Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, October 22, 2009

Fed Issues Proposal to Review Incentive Compensation Practices at Big Banks

This morning I read in the New York Times that Morgan Stanley had returned to profitability and had plans to pay its employees healthy bonuses, because, its CFO said, "we have to pay people competitively." He also said the company planned to hire 400 new employees, mostly outside the U.S., to rebuild its trading business.  NYTimes, Morgan Stanley Returns to a Profit.  Maybe someone in government took notice too, because later today the Federal Reserve announced proposals on executive compensation o discourage excessive risk-taking at the big banks.  Here is part of the press release:

The Federal Reserve Board on Thursday issued a proposal designed to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of their organizations.

The proposal includes two supervisory initiatives. One, applicable to 28 large, complex banking organizations, will review each firm's policies and practices to determine their consistency with the principles for risk-appropriate incentive compensation set forth in the proposal. These firm-specific policies will be assessed by supervisors in a special "horizontal review," a coordinated examination of practices at the 28 firms. The policies and implementing practices adopted by these firms in response to the final supervisory principles will become a part of the supervisory expectations for each firm and will be monitored for compliance.

Second, supervisors will review compensation practices at regional, community, and other banking organizations not classified as large and complex as part of the regular, risk-focused examination process. These reviews will be tailored to take account of the size, complexity, and other characteristics of the banking organization.


Flaws in incentive compensation practices were one of many factors contributing to the financial crisis. Inappropriate bonus or other compensation practices can incent senior executives or lower level employees, such as traders or mortgage officers, to take imprudent risks that significantly and adversely affect the firm. With that in mind, the Federal Reserve's guidance and supervisory reviews cover all employees who have the ability to materially affect the risk profile of an organization, either individually, or as part of a group.

The findings from these reviews will be incorporated into the banking organization's supervisory ratings. In appropriate circumstances, the Federal Reserve may require an organization to develop a corrective action plan to rectify deficiencies in its incentive compensation programs and processes.

To monitor and encourage improvements, Federal Reserve staff will prepare a report after the conclusion of 2010 on trends and developments in compensation practices at banking organizations.

  In addition, Kenneth Feinberg provided additional information on the negotiations with the seven companies bailed out by the government and how he made his decisions to slash top officers' compensation; The Special Master for TARP Executive Compensation Issues First Rulings.   NYTimes, Fed Plans to Vet Banker Pay to Discourage Risky Practices.

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