial institutions. And the certainty of that guarantee has grown with the— with their size. Why does it make sense, if the—if that’s the truth of the matter, to have incentive pay be equity-based, for those institutions? Mr. FEINBERG. What’s the alternative? Mr. SILVERS. I mean—— Mr. FEINBERG. I mean, in—you talk about what’s implicit. What is the alternative? I mean, I guess one alternative is: don’t bail out these companies. If—let the free market really control—— Mr. SILVERS. Well, I mean, I know that my fellow panelist, Professor Troske, would like to have that happen. I think history suggests that, with these very large financial institutions, despite all of our desires, it doesn’t, that there is an implicit guarantee operating, and as long as we have institutions of that size, it will operate. And so, the question is—I mean, this is not a—I’m not being critical of your work in—in a respect, because you applied, I think, very—you know, in a very thoughtful way, the prevalent thinking around long-term equity-based compensation. But, if these institutions have a government guarantee behind them, doesn’t that suggest that we ought to be looking at measures of performance that are: (a) more risk-based; and (b) maybe tied more to debtholders, as I think we’re going to hear from witnesses, following you. Mr. FEINBERG. You may be right. I think, really, your question is better directed to the Chairman and the Congress, in terms of an overview as to what the appropriate role of government is. Congress had already spoken and delegated to me, through the Treasury, certain limited function and—— Mr. SILVERS. But, Mr. Feinberg, they didn’t delegate to you, specifically, equity-based pay. Mr. FEINBERG. I understand that. But, I don’t really think— when you talk about the type of meltdown you’re discussing, Mr. Silvers, I’m not sure what the pay package would be that would minimize the likelihood of that type of meltdown. You’re talking about a meltdown that maybe should have resulted in these seven companies not being protected by the government. Mr. SILVERS. Well, a larger question. My time’s expired. The CHAIRMAN. Since I’ve been asked, I have spoken: I think ‘‘too-big-to-fail’’ should not be too big to fail. And I’ve worked mightily to do it. I didn’t succeed in all the things I wanted to, but I’m very interested to hear Dr. Troske’s questions. Dr. TROSKE. Thank you. And I do—you know, as Mr. Silvers has indicated, I do have somewhat of a preference for that, but I do recognize the problems of allowing large financial firms to fail in the midst of a financial crisis. But—and it does bring up the issue, I think—and maybe you can talk a little bit about that—is—I mean, VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00043 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 38 is—when you have these guarantees, you really don’t—there aren’t a lot of people around, involved with the company. In some sense, it allows them to ignore really bad risk, right? Large level—what’s known as black swans, now. The—just—you don’t have to worry about it. If—once it gets so bad, after a certain point, well, the government’s going to step in. And so, given that, it’s hard for me to imagine an incentive-based compensation structure that is going to be created that gives an executive a lot of incentive to worry about that. Mr. FEINBERG. Well, you may say that. I must say, one thing I learned in this job is the desire of these companies to get out from under any government regulation. I mean, Citigroup and Bank of America, as I understand it, borrowed money to get out from under TARP and my restrictions. Again, I go back, I guess, to the question that—my role was so limited, all I could do, under the statute and regs—and Mr. Silvers thinks maybe I could have done more—but, all I could do was try and tinker with ways that might be a model to deal with these seven companies. And I think, within that limited framework, we did what we were supposed to do. Dr. TROSKE. So, let me ask you a little bit about that, because I think, while you are right—your description is, obviously, correct, that your—you were limited in what you could do. You clearly scared these people. And it is the case—I mean, I think, you have described it as—that in order to get out from under you, they paid back TARP funds quickly. Do you think that’s a good thing? Mr. FEINBERG. Congress certainly did. Congress felt that the single most important thing I could do is get those seven companies to repay the taxpayer. That was the number—Secretary Geithner made that clear, Congress made that clear, the administration made that clear; and we succeeded, with three of those companies already repaying. Dr. TROSKE. And so, let me ask—build on that again a little. And I want to be clear, I—you know, the companies that went bankrupt, I think, deserve almost anything they got, and then took the money. I’m not a big sympathy—I’m not very sympathetic. But, there were companies that were requested to take TARP funds, that were not in the same financial situation, and yet they came under your purview. And it also does seem to be the case that the rules of the game changed over—I mean, I think, the final rules regarding what you were allowed to do, many of them were adopted after the original TARP legislation, in October of 2008. Do you think that they were aware—many of the executives were aware, when they took the original TARP money, what they were agreeing to? And—— Mr. FEINBERG. No. Dr. TROSKE. And do you think it’s, in some sense, fair to them to change the rules of the game in the midst of it? And I know I’m asking you to expand on what—that’s not part of your—— Mr. FEINBERG. It really isn’t part of my mandate. Dr. TROSKE. Yeah. Mr. FEINBERG. I—you’d have to ask each company, and each corporate official who made these decisions, what they knew and when they knew it. But, I do agree with the argument that, once Con- VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00044 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 39 gress provided substantial taxpayer assistance to these companies, I was, in effect, a surrogate creditor for the taxpayer. And I’m hard-pressed to accept the argument that it was inappropriate for us to change the rules or to modify the rules. The taxpayers were creditors, the government had a right, I think, especially under the congressional legislation, to influence pay practices, at least to a limited extent, with those companies. And I think we did that—exactly what Congress wanted us to do. Dr. TROSKE. Okay. I would agree with you. I think they learned a valuable lesson about what comes with taking money from the public trough. The CHAIRMAN. Superintendent Neiman. Mr. NEIMAN. Thanks. Well, we talked about what should be the regulatory governmental regime principle, versus rules, regarding incentive comp. But, another key question is the scope of the institutions that should be subject to these standards. My question is: Where should we draw the line? Your line was pretty clearly drawn, with respect to TARP recipients, the seven you referenced. But, I’d be interested in your views as to—in expanding that out. Should it be—should it cover only insured banks? What about other financial institutions, like security firms and insurance companies? Should we only be focusing on those systemically significant institutions; you know, beyond the explicit guarantees of insured banks, but to those with implicit guarantees? Mr. FEINBERG. I’m not the expert, there. I mean, I must say, you’re asking a very legitimate question to somebody who had just seven institutions to worry about, and we worried, at 3 a.m., what to do with those seven. Whether or not the Federal Reserve and the FDIC should expand their authority to encompass prescriptions on pay for others and other agencies, you’re asking the wrong witness, on that. Mr. NEIMAN. Well, you know, maybe I’ll take it—you know, I’ll come at it a different way, because I think your experience and learnings are helpful. What should be the principles that we should be guided by in determining the scope? Is it simply protecting the taxpayers, whether through explicit—as a result of explicit guarantees or implicit guarantees? Is it financial stability? Mr. FEINBERG. Well, financial stability protects the taxpayers. I think that—in my situation, I had—you’re right, I had a rather explicit mandate tied to the fact that the taxpayer cut a check to each of these seven companies, and that made us a creditor. I’m not suggesting that that’s the way to do it next time, but I do think that, in terms of prescriptions, there ought to be some rule tied to taxpayer protection and financial stability in the marketplace. So, how that translates, you’ll have to ask others. Mr. NEIMAN. Okay. And—also, in your experience—you know, we’re talking about—to the extent it even should extend to the shadow banking system, to the extent that controls that we put in place in regulated entities may shift some of these riskier activities and compensation programs into less regulated entities. Mr. FEINBERG. I think that’s right. I also think—be careful about—in my experience, be careful about looking only at the issue of scope, because I think what we learned, in the special master’s VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00045 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 40 office, is: every bit as important, if not more important, than scope is enforcement. And, at the end of the day, who are in the front line enforcing these regulations and the scope of regulatory effort is every bit as critical as what, on paper, looks to be a fairly sensible regulatory regime. Mr. NEIMAN. Yeah. And, I—you know, where we left off, in principle versus rules—I think the first time a regulator takes a significant enforcement action under a principle-based regime, the industry will first say, ‘‘Give me the rules. We can’t live with this ambiguity. Give us the rules and we will comply.’’ So, it—there really is the balance. I’m also interested in your views on culture, because you’ve seen very different institutions and—with the large investment banks converting to bank holding companies, with trading mentalities. I’d be interested in your views as to how much culture really plays in—— Mr. FEINBERG. Oh. Mr. NEIMAN [continuing]. These kinds of organizations. Mr. FEINBERG. We found cultures critical. Goldman, Morgan— they’re different. One fascinating aspect of what I learned in this is the relative lack of interest in the public when it came to GM and Chrysler. I mean, almost all of the media and public attention was addressed to Bank of America, Citigroup, and AIG. There was, relatively speaking, much, much less interest in General Motors and in Chrysler, in GMAC and Chrysler Financial. Part of that, I think, was driven that—if you look at the pay packages of these Wall Street firms, relative to GM and Chrysler, it was like Earth and Mars. I mean, I think, if I remember correctly, the top three people of the 25 at Citigroup got more compensation before we arrived than all 25 people at GM, which was, to me, a little bit astounding. Mr. NEIMAN. Thank you. The CHAIRMAN. I think, I can answer that question. I think that people in America believe that they were the people that brought this thing down, they’re the people that caused the unemployment, they’re the people that caused foreclosure, they’re the people that did all that, number one. Number two is, they came through this thing and started making money faster than any other economic entity in the country, and got back to where they were, when all the others were floundering. So, I think—it’s very obvious to me that that was the cause-effect. I want to thank you for your testimony. Illuminating, as usual. And thank you for your public service. Mr. FEINBERG. I just want to thank the Panel for—this is the third opportunity I’ve had to meet, formally or informally, with the panel, although not with the distinguished Chairman. And I want the panel to be—rest assured that the acting special master, Patricia Geoghegan, who’s right here, will continue the fine work of the special master’s office. So, thank you very much. The CHAIRMAN. Great. Thank you. And can the second panel come forward? [Pause.] Very good. I’m pleased to welcome our second panel, a truly distinguished group of academics and industry experts who will help us evaluate VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00046 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 41 the TARP’s executive compensation restrictions and the work of the special master, Feinberg. We are joined by Professor Kevin Murphy, from University South Carolina’s Marshall School of Business; Professor Frederick Tung, from Boston University School of Law; Rose Marie Orens, a senior partner at Compensation Advisory Partners; and Ted White, strategic advisor from Knight Vinke Asset Management and the cochair of the International Corporate Governance Network, Executives Remuneration Committee. We’ll believe with—we’ll begin with Professor Murphy. Please keep your oral testimony to 3 minutes, as we know, and we’ll put the whole record—everything you—your total testimony in the record. Thank you. smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF KEVIN MURPHY, KENNETH L. TREFFTZ CHAIR IN FINANCE, UNIVERSITY OF SOUTHERN CALIFORNIA, MARSHALL SCHOOL OF BUSINESS Mr. MURPHY. Good afternoon, Chairman Kaufman and Panel members. I have been asked to address a set of 11 very provocative questions, and I want to begin by commending the Panel for asking exactly the right questions, even though they are very hard questions. I have 3 minutes to summarize my responses, so my challenge is to figure out what to do with my remaining time. [Laughter.] Seriously, I’ve offered a 25-page report detailing my responses to these questions and could spend the full semester talking about these issues; and, in fact, intend to, when I get back to Southern California. I’ll refer you, in part, to my report and wait for the Qand-A for specific responses to specific questions, but I would like to summarize several general themes and conclusions emerging from my responses. First, when the pay restrictions were enacted in February 2009, Congress was angry at Wall Street and its bonus culture, and suspicious that this culture was the root cause of the financial crisis. By limiting compensation to uncapped base salaries, coupled with modest amounts of restricted stock, Congress completely upended the traditional Wall Street model characterized by low base salaries coupled with high bonuses paid in a combination of cash, stock, and stock options. One interpretation of Congress’s intentions was to punish the executives at firms alleged to be responsible for the crisis. More charitably, Congress may have decided that banking compensation was sufficiently out of control that the only way to save Wall Street was to destroy its bonus culture. Whatever the intent, it is my opinion that the restrictions were misguided and not in the interest of protecting taxpayers. Second, while ostensibly designed to implement the pay restrictions, Treasury’s interim final rule circumvented Congress by blending the enacted restrictions with the, frankly, more sensible restrictions proposed earlier by the Obama administration but dismissed by Congress. In particular, Treasury circumvented the intentions of Congress by allowing salaries to be paid in the form of nontransferable stock and by imposing more severe pay restrictions VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00047 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 42 smartinez on DSKB9S0YB1PROD with HEARING on firms requiring exceptional government assistance. In my opinion, these changes benefited taxpayers, relative to the strict adherence of TARP. Third, the special master, guided by a well-intentioned but ill-defined public-interest standard, was forced to navigate between the conflicting demands of politicians, who insisted on punishments, and taxpayers and shareholders, who were legitimately concerned about attracting, retaining, and motivating executives and employees. Too often, the politicians won. Overall, the pay restrictions for TARP recipients were valuedestroying. Ultimately, the most productive aspect of the restrictions was the pressure they put on TARP recipients to escape the restrictions by repaying the government sooner than most anticipated. In retrospect, the TARP experience is a case study in why the government should not get involved in regulating executive compensation within the financial sector or more broadly. Thank you. [The prepared statement of Mr. Murphy follows:] VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00048 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00049 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 79 here 64160A.015 smartinez on DSKB9S0YB1PROD with HEARING 43 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00050 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 80 here 64160A.016 smartinez on DSKB9S0YB1PROD with HEARING 44 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00051 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 81 here 64160A.017 smartinez on DSKB9S0YB1PROD with HEARING 45 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00052 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 82 here 64160A.018 smartinez on DSKB9S0YB1PROD with HEARING 46 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 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64160A.034 smartinez on DSKB9S0YB1PROD with HEARING 62 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00069 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 99 here 64160A.035 smartinez on DSKB9S0YB1PROD with HEARING 63 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00070 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 100 here 64160A.036 smartinez on DSKB9S0YB1PROD with HEARING 64 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00071 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 101 here 64160A.037 smartinez on DSKB9S0YB1PROD with HEARING 65 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00072 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 102 here 64160A.038 smartinez on DSKB9S0YB1PROD with HEARING 66 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00073 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 103 here 64160A.039 smartinez on DSKB9S0YB1PROD with HEARING 67 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00074 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 104 here 64160A.040 smartinez on DSKB9S0YB1PROD with HEARING 68 69 The CHAIRMAN. Professor Tung. smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF FRED TUNG, HOWARD ZHANG FACULTY RESEARCH SCHOLAR AND PROFESSOR OF LAW, BOSTON UNIVERSITY SCHOOL OF LAW Mr. TUNG. Good day, Senator Kaufman, Panel members. Thank you for the opportunity to allow me to testify. My name’s Fred Tung. I’m a law professor at Boston University. I teach and research in the areas of corporate and bankruptcy law. Among my research interests, I have been doing work on corporate executive compensation and am currently investigating the incentive structure of banks, executive compensation preceding the financial crisis, and its potential role in the crisis. For today’s hearing, I’ve been asked, among other things, to draw on my recent academic work to suggest executive pay structure reforms that might help curb executives’ incentives toward excessive risktaking. I have a few suggestions, all of which come under the general themes of: number one, one size won’t fit all; and, number two, a light regulatory