Federal Reserve Proposes Executive Comp Policies

September 21, 2009 (PLANSPONSOR.com) - The Federal Reserve would have to approve executive compensation policies set by financial institutions as part of its proposal designed to curb excessive risk-taking.

The Wall Street Journal reports that under the proposal, the Fed could reject any compensation policies it believes encourage bank employees — not just chief executives, but also traders and loan officers — to take too much risk. The bank would set the pay of individuals, but the Fed would review and, if necessary, amend each bank’s salary and bonus policies to make sure they do not create harmful incentives, the Journal said.

The proposal will likely push banks to use “clawbacks” — provisions to reclaim the pay of staffers who take risks that hurt their firms — in certain pay packages, among other tools to discourage risk-taking. The central bank could also demand that more pay be offered through restricted stock or other forms of long-term compensation designed not to reward short-term performance.

The proposal would apply to banks regulated by the Federal Reserve, not savings-and-loans or state banks that are overseen by the Federal Deposit Insurance Corp. Sources familiar with the matter told the Journal that a final proposal is still a few weeks from completion and could be revised along the way.

According to the newspaper, the strategy appears to go further than what some in the industry were expecting, given that it would apply to many employees, not just top earners. It goes beyond a more generic list of “best practices” that many thought the Federal Reserve would craft.

The Federal Reserve’s board will consider the proposal in the coming weeks, and if approved, it will be proposed for public comment.

The Fed’s move follows attempts by Washington to rein in bank compensation. In June, the Obama administration named Kenneth Feinberg as pay czar to ensure that companies receiving federal bailout funds are abiding by executive-pay guidelines (see Obama Expected to Appoint Feinberg to Police Executive Pay ).

In July, the House Financial Services Committee approved a bill to give bank regulators the ability to ban “imprudently risky compensation practices” at banks with more than $1 billion of assets (see House Approves Exec Comp Reform ), in line with the Fed’s likely proposal.

Meanwhile, banks have been boosting the base salaries of traders and investment bankers to prevent the recipients’ overall compensation from shrinking (see Financial Firms Pumping Up Base Salaries over Bonuses ).