Federal agencies are now preparing new regulations for enforcing the Dodd-Frank banker pay reforms enacted last summer. These new regs, says the AFL-CIO, need to prohibit the ‘incentive’ that’s still stuffing bankers with billions.
If you wear a power suit to work every day, you probably don’t care all that much about your salary — because most of your income doesn’t come from salary. Most comes from something called “incentive-based compensation.”
This “incentive-based” pay can come in many forms. You can get cash as an incentive if you meet certain “performance” goals. You can get actual shares of stock as a incentive. Or, maybe best of all, you can get stock options.
Stock options, in today’s corporate and banking world, essentially serve as lottery tickets for big-time executives. Lottery tickets with a difference. The first difference: These executive lottery tickets come free. Executives pay nothing to get them. The second: This executive lottery pays off big — and often.
Regular folks who play the lottery can, of course, certainly hit the jackpot. But the odds against scoring a major windfall can routinely run up to 76 million-to-one, the equivalent of throwing heads on 26 consecutive coin tosses.
Financial industry execs who play the stock option lottery don’t have to toss 26 heads in a row to score big. They merely have to jack up their share price. And they’ve become quite adept at doing just that, by any means necessary.
Those means, we’ve learned from various investigations into the 2008 financial industry meltdown, have included everything from bankrolling subprime loan scams to cheating their own clients. Why do top execs take all these risks? With stock options, executives simply have no incentive not to take risks.
Stock options give executives the “option” to purchase a specified number of their firm’s shares, at the current share price, at some future date. At that future date, if the shares have jumped in price, the executives “exercise” their options. They buy shares at the old price and then sell them off at the new one.
If their firm’s shares should decline in value over time, the executives lose nothing — since they’ve paid nothing for their options. But their gains, on the upside, have no limit. The higher a share price rises, for whatever reason, the bigger the executive personal profit from exercising the option.
These personal profits have been — and continue to be — enormous. Consider the power-suited executive phalanx at Goldman Sachs. Since 1999, the New York Times reported earlier this year, some 860 top Goldman execs have cashed out $20 billion from selling off shares from their personal stock stashes.
Those shares came, in part, from option grants. In 2007, for instance, Goldman’s board approved grants that gave execs options to purchase 3.5 million shares. But then came the 2008 meltdown, and Goldman shares plummeted in value.
Goldman’s response: more options. Lots more. In December 2008, with Goldman shares trading at record lows, the bank’s top execs received nearly 36 million stock options, ten times the previous year’s total.
Goldman’s top execs also received, at about that same time, a massive bailout from Uncle Sam that saved the bank from collapse and set the stage for a robust share price recovery. By January 2011, the bank’s top 475 execs could look forward to $2.7 billion in personal profits from the 2008 stock option grant.
Last summer, members of Congress took a stab at curbing such gross excesses. The Dodd-Frank financial reform legislation they passed includes a section that expressly prohibits “any type of incentive-based compensation” that “encourages inappropriate risks by providing excessive compensation.”
But this section 956 leaves the enforcement specifics up to the seven federal agencies that monitor the financial sector. This past March, these seven proposed draft regulations for implementing the lawmaker intent. Bank lobbyists and public interest groups have been sparring over these draft regs ever since.
Much of the debate has revolved around a proposed regulatory rule that would require big banks to defer 50 percent of incentive compensation for a minimum of three years. The goal: to prevent executives from enriching themselves with short-term moves that end up wreaking long-term havoc.
Public interest groups like Americans for Financial Reform and Public Citizen are pushing for rules that require banks to defer a greater share of executive incentive pay — and for a longer deferral period. They’re also pushing for a clearer — and tougher — definition of “excessive compensation.”
The AFL-CIO, America’s biggest union federation, is pushing for even stiffer changes. Last Tuesday, the AFL-CIO’s top investment analyst, Daniel Pedrotty, asked regulators to place an outright ban on all big bank stock option incentives.
“Stock options promise executives all of the benefits of share price increases with none of the risk of share price declines,” noted Pedrotty. “In other words, stock options provide executives with asymmetric incentives to shoot for the moon.”
Options, he continued, also let top execs “inappropriately profit from share price volatility without creating additional value.”
The AFL-CIO bottom line: Stock options don’t rate “as an appropriate form of compensation for executives and should be prohibited.”
Mary Jo Carey would likely agree with this AFL-CIO appraisal. Before the 2008 financial collapse, she worked as a loan officer with a small brokerage firm in her Taos, New Mexico hometown. Carey recently sent the Securities and Exchange Commission a letter asking for tough restraints on Wall Street’s “outrageous pay practices,” one of thousands of citizen letters the agency has received.
“Currently, most bankers receive stock options,” Carey wrote. “So if they can generate more profits, the stock price goes up, and their options become more valuable. This is insane! This will just cause another collapse.”
“I watch the revolts in Egypt, Tunisia, etc. and think,” Carey added, “that will be us someday. We are run by rich guys.”
How much those rich guys get their way on Section 956 will soon be apparent. The SEC and other involved federal regulatory agencies could be adopting final regs on financial institution executive incentive pay as early as this August.
Sam Pizzigati edits Too Much, the online weekly on excess and inequality published by the Washington, D.C.-based Institute for Policy Studies. Read the current issue or sign up to receive Too Much in your email inbox.