touch may be best. So, I’m taking something—more of a prospective approach to these issues than maybe some of the other panelists. So, number one, I think it would be useful to focus more on portfolio incentives and less on annual pay. The current discussion of financial executives’ compensation structures has missed what I believe to be a very critical issue, the issue of portfolio incentives. There’s been an almost singular focus on annual compensation structures, to the virtual exclusion of any consideration of executives’ existing portfolio incentives. Most executives at large financial institutions hold large portfolios of their own firms’ securities, primarily stock and options and other claims on the firm. Because these portfolios typically dwarf the value of executives’ annual pay packages, their existing portfolios exert much stronger influence on their risktaking tendencies than does annual pay. So, for example, at the end of 2006, just before the financial crisis, the average large-bank CEO held an equity-based portfolio worth over $92 million. By contrast, the average annual compensation then was a mere 5 million. So, the composition of the portfolio—the stock, the options, and potentially other claims against the firm—has a far greater influence on CEO decisionmaking than the composition of the pay portfolio—the annual pay. We should be thinking about using the structure of annual pay to tailor portfolio incentives, as opposed to looking just at annual pay, thinking that’s the only incentive that matters. The other important idea I want to raise is, we should think about paying financial firm executives with something other than just their equity interest in the firm. One suggestion is the use of inside debt. Recent theoretical and empirical work outside the banking context suggests that when executives hold debt claims against their own firms, what academics call, ‘‘inside debt,’’ their appetite for risk declines. I see I’m running out of time. Let me just say that I also believe that, when we think about reform of executive pay, we need to think of it as part of an integrated piece of a multifaceted financial VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00075 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 70 regulatory system. It’s not a substitute, but a complement to existing financial regulation. And thank you for the opportunity to testify. The CHAIRMAN. Thank you, Professor. Mr. White. smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF TED WHITE, STRATEGIC ADVISOR, KNIGHT VINKE ASSET MANAGEMENT; COCHAIR, EXECUTIVE REMUNERATION COMMITTEE, INTERNATIONAL CORPORATE GOVERNANCE NETWORK Mr. WHITE. Good afternoon, Chairman Kaufman, panel members. I would also like to express my gratitude for the opportunity to be here with you today. My background is that as of an active manager. I have a tremendous amount of experience with the institutional community; in particular, in engaging companies on matters of corporate governance and executive compensation. What I would like to do is get right to the point it—with some of the very significant aspects of executive comp, particularly with the financial sector, which we have identified through some of our work with companies—and some of those in the TARP, in fact— where I think that the most significant differences of opinion on alignment of interests come from. In many ways, the matter of executive comp is actually quite simple. The implementation of it, I find to be extremely complex. And I have a fair amount of sympathy for the special master in the task that he had before him; in general, give him good marks for taking on—you know, for climbing that mountain, but I think there’s very significant aspects of comp that were, frankly, unaddressed in this. Let me get right to some very significant aspects of comp where I think you should pay particular attention. First is in disclosure. Disclosure is obviously important to investors, in that we—that’s how we understand plans. But, I think that it also has a very significant role in making companies go through an extremely rigorous process in justifying the—not only the design of comp plans, but also their implementation. All right. There is a certain amount of rigor that goes into a plan when you know that you have to justify it. Term structure, which I think would be consistent with the issue that the previous panelist just got to, is another area where I think there’s very significant disconnect. By ‘‘term structure,’’ I mean a number of elements of a plan that lead to an alignment of interests along a horizon, so not only annual pay versus long-term pay, but also the mechanics of long-term pay, the types of metrics that are encompassed in that. There’s an all-encompassing equation that you look at to try to determine whether or not a plan is well aligned with your interests as a long-term investor. And I think, in the cases of financial institutions, in particular, there’s a big disconnect between the cycle of that industry and where the alignment of interest is driven, from the comp plans. They are way too short-term. The metrics and mechanics. There are several metrics that I would point to. One, in particular, the use of ROE, which is preva- VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00076 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 71 smartinez on DSKB9S0YB1PROD with HEARING lent in the industry. That metric is not risk-adjusted and, I think, probably had a role in emphasizing a certain risky behavior, and it missed an opportunity for comp plans to mitigate risk taking behavior. Realizing that I’m out of time, I’m going to—I’m just going to list the other areas where—I’ll talk about later, under questions—is: the mechanics of the plan; the role of the committees—in particular, whether or not they use the subjective or a formulaic-type process; risk, as a category; and, in employment contracts, severance change of control. [The prepared statement of Mr. White follows:] VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00077 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00078 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 113 here 64160A.041 smartinez on DSKB9S0YB1PROD with HEARING 72 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00079 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 114 here 64160A.042 smartinez on DSKB9S0YB1PROD with HEARING 73 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00080 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 115 here 64160A.043 smartinez on DSKB9S0YB1PROD with HEARING 74 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00081 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 116 here 64160A.044 smartinez on DSKB9S0YB1PROD with HEARING 75 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00082 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 117 here 64160A.045 smartinez on DSKB9S0YB1PROD with HEARING 76 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00083 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 118 here 64160A.046 smartinez on DSKB9S0YB1PROD with HEARING 77 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00084 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 119 here 64160A.047 smartinez on DSKB9S0YB1PROD with HEARING 78 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00085 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 120 here 64160A.048 smartinez on DSKB9S0YB1PROD with HEARING 79 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00086 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 121 here 64160A.049 smartinez on DSKB9S0YB1PROD with HEARING 80 81 The CHAIRMAN. Thank you very much. Ms. Orens. smartinez on DSKB9S0YB1PROD with HEARING STATEMENT OF ROSE MARIE ORENS, SENIOR PARTNER, COMPENSATION ADVISORY PARTNERS, LLC Ms. ORENS. Good afternoon, and thank you, Mr. Chairman and Panel, for inviting me. My background is a bit different. I’m actually executive compensation consultant to boards of directors, primarily compensation committees, of course, and have been for over 25 years. In the last 15, I have spent most of my time with financial institution companies. So, I’m pretty well—pretty knowledgeable about TARP and their—those issues, as well as those who have not been involved in TARP. So, I thought that would—might be a helpful perspective. I have spent the last several years being heavily involved in the issue and the question that has come up among many committees: To what degree has incentive compensation brought on the financial crisis? My view is that is has not helped, but it was certainly not the primary cause. And I think we’ve started to talk about that today. It was a plethora of things. Incentive compensation will not be the solution to the problem, but it is something that we need to fix. The debate and the—what I’ll call ‘‘the intervention,’’ by the government in the United States and Europe, that is going on is probably positive, in terms of getting us thinking about this. But, we really have to now move on to where we—it is that we want to go. And that’s, I think, the objective. When we look back in 2008 and ’09 at TARP, aside from the special master, there were a number of aspects of TARP that have actually been very positive. We don’t spend that much time talking about them. It was TARP that brought up risk assessment for the first time. And if I say one thing that’s come out of TARP, in terms of compensation and for companies overall, the word ‘‘risk’’ is heard on everyone’s—in everyone’s mouth, in every program, in every committee that I go to—every comp committee. This is a real and very sincere effort that is taking place today, that did not exist prior to 19-—to 2008. Didn’t exist. Nowhere near where we are today. Also, the other issues that TARP brought out and required as part of the other TARP participants was a mandatory ‘‘say on pay,’’ which is—as you know, is now being required by the SEC for everyone; an end to ‘‘golden parachutes,’’ as we knew them, and ‘‘gross-ups.’’ These were all practices that we had tried to get away with for a long time, to get companies used to giving them up; and TARP put us in a position to be able to do that. And they’ve been broadly accepted now by all other companies, and they’re now part of the Dodd-Frank bill in the SEC. And so, besides pay, there were a lot of practices and mentality that has changed tremendously in compensation over the last few years that probably doesn’t get as much press. As we go forward, I think the one thing we really should take away from today, and continue to, is that risk is not a fact in companies. All right? It was not front and center, as it ought to have VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00087 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 82 smartinez on DSKB9S0YB1PROD with HEARING been. It certainly was not front and center in compensation, mostly because companies didn’t know how to manage it or what it—how to determine it. They are all wrestling with that. They’ve done that because of regulation. They will continue to get better at it. There is an integrated process that exists today, between risk management, HR, and finance, in the development of compensation programs, that was never there before. It’s very positive. It will continue. Compensation committees are committed to it and required to by the Treasury and the other regulations. I think, in terms of where we’ve been, I do not really call the special master’s program a pay-for-performance structure. I think it was pay-for-stock. And I think ‘‘pay in stock only’’ is a really frightening concept. As you know, people had millions of dollars of stock; it didn’t change anything. I think it’s an easy way to think you’re paying for performance, but you’re not. It’s much more complex. The CHAIRMAN. Could you begin to wrap this up? Ms. ORENS. Yup. Only one thing. The CHAIRMAN. Thank you. Ms. ORENS. I would leave you with one last thought, which is, there is no size-fits-all. An investment bank and a regional bank have very little in common, in their pay programs, risk, or their culture. All right? So, we focus so much on Wall Street, and, as a result, all these other banks—regionals and communities—have to live with the outcomes. And I would ask you to think about—there was a huge difference there in how we do things and how compensation is administered. [The prepared statement of Ms. Orens follows:] VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00088 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00089 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 127 here 64160A.050 smartinez on DSKB9S0YB1PROD with HEARING 83 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00090 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 128 here 64160A.051 smartinez on DSKB9S0YB1PROD with HEARING 84 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00091 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 129 here 64160A.052 smartinez on DSKB9S0YB1PROD with HEARING 85 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00092 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 130 here 64160A.053 smartinez on DSKB9S0YB1PROD with HEARING 86 VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00093 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 Insert offset folio 131 here 64160A.054 smartinez on DSKB9S0YB1PROD with HEARING 87 smartinez on DSKB9S0YB1PROD with HEARING 88 The CHAIRMAN. Great. Thank you. Mr. White, would you comment? In your experience now, recently, has risk become more and more important, in terms of executive compensation? Have you noticed a difference? Mr. WHITE. I completely agree with that. I think one of the— probably the most significant lasting impact from TARP and the special master’s work is in the area of risk and the recognition of the interaction of risk and executive comp. I would say, though, that I think the work is somewhat in its infancy, and there’s greater emphasis right now on what I would call ‘‘micro risks’’ within the company, and less emphasis on ‘‘macro risks.’’ The CHAIRMAN. Thank you. Can I—I’d like each of the panel—we’ll start at the other end, Ms. Orens, with you, and—how do you think the special master did? Did he do a good job, an appropriate approach of balancing fairness and competitiveness? Ms. ORENS. I think that the special master had a thankless job. [Laughter.] It’s extremely difficult. I can only imagine what it—how difficult it was, when you looked at the variety of companies and the situation. I think that he did implement the program, as it was put in place—— The CHAIRMAN. Okay. Ms. ORENS [continuing]. With little choice. But, I don’t think it’s a model for the future. The CHAIRMAN. Mr. White. Mr. WHITE. I have a tremendous amount of sympathy for the role; I think, incredibly difficult, under the circumstances. There’s a number of areas where I would give the work of the special master positive marks. I do think there’s some nuances to particularly what I’d reference as ‘‘term structure’’ within the industry, which, frankly, was, to my knowledge, not addressed, as well as some of the underlying drivers in performance metrics, where I think there was probably an opportunity to bring those things out, debate those with the companies, and maybe set some structures that were more appropriate for long-term performance. The CHAIRMAN. Professor Tung. Mr. TUNG. I have a tremendous amount of respect for Ken Feinberg and the work that he’s done with TARP and some of his other activities. I think that the salary-stock approach was a useful way to generate a longer-term perspective than what came before. I think there are other approaches that could do that as well. I think it’s a hard task. We don’t know, really, very well how to limit risk through executive comp. As Kevin Murphy’s memo points out, for 20 years we’ve been trying to get executives to take more risk, because we thought that—remember, back in the ’90s, companies were big, they were run like bureaucracies; we wanted to incentivize them to be leaner and meaner, and came up with this, you know, performance-based pay. And now we’re essentially trying to do the opposite, trying to figure out how to sort of cabin the beast. And I think it’s a tricky task. The CHAIRMAN. Professor Murphy. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00094 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 89 Mr. MURPHY. Yeah. Now, as Mr. Feinberg himself recognized, he had a very limited set of tools available to him. And so, what he was doing, at most, was constrained by—he had base salaries to work with, he had restricted—some amounts of restricted stock to work with, and then this new construct of salarized stock to work with. What—within those concepts, I was disappointed that he didn’t take more of a taxpayer perspective. In other words, how do we maximize taxpayer return, how do we protect taxpayers, or maximize shareholder return while protecting taxpayers? I don’t think that protecting taxpayers meant punishing executives by lowering the competitive compensation. I would have liked—I’d like to see large potentials for upside gain, large potentials for downside losses, and relatively small base compensation. And I don’t really quarrel with Mr. Feinberg in the structure of pay that he established. The CHAIRMAN. Good. Mr. McWatters. Mr. MCWATTERS. Thank you. I’d like for each of you to respond to a question that I asked in my opening statement. And I’ll go ahead and read the question again: How does a TARP recipient—a too-big-to-fail TARP recipient, let’s specify that—such as Citi, Bank of America, Goldman, or AIG—structure a compensation program so as to identify and minimize unnecessary and excessive risktaking while encouraging managers to assume sufficient risk so as to ensure the long-term profitability of the enterprise? We’ll start with Professor Murphy. Mr. MURPHY. Unnecessary and excessive risks are always something that’s easy to detect in hindsight, but something that is very hard to identify ex ante. And I share your concern that the implicit too-big-to-fail guarantee is certainly the cause of a lot of concern, much more concern than direct investment—government investments into companies where we actually can measure what the return are—is on those investments. The—then I believe that the best way—the best way to encourage executives to not take unnecessary and excessive risks is to make sure that their longrun wealth is tied to the longrun prospects at the firm, which is not only the shareholder wealth, but also penalizes them highly if they rely on the government for assistance. Mr. MCWATTERS. But, wasn’t that true with respect to Merrill, Lehman, and Bear a few years ago? Didn’t they have long-term compensation packages? Mr. MURPHY. I—— Mr. MCWATTERS. And they were wiped out. So, I mean, there was a—there was an implicit clawback there. They gave the money back. Mr. MURPHY. They—we can look, in retrospect, and—when we uncover all the causes of the financial crisis, I suspect that we’ll find that compensation played some role, but a fairly minor role compared to housing policy, monetary policy. And clearly, these executives were punished by—for their actions. Mr. MCWATTERS. Okay. And so, it sounds like it’s just difficult to do this, difficult to look into a crystal ball and figure out what the—what is excessive and unnecessary risktaking today. VerDate Mar 15 2010 06:21 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00095 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 90 Mr. MURPHY. Absolutely. It’s easy after the fact, when something happens and we can say, ‘‘Hey, that looks like an unnecessary risk.’’ I think, if you go back 3 years ago, no one thought Mr. Mozilo, at Countrywide, was taking unnecessary risks; we were celebrating the fact that he was getting—helping to get so many people into housing that could have not afforded it before. Mr. MCWATTERS. Absolutely. Professor Tung. Mr. TUNG. I—sir, let me go back to my earlier suggestions. I think, number one, we have to look at portfolio incentives. Number two, to the extent that we can pay executives, at least in part, with, for example, debt securities issued by their own firms—debt securities are more sensitive to risk than equity—that may be a way to make executives at too-big-to-fail firms a little more concerned about risk—gives them a little bit more skin in the game, because the bond—the market pricing of the bonds would, to some extent, reflect risktaking by the company. Now, having thrown out those two ideas, I do think the devil’s in the details. We don’t know how much debt is the right amount. We don’t know what the right proportion is. The research on inside-debt incentives is relatively new. Conceptually it seems to make sense. But, I think, whatever we do, it’s going to involve a lot of tinkering, and we should be cognizant of the fact that we’re really going down a road of experimentation, to some extent. Mr. MCWATTERS. Okay, well, taking some debt as compensation, does that make the executive overly conservative? And is that in the best interest of the equityholders, who may want the executive to take more entrepreneurial risk? Mr. TUNG. That’s exactly the problem. Sir, the question, ‘‘Will the executive be too risk-averse?’’ really depends on the proportion of debt-to-equity compensation. Certainly, shareholders would be less excited about executives taking debt, because their interest is in the stock price. To the extent that we have government subsidy of the risks that financial institutions are taking, it seems to me that it’s not just the stockholders’ return we’re concerned about. We’re concerned about preserving the deposit insurance fund. We’re concerned about the costs of too-big-to-fail and other sorts of implicit government subsidies. Mr. MCWATTERS. Okay, thank you. My time’s up. We’ll continue next time. The CHAIRMAN. Mr. Silvers. Mr. SILVERS. Professor Tung, I—in a way, Mr. McWatters took my question, and your answer, away from me, but I want to push you a little further on it. Do you think that, in relationship to your ideas, that there is a difference between, say, the stress-test institutions, which we should use as perhaps a proxy for too-big-to-fail, and, say, the typical bank that’s subject to FDIC insurance? Mr. TUNG. Do I think there’s a difference in what—— Mr. SILVERS. In terms of the suitability or the need for your type of compensation. Mr. TUNG. Okay. So, right—by the way, I have to say to Mr. Silvers, I was gratified that you knew what was in my paper. And we don’t get many—we don’t get high subscription volume for the academic papers we write, so I’m grateful. VerDate Mar 15 2010 06:04 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00096 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 91 Mr. SILVERS. Thank the staff. [Laughter.] Mr. TUNG. Thank you. So, I do think one important facet of sub-debt compensation, you have to worry about the depth of the market in the securities that you’re using as compensation, because if the market is in a deep one, where you don’t have a lot of analysts following a lot of institutions involved with it, you can’t be as confident that the market price is going to reflect risktaking, because there’s not enough folks paying attention to that particular institution. The smaller the banks get, the less volume you have in their debt trading, the more that’s going to be a problem. Mr. SILVERS. Now, you heard, I assume, my exchange with Mr. Feinberg about the sort unique circumstances of a implicit—or, in certain respects, explicit—guarantees, and the position of the government as both holder of preferred stock and guarantor of the balance sheet. What are your reflections on that circumstance, which is really, in a sense, what we’re about here? Mr. TUNG. You mean, how do we fix that? Mr. SILVERS. No. I’m not going to task you with that. I’m interested in the—so, the government is in that position, as we continue to be at AIG, at Citigroup, perhaps at all of them—perhaps at all of the stress-test institutions, we continue to be in that position. What’s the appropriate public policy, in relation to pay, at institutions that—where the government has that combination of interests? Mr. TUNG. Well, I guess, one of the things—I mean, it seems to me that, because of the large taxpayer investment in those institutions, we want to worry about getting the taxpayers’ money out. At the same time, we’re worried about the safety and the soundness of those—— Mr. SILVERS. Yes, we do—there’s been a lot of talk about how much we want that money back. Do we want the money back at the expense of destabilizing those institutions? Mr. TUNG. Absolutely not. No. Mr. SILVERS. All right. Mr. TUNG. We don’t want them to lever up to buy off the taxpayer. I mean, it’s—— Mr. SILVERS. Right. Mr. TUNG. And I think the point’s been made that, to the extent we make the compensation constraints too onerous, that provides incentive for those companies to try to get out from under—they don’t want the government being an investor if the government is—— Mr. SILVERS. Although, that’s only true if we let them—— Mr. TUNG. Right. Mr. SILVERS [continuing]. Right? Isn’t—that’s only true if Treasury or the regulators allow them to lever up recklessly. Professor Tung, if you don’t mind, my—I want to stop you there. Mr. White, you talked about, essentially, I think, an issue you had about the construction of time horizons in the work of Mr. Feinberg. Can you expound on that? Mr. WHITE. Yeah, sure. The point that I would make is that one of the things that we examine very closely when looking at executive comp across any industry, and certainly applies here, is wheth- VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00097 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 92 er or not the incentives that are inherent in the compensation plan are consistent with the cycle that the industry finds itself in, with its opportunities, its challenges. It is very circumstantial, and I agree with all the comments from the panelists, including earlier, that it is a case by case scenario. In the situation with the financials, I think the disconnect is probably larger than most other industries, in that I believe that the cycle that they operate in is multiyear—right?—and it—and they’re, effectively, leverage plays on the economy. But, their comp programs are heavily weighted towards annual performance. I think there is a very significant macro risk, encompassed in that disconnect, that simply wasn’t addressed. Right? The—some of the micro risk with whether or not, you know, they understand a VAR model or—there are some things that are very programmatic, I think are—they’re coming up the scale very fast. But, at the same time, I think we’re missing what is an elephant in the room. And the potential implications, in my mind, are this, that an industry that is so short-term-oriented may overcompensate for risk, wherever it happens to be on that slope. If my vision is only a year long and we’re on a downward slope, I’m going to manage with that in mind; same on the upward slope. And I think that probably has the potential to make them overemphasize behaviors in each one of those aspects of the term. Did I cover it—does that—— Mr. SILVERS. Yes. And, my time is expired. You’ve covered it admirably. The CHAIRMAN. Dr. Troske. Dr. TROSKE. Thank you. I thought the point that Professor Tung made is an important one to remember. I do recall being in graduate school and hearing and seeing papers by Professor Michael Jensen and George Baker, and then a very young Professor Murphy at the time, telling us about the fact that executive pay was not closely enough tied to the risk of the company. And I think it’s had a major influence. Professor Murphy, first I’d like say I agree with your claim in your report that one of the primary effects of the special pay master was to push firms to pay back their TARP funds very quickly. I guess I consider that a pretty big success of the program. I think he indicated he did, as well. Do you agree? Do you—couldn’t we view the work of, sort of, the special pay master as a way to sort of push firms, to punish them, in some sense, for taking this money, and maybe that was a good outcome? Mr. MURPHY. I believe it’s a good outcome, although I share the potential concern, by Mr. Tung and Mr. Silvers, that, to the extent the companies borrowed money from the private sector in order to escape those regulations, they haven’t really escaped the problem, but they’ve certainly gotten off the taxpayers’ dime. I think that was very beneficial. But, when we’re talking more broadly about regulating pay, this was a case where regulating only a couple firms and—who could escape the regulations by taking particular actions. If we regulate more broadly, we won’t have that opportunity. Dr. TROSKE. So, let me ask you—I’m sort of—I’m going to put you on the spot a little. There’s a proposal—I think it’s—as my VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00098 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 93 opening statement indicated, I think one of the problems that—inherent in all of this is just the fact that firms are insured against failure; they’re too big to fail. There’s been a proposal floated by the Narayana Kocherlakota, the president of the Minneapolis Federal—the Federal Reserve Bank of Minneapolis, to essentially float bonds against these companies. So, there’s a Goldman Sachs bond that pays off if the government has to—had