Sunday, April 17, 2011

Key Senators Urge SEC to Prohibit Executive Hedging as Part of Dodd-Frank Incentive Compensation Regulations

In a letter to the SEC, three US Senators urged the Commission to prohibit highly-paid corporate executives from hedging in any way on their own incentive-based compensation arrangements as part of the regulations implementing Dodd-Frank provisions. Senators Robert Menendez (D-NJ), Frank Lautenberg (D-NJ) and Jeff Merkley (D-OR) reasoned that the use of hedging by corporate executives of their own compensation arrangements takes the "incentive" out of incentive-based compensation, thereby undermining the accountability of the executives who engage in these tactics and significantly undermining the legislative intent of Dodd-Frank to deal with incentive-based compensation. Executives should benefit when their company does well said the Senators, and, if they are allowed to hedge, it takes their company out of the equation, permitting them to profit regardless and encouraging excessive risk-taking.

Section 956(b) of Dodd-Frank requires the SEC and other federal regulators to adopt regulations prohibiting any types of incentive-based payment arrangement that they determine encourages inappropriate risks by covered financial institutions, which includes SEC-registered broker-dealers and investment advisers.

During debate of the Dodd-Frank Act, the Senators offered Amendment No. 3818 to prohibit executives and other highly-compensated employees, those making more than $1 million, from engaging in trades that would bet against their own company's stock. While the amendment was never voted on, they noted, it was supported by the Americans for Financial Reform, the Council of Institutional Investors, and former SEC Chief Accountant Lynn Turner.

When offering the amendment, Senator Menendez said that executives and highly-compensated employees should never have financial incentives to act against the best interests of their companies. Citing a study indicating that in 2,000 cases at over 900 firms executives tried to profit by betting against their own company, Senator Menendez said that if the executives can hedge their stock it does not matter how well the company does because either way the executive makes money. Not only is this fundamentally wrong, he emphasized, it may in some cases give executives an incentive to use their status to take a position that may not be in the company’s best interest and then make a profit by selling the company stock short. Cong. Record, May 5, 2010, S3153.

In their letter to the SEC, the Senators observed that the SEC and the other regulators on the joint proposal recognized in the proposing release that the use of personal hedging strategies, such as financial derivatives, on incentive-based compensation arrangements for highly-paid executives would make many of the provisions prescribed by the agencies less effective.

In their letter to the Commission, the Senators said there is ample evidence suggesting that this type of hedging is a widespread problem that has serious implications for investors and for the health of their companies.

The Senators cited other federal officials who have taken exception with the hedging tactic. For example, the Treasury Special Master for TARP Executive Compensation, who was responsible for overseeing the distribution of compensation to top executives at companies that received federal bailout assistance, banned executives under his jurisdiction from this practice because he wanted to ensure that they could not undercut the links Treasury created between compensation and long-term performance.

1 comment:

John Olagues said...

What in God's name does a Senator know about hedging compensation grants and its consequences to the purpose of the the grants of employee stock options?

These Senators are being told by the companies to try to prohibit hedging because hedging benefits the employee and reduces corporate profits. Very few executives hedge their position, so why all the fuss.

John Olagues