Treasury and SEC Aim to Align Executive Compensation with Risk Management

New Treasury guidance on executive compensation includes immediate restrictions on companies receiving exceptional financial recovery assistance, such as limiting the total amount of compensation to no more than $500,000 for senior executives except for restricted stock awards. But the Treasury and the SEC have also agreed to work together to align executive compensation with proper risk management and long-term value. This effort will begin with an examination of how company-wide compensation strategies at financial institutions, not just those related to top executives, may have encouraged excessive risk-taking that contributed to current market events. Next, Treasury and the SEC will begin developing model compensation policies for the future.

Under this rubric, compensation committees of all public financial institutions, not just those receiving government assistance, would be required to review and disclose executive and employee compensation arrangements and explain how these arrangements are consistent with promoting sound risk management and long-term value creation for their companies and their shareholders.

Currently, Treasury regulations for financial institutions participating in the troubled asset relief program (TARP) require the compensation committee to meet, within 90 days after a purchase under the program, with senior risk officers of the financial institution to ensure that the firm’s incentive compensation arrangements do not encourage senior executive officers to take unnecessary and excessive risks that might threaten the firm’s value. After that, the compensation committee must meet annually with senior risk officers to review the relationship between the financial institution’s risk management policies and the compensation arrangements.

Also, the compensation committee must certify that they have done so in order to assure investors and taxpayers that the institutions are complying with the requirements.Over the last decade there has been an emerging consensus that top executives should receive compensation that encourages more of a long-term perspective on creating value for their shareholders and the economy at large. In order to promote this goal, Treasury and the SEC will consider requiring senior executives at financial institutions to hold stock for several years after it is awarded before it can be cashed-out as this would encourage a more long-term focus on the economic interests of the firm.

With regard to companies receiving exceptional financial recovery assistance, the amended Treasury guidance requires that the senior executive compensation structure and the rationale for how compensation is tied to sound risk management must be submitted to a non-binding shareholder resolution. Going forward with regard to all financial institutions, Treasury and SEC will also explore giving shareholders a non-binding vote on both the levels of executive compensation as well as how the structure of compensation incentives help promote risk management and long-term value creation for the firm and the economy as a whole.

Finally, Treasury will host a conference with shareholder advocates, institutional investors, policy-makers, executives, and academics on executive pay reform at financial institutions. Treasury will seek testimony, comment, and white papers on model executive pay initiatives in the cause of establishing best practices and guidelines on executive compensation arrangements for financial institutions.