to step in and bail out the firm. And then, simply, the price of that bond will be what we charge Goldman Sachs for the insurance that we’re providing them. Presumably, the price will reflect the riskiness that the executives and the firm are engaging in, both investment decisions and executive—and their compensation. And once firms are forced to pay for this insurance, then they make the appropriate decisions. I know I’m putting you on the spot a little. I don’t know whether you’ve seen Narayana’s—or—— Mr. MURPHY. I think it’s—— Dr. TROSKE [continuing]. His plan. Mr. MURPHY. I think it’s an intriguing idea. I think that then AIG will create some synthetic CDOs that are associated with these bonds, then we’ll see what—we’ll see how that works out. The—there—it has always—it’s just going to be a fact of life that we can reward executives on the upside all day long, but we’re never going to be able to penalize executives efficiently for huge downside occurrences, whether they’re buying insurance or not. We’re—we can’t—we’re never going to be able to punish them sufficiently for huge downside occurrences to eliminate this problem. Dr. TROSKE. Professor Tung, I’d like your thoughts on that, because it seems like Dr. Kocherlakota’s plan seems, certainly, related to yours; it’s an alternative way of getting to the same outcome. You want to provide these executives—force them to hold debt. Dr. Kocherlakota wants them to just sort of pay for the insurance. Either way, they have to—that cost becomes part of something they have to take into account. What are your thoughts? Mr. TUNG. I mean, it sounds plausible. You know, I’d want to read the paper. I guess you’d have to find some private institution or group of institutions to take the—essentially, the failure risk of Goldman Sachs or whatever entity you’re trying to insure. And then, of course, you’re essentially putting—shifting the credit risk to those institutions that are selling the insurance, which is—basically, we’re back to CDS and CDOs. Right? So, it’s just sort of more bets—more side bets on the solvency of a particular institution. Dr. TROSKE. Okay, thank you. My time’s up. The CHAIRMAN. Mr. Neiman. Mr. NEIMAN. Thank you. You know, we’re talking about using bonuses and long-term awards to reward performance and discourage excessive risktaking. I’m intrigued by Professor Tung’s use of sub-debt. Mr. White was— I think, also referenced that a return on equity is not a risk-adjusted measure and misses an opportunity. But, both of those are corporatewide and—or are at least bankwide measurements, and may not necessarily reflect the risk taken by an individual business unit or executive. So, two executives, both generating $1 million in revenue, or even earnings, may have very different risk profiles. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00099 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 94 And, in a bonus award program, issuing the same bonus to both really misses the boat. I’d be interested in some of your reaction as to what are the appropriate metrics to use to distinguish and change behavior under those regimes. Ms. Oren’s just nodding, so it seems like—— Ms. ORENS. Well, I do this for a living, so I can certainly opine on it. What is going on in a—on a broad scale in most financial institutions, both the large ones and the regionals, is an assessment of where their risk is, where is their greatest level of risk within their organization. And you can start with the credit risk, but they also look beyond that. There is credit, market, operational—there’s, obviously, the whole area—there’s a variety of risks that we wouldn’t relate to the kind of problems we’ve had, but are still certainly within that risk umbrella and need to be considered. And if you start with the theory that you’re—you can begin to allocate capital to businesses, which they are trying to do, and can now look at each of those—major business units and ultimately the lower— the smaller ones, and assess where the greatest risk is, then you can begin to really charge the costs of capital, you can calculate the risk-weighted assets—— Mr. NEIMAN. Right. Ms. ORENS [continuing]. And you can assess that as part—that has become, in a sense, a metric. So, two businesses that may each bring in $20 million, on the bottom line, one that takes a lot of capital and is risky beside—taking capital alone, is not a negative, it—you’ll get charged for it, but if, on top of it, this is viewed to be a particularly risky but appropriate business for the company—that’s already been decided— then you’re charged even more—versus the other business. And then, secondarily, to, I think, this gentleman’s point is where you say, ‘‘What’s the time horizon, then? If this is such a risky type of business to us, how do we pay this?’’ And we don’t have to pay it the same as we do another business unit. Mr. NEIMAN. And then, is this where, whether you’re using clawbacks or longer-term vesting periods comes into effect to change—— Ms. ORENS. Absolutely. The clawback is actually being put in, across the board, because you don’t know where that issue is going to arise. And you want to—you don’t want people to feel, ‘‘Well, in this business unit, I’d have to have a clawback; in another one, I wouldn’t.’’ So, they’re really being very broadly put into programs. But, absolutely, the time horizon, the balance of cash and other forms of compensation, even though it might be cash, but it’s longer-term in nature, is being determined, if you will, business by business. Mr. NEIMAN. I’d like to—— Thank you. I’d like to give any other witnesses a chance to comment on that, as well. Mr. MURPHY. I agree that there’s going to be two ways to charge executives for the risk, and one is up front, with how we measure their performance, whether we adjust that performance for risk. And I have—certainly endorse what Ms. Orens says. More gen- VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00100 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 95 erally, though, we need to hold—to the extent possible, we need to hold executives and employees accountable for the downside, as well as the upside. Ms. ORENS. Uh-huh. Mr. NEIMAN. Great. Thank you very much. The CHAIRMAN. I’d like to go through each panel member, starting Ms. Orens, and—one of the objectives of the special master was to have some impact on executive compensation down the road. Do you think there’s been a long-term effect of what the special master’s done? Ms. ORENS. I think there is an effect from what TARP and all the government intervention and the public outcry has been. I think that’s been actually enormous. I think that’s been a huge impact on compensation committees, on management understanding the level of scrutiny, and in the fact that the Treasury, clearly, and now the regulators, as they’ve gone around to the horizontal reviews, how serious and, you know, different the environment is than it used to be. So, if you say that, ‘‘Yes, there was lots of press and people understand all that,’’ and whatever, I think the aspect that has really gotten more important is the issue of, really, governance. You know, there’s just a whole lot more attention to, and there’s a whole different way of looking at compensation than I think there was prior to the crisis. And that’s—— The CHAIRMAN. So, you—— Ms. ORENS. A positive. The CHAIRMAN [continuing]. Do you think it’s actually affected executive compensation? Ms. ORENS. I’m sorry? The CHAIRMAN. Do you think it’s actually affected executive compensation? Ms. ORENS. I think it has, today. I have the same concern that Mr. Feinberg offered, which is: Can we stay the course. I—let’s not just start this process, let’s keep at it. I’d like to believe we will, because of—back to the question of enforcement. We need the regulations. We need them interpreted and implemented appropriately. You know—there’s a lot of education that needs to occur on that side, if you will. I can’t take an examiner seriously who doesn’t know anything about compensation and tells me the same three things they’ve told every bank. So, it’s going to take a while, but I think there’s an enormous willingness today to say, ‘‘Look, you know, we get it. We want to do the right thing. We understand what happened.’’ You know, we’ve all been extremely hurt by it—— The CHAIRMAN. Right. Ms. ORENS [continuing]. Both, you know, the public as well as the employees. And right now, it resonates; it resonates broadly. The CHAIRMAN. Great, thank you. Mr. White. Mr. WHITE. I think the area with the most long-lasting impact is likely to be in the sensitivity to risk. And I think that’s a very positive thing. I think the second most significant implications will be in areas around the periphery of contractual arrangements, severance change in control, some of those. I suspect those will be VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00101 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 96 longer-lasting. I’m anticipating some companies will unwind some of the restrictions that have been placed there. And then, I think the work will also be somewhat foundational for how the Fed, in particular, picks up its oversight role; hopefully, with nuances toward the things that we’re bringing out today, which are actual drivers of performance, in terms of structures and things like that. I would agree with Dr. Murphy, that just outright restrictions on incentive are ultimately not going to be that—you know, from an equityholder’s perspective that’s a tool that we need. The CHAIRMAN. Got it. Professor Tung. Mr. TUNG. I agree with the comments of the other two panelists. Certainly, the process of crafting TARP, the process of crafting ESA and then ARRA and then the Fed guidelines, have all focused public, congressional, executive regulatory attention toward the role of executive compensation in financial institutions. And that, I suspect, would be long-lasting. How it plays out, in terms of actual behavior of corporate boards and executives, I think there’s going to be a—you know, an interaction between regulators and the regulated that will be interesting as it unfolds. The CHAIRMAN. Great. Professor Murphy. Mr. MURPHY. I think we can connect the dots directly from TARP to the Dodd-Frank Wall Street Reform Act. And that Act included in it the most sweeping reforms of executive compensation applicable to all firms, not just financial institutions, in U.S. history. That is going to have implications for executive compensation for decades to come. The CHAIRMAN. Thank you. Mr. McWatters. Mr. MCWATTERS. Thank you. Ms. Orens, I read your opening statement. And I want to read a sentence to you and see what your response is. You say, on page 2, that, ‘‘While delivering compensation in stock reinforces long-term focus’’—okay?—‘‘it does not guarantee the existence of pay-for-performance programs or a culture that properly evaluates individual risktaking.’’ Ms. ORENS. Uh-huh. Mr. MCWATTERS. Well, this just sort of blows a lot of stuff out of the water. So, what do you mean? Ms. ORENS. Be happy to answer that. I think this goes back to some of the comments that were made by Mr. Feinberg. Stock is an important vehicle in executive compensation. It’s a very important vehicle. But, when we think about stock that’s just given to you as restricted stock—all right?—which has been the TARP type of stock or the deferred stock—we call it all-you-have-to-do-isbreathe stock. All right? I stay employed, I get this. I thought we didn’t want guarantees. It’s a guarantee. The risk is, the stock might go up and stock might go down, but I still have a great chance of getting something. On the other hand, we dislike options intensely, because, we say, ‘‘Oh, they create risk. They create people who want to just, you know, blow through and get all these huge numbers.’’ Well, at least VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00102 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 97 they don’t pay unless there’s some performance above a certain level. So, that’s a contrast there, between performance and not performance, to me. If you go back to the point of—to me, the company develops the culture of risk, or it doesn’t. From everything I’ve seen, there are companies who, at their heart, were willing to take enormous risk. How much they were taking, they didn’t even know. Go back from 2005. All right? It’s—— Mr. MCWATTERS. Okay. Ms. ORENS. They—— Mr. MCWATTERS. Okay. That’s helpful. Ms. ORENS. Yeah. Mr. MCWATTERS. What if an employee, one employee, runs a division, and that division does very well, that employee makes a ton of money for the company, but the company, overall, does poorly. What happens to that employee? Ms. ORENS. Mr. McWatters, that’s actually a philosophic question that, as a designer of programs, you start with the committee—compensation committee—and you say, ‘‘What kind of program do you want to have?’’ In true pay-for-performance—I’ll take away the risk of this individual and all that, for the moment—but, if I even had a salesperson who was extraordinary sales performance in this year, and the rest of us are not getting bonuses, do you want to pay, or don’t you? That’s part of your philosophy and design. People might very readily say, ‘‘No, you’re a part of the team. We will not structure compensation that way. That’s the way it is. Salesperson, join the company, don’t join the company. You know the facts.’’ Mr. MCWATTERS. Okay. Okay. But, if that made the media, the employee that walked away with the big bonus even though the company is doing poorly might not be well received. Ms. ORENS. But, I would say to them, ‘‘Are you willing’’—— Mr. MCWATTERS. Sure. I—— Ms. ORENS [continuing]. ‘‘To have that published?’’ Mr. MCWATTERS. Absolutely. Ms. ORENS. That’s how you have to answer it. Mr. MCWATTERS. Professor Murphy, also reading from your opening statement, on page 2, you say, ‘‘It is my opinion that the TARP pay restrictions were ultimately destructive and designed to meet political objectives rather than their legitimate purpose of protecting U.S. taxpayers.’’ That’s very interesting to me. What do you have to say? Mr. MURPHY. Now, remember, when I’m talking about the TARP restrictions there, I’m talking about the TARP restrictions actually in the February 2009 bill—— Mr. MCWATTERS. Yes. Mr. MURPHY [continuing]. Which, of course, were changed in the—— Mr. MCWATTERS. Yes. Mr. MURPHY [continuing]. Treasury restrictions. The elimination, the exclusion, of any kind of bonuses, stock options, signing bonuses, severance bonuses, any kind of incentive pay, except for modest amounts of restricted stock, coupled with no restrictions on VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00103 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 98 the level of base salaries, would run counter to virtually any concept of best practices in compensation design. Mr. MCWATTERS. And it sounds like we’ve moved away from that. Mr. MURPHY. Excuse me? Mr. MCWATTERS. Sounds like we have moved away from that. Mr. MURPHY. That if—well, we heard the special master talk about his own vision for pay. It was the opposite. It—his vision of pay was low base salaries coupled with high longrun pay for performance. Mr. MCWATTERS. Okay. Thank you. The CHAIRMAN. Mr. Silvers. Mr. SILVERS. Okay. Professor Murphy, you say that—and you just said that—you said you thought that pay ought to be more aligned with common equity through—and should have been in the amendment to the TARP statute. Did I hear you right? Mr. MURPHY. I believe the pay should be aligned with the longrun value of the firm, which is not equivalent to the common equity. Mr. SILVERS. Well, you just talked about options as something that you thought should’ve—there should’ve been an ability there to award more stock options. Mr. MURPHY. I included, in the arsenal of tools, the compensation practitioners use, includes stock options, restricted stocks, salarized stock—— Mr. SILVERS. Okay, stop. Mr. MURPHY [continuing]. Performance bonus plans—— Mr. SILVERS. Stop. What instrument did the Federal Government hold in the firms at issue at the time that that statute was passed? Mr. MURPHY. The Federal Government held preferred stock and warrants. Mr. SILVERS. All right. And, the preferred stock was the dominant instrument, was it not? Mr. MURPHY. The—— Mr. SILVERS. Economically dominant. I mean, I refer to our February 2009 report, where, in general, the warrants were a small fraction of the value of the preferred, were they not? Mr. MURPHY. That’s correct. Mr. SILVERS. All right. And was the government not, effectively, the guarantor of these firms? Mr. MURPHY. That is—well, that’s correct. Mr. SILVERS. All right. So, in what sense was the government’s interest the same interest as the same common stockholder’s? Mr. MURPHY. I was not insinuating what they were. Mr. SILVERS. Okay. Now—— Mr. MURPHY. If you read my report—— Mr. SILVERS. Now that—— Mr. MURPHY [continuing]. I—— Mr. SILVERS. No, but—stop. Mr. MURPHY. Okay. Mr. SILVERS. What was the public interest in this circumstance? Was it to maximize the financial payout, risk—on a risk-adjusted basis—to the public of its investment in these firms? Is that an adequate description of the public interest? VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00104 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 99 Mr. MURPHY. Yes. Mr. SILVERS. Yes, it is. Mr. MURPHY. In general terms, yes. Mr. SILVERS. All right. So then, are you aware of this committee’s February 2009 report finding that we underpaid, by 30 percent, roughly, for the securities we purchased, in the capital purchase program, from the nine major banks and AIG? Mr. MURPHY. Not the details, but, yes, the finding. Mr. SILVERS. All right. So, would you agree that we started off on the wrong foot by doing that, that we should have taken 100 percent? Mr. MURPHY. It’s beyond the scope of my testimony. Mr. SILVERS. Well, doesn’t it flow logically, from your proposition, that it’s all about that narrow interest? How can it be that we should be structuring executive pay to achieve this narrow financial interest? And we start off, essentially, throwing that financial interest to the wind and acting in a manner precisely contrary to the way that any financial actor would act in this circumstance. Why does one not flow completely from the other? Mr. MURPHY. Taxpayers had a legitimate interest in the compensation policies to protect their interest and to maximize the return on their interest. Mr. SILVERS. So—but, not in the interest to get full value for their money when they made the investment? Mr. MURPHY. They should have received full value for the money when they made the investment. Mr. SILVERS Okay, good. Now, here’s my second question. You said, earlier in your testimony, that you thought folks had been punished—what was my quote? You said, you thought that the executives involved in these firms have been adequately punished or severe—I forget the quote exactly. I’m trying to find my notes. ‘‘Clearly, they were punished for their actions,’’ that’s a quote from your earlier testimony. Mr. MURPHY. The—— Mr. SILVERS. Am I quoting you correctly? Mr. MURPHY. Yes, that was in—— Mr. SILVERS. Okay. Mr. MURPHY [continuing]. Regard to the people—— Mr. SILVERS. Do you know—— Mr. MURPHY [continuing]. At Bear—— Mr. SILVERS. Do you know—well, you—you made a broad statement. Let’s take Bear Stearns. To your knowledge, is any executive of Bear Stearns homeless today as we sit here? Mr. MURPHY. Not to my knowledge. Mr. SILVERS. Is any executive of Bear Stearns drawing unemployment? Mr. MURPHY. Not to my knowledge. Mr. SILVERS. Is any executive of—has any executive of Bear Stearns had to take their children out of college—— Mr. MURPHY. Not to my—— Mr. SILVERS [continuing]. And put them to work—— Mr. MURPHY [continuing]. Knowledge. Mr. SILVERS [continuing]. To support their family? Mr. MURPHY. Not to my knowledge. VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00105 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 100 Mr. SILVERS. Has any executive of Bear Stearns lost their healthcare and had to go to an emergency room to get it? Mr. MURPHY. Not to my knowledge. Mr. SILVERS. All right. Has any executive of Bear Stearns had to—has any executive of Bear Stearns suffered in any respect, comparably, to that of the millions of Americans whose lives they destroyed? [Pause.] My time is expired. The CHAIRMAN. Dr. Troske. Dr. TROSKE. Thank you. Ms. Orens, I guess I’ll ask you a similar question that I asked Mr. Feinberg. You’ve worked with these TARP companies. Do you think they, in essence, scrambled to get out from under his purview by—because they were concerned about the impact that he was going to have on their pay? Ms. ORENS. I think it’s more—a little bit more complex, Dr. Troske. From the moment that anyone became a TARP participant—and I think this was part of that unknown aspect of TARP and—you know, it was one thing in October, and it changed a bit later—you became a tainted company. Companies felt that they were just being looked at as if they were, you know, severely at a disadvantage and in terrible shape, when some of them thought that they’d actually taken the money and been patriotic. So, you had a number of companies who really felt like, you know, they were tainted. It wasn’t even the—the compensation just exacerbated it, but they felt—TARP became just very negative. Their— you know, their share price, everything was affected. And so, I think they acted, those that went, about July—a number of them paid back, in the first big group. They did it for both reasons. But, I will tell you, they did it more for the taint than they did it for the comp, initially. Dr. TROSKE. Thank you. I want to ask a question. So, recent article in the New Yorker magazine claims that capital had become accustomed to saying yes to talent, even in cases where talent does not end up being all that talented. I guess the implication seems to be that executives are overpaid and they’re not worth what they’re—the value that they bring is less than the compensation that they’ve received. Is that your opinion? Do you think that there’s any evidence—— Ms. ORENS. I think they’re—— Dr. TROSKE [continuing]. That suggests that? Ms. ORENS [continuing]. Just like athletes and actors and actresses, some points people are definitely not worth the money that they’ve been paid, but they’ve convinced someone or have been good enough for a long enough period of time. I think, unfortunately, companies don’t do a good enough job of determining that people are really worth their contribution, not just on a market basis, but that if I’m going to pay somebody several million dollars, they’re really—they really are very good. I don’t think they do a good job. Dr. TROSKE. Mr. White, I like to—your response to that. Mr. WHITE. It’s an excellent question. I agree there’s—that it is a complicated issue in determining the value in—from an investor standpoint, I think the problem is, is that companies don’t view VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00106 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 101 that with a return-on-investment type of perspective. And it comes up in a number of facets of our discussion with them; for example, when they ask the market for equity. When they come for approval for equity, their question is always raised in, ‘‘What’s your limit?’’ In other words, ‘‘How much can we get? What’s—how much dilution will you allow?’’ instead of, ‘‘This is the amount of investment we need to make in the management team, and this is the return we expect on it, and this is how we’re going to measure it over time, and adjust, if our approach to this is incorrect.’’ So, I think that the philosophy of how they pay doesn’t lend itself well to making that evaluation. Dr. TROSKE. Okay. Let me ask you another question. We talked a little bit about ‘‘say on pay.’’ Mr. White, from investors—is that something meaningful? I mean, a nonbinding vote—is that—do you think that that’s—has any impact? Mr. WHITE. I think it has tremendous potential to bring equityowners—long-term equityowners more into the discussion and more into a role of oversight. If there’s anything that, you know, I would have to say is—been missing in the issue of executive compensation, is a greater scrutiny from long-term owners. Right? We care about the issue, but we simply haven’t done enough. And I think that is one vehicle that will facilitate that. Dr. TROSKE. Thank you. The CHAIRMAN. Superintendent Neiman. Mr. NEIMAN. Thank you. Most of the focus and discussion so far has been on the compensation of sales and revenue generators within our large firms. But, what about the risk-and-control functions? And, while I’ve seen instances of senior risk and credit folks being attracted away with big comp packages, overall I think the surveys will show that they are compensated at significantly less levels. There’s a recent IIF, Institute International Finance, study out on compensation in wholesale institutions. So, I’m interested in—on your views on both the level of compensation and the incentives—and really, it does relate to the independence, as well—with respect to risk and control and compliance folks. Who’d like to start? Ms. ORENS. I’ll be happy to start. Mr. NEIMAN. Go ahead. Ms. Orens. Ms. ORENS. It’s an excellent point, Mr. Neiman, another area we would look to what went wrong, historically. It’s—particularly within the Wall-Street-type firms, I think, as you well know, risk management was not a particularly attractive function, and you tended to report within the business unit, which meant that you really weren’t going to criticize, to a large degree, what was going on. And maybe you had a dotted-line relationship to the head of risk on a corporate basis. And now that’s all changed. Mr. NEIMAN. And are there incentive programs out there for risk? Ms. ORENS. Yes. You—it’s part of, obviously, the Treasury regulations, as well, to determine how best to do that. But, they are no longer compensated within their line of business, nor—typically would those leaders—have final say about how they’ve done their role. The determination will be done by the head of risk. It will VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00107 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160 smartinez on DSKB9S0YB1PROD with HEARING 102 normally be a more corporate-style payout—you know, less shortterm, more long-terms; actually, an attractive salary, because it’s a very professional-type position. It’s being compensated, as it should be, to the type of perspective that person needs to have. Mr. NEIMAN. I want to shift onto some international global competitiveness issues. You know, there are a number of areas where the U.S. has been a first mover on many issues in regulatory reform. But, I’m interested in the impact. And you hear the feedback. If we are the first mover in areas of compensation, what impact will that have on where individuals—will they shift to jurisdictions with less constrictive compensation schedules? You know, we heard Mr. Feinberg say that, despite the rules he put into place, 85 percent were still there after that—a year after. Any thoughts on these issues—the international issues? Should there be anything restraining the U.S. from proceeding with a stringent regime? Mr. MURPHY. I’ll start, if I may. Mr. NEIMAN. Mr. Murphy. Mr. MURPHY. This is—the United States is still the place you want to be if you’re an executive, even given the current restrictions. If we look at what’s going on in Europe in the financial institutions, they have adopted more of a rule-based system and not a principles-based approach. They’re—I think, will be much more restrictive, in years to come, than anything I anticipate out of the United States. Ms. ORENS. Yeah. I think we’re having pressure, obviously, from Europe to adopt similar-type programs. And, the U.K. is currently, kind of, in between, also. They don’t totally want to go the full route of the European Parliament. Mr. NEIMAN. Then my—I think—my recollection, after London bank tax, is that what they feared was a big shift. There—it—I don’t think there was a—any major impact on movement of employees outside of—— Ms. ORENS. It was a 1-year event. You have to watch it about 1-year events. If there’s sustained view that the U.K. doesn’t want to have people there, U.S. companies will—you know, their employees will say, ‘‘I don’t want to go to the U.K. if I’m going to be subject to those types of restrictions.’’ So, I think coordination is important. And I—but, I do think that the U.S. should keep to a more principled—even if there’s some clear—you know, clearly some guidelines, but principles rather than fiats. And the Europeans now are just saying, ‘‘They’ll pay X in cash, X in stock, some of it will be contingent, et cetera.’’ And, again, it’s a one-size-fits-all approach, assuming everybody in the world is exactly the same kind of company, and they’re not. Mr. NEIMAN. Thank you. Ms. ORENS. And I think it makes us uncompetitive, which is a problem right now. I don’t think we want to lose those jobs. Mr. NEIMAN. Thank you. The CHAIRMAN. I want to thank the panelists for doing a great job. I want to thank you for coming. I want to thank you for what you had to say. And, with that, the hearing is adjourned. [Whereupon, at 1:10 p.m., the hearing was adjourned.] VerDate Mar 15 2010 02:23 Mar 11, 2011 Jkt 064160 PO 00000 Frm 00108 Fmt 6633 Sfmt 6602 E:\HR\OC\A160.XXX A160
@FedFRASER