Senate Finance member advances new bank pay rules
January 13, 2010
WASHINGTON, D.C. - As a fresh round of hefty Wall Street bonuses seems certain to rekindle public ire, a member of the key Senate Finance Committee is offering President Barack Obama legislation that aims to curb big CEO payouts and risky behavior by financial industry executives.
In a letter to President Obama today, U.S. Sen. Bill Nelson (D-FL) unveiled a detailed plan designed to “put an end to Wall Street compensation practices that emphasize short-term, unsustainable, and illusory profits and refocus the financial sector on its critical role as a bridge between lenders and borrowers.”
The Florida Democrat told Obama he thinks a White House proposal for new fees on big banks, which the president is reportedly poised to announce Thursday, doesn’t go far enough to address things like the billions of dollars in bonuses for 2009 that are expected to be the largest in Wall Street history.
“Like most Americans, I continue to be disturbed by the inflated executive bonuses being paid out by the same banks and Wall Street firms that helped get us into the current economic mess,” Nelson wrote of the need for his legislation, which he’s given to congressional lawyers for final preparation and shared with the office of Finance Committee Chairman Sen. Max Baucus.
Nelson’s legislation doesn’t set specific pay limits, but conditions a bank’s tax breaks on compliance with new requirements governing compensation and risky practices.
Meantime, the Federal Deposit Insurance Corporation on Tuesday moved to provide incentives to banks that adopt compensation programs aligned with stakeholder interests. On Wednesday, some of the nation’s top bank chiefs defended their bonus and pay practices in testimony before a special commission investigating the financial collapse in 2008.
Additionally, the Associated Press reported Obama plans on Thursday to announce a new fee on banks to recover taxpayers’ money used to bailout financial institutions after the collapse. But, according to Fox News, the president has ruled out levies on executive compensation.
“I encourage you to strengthen your proposal by incorporating in your 2011 budget the executive compensation reforms I’ll soon be introducing in the Senate,” Nelson wrote in his letter to the president.
Nelson’s legislation says compensation over $1 million would be nondeductible unless it is performance based, at least half of performance-based compensation must vest over a period of five years or more. It would require that executives at public companies be paid in employer stock and that compensation must include arrangements for return of the money if misconduct surfaces. Also, employees must end the use of personal hedging strategies, such as compensation insurance.
These requirements, and others, would apply to high-level executives and other employees whose actions affect the institution’s risk exposure.
Below is the text of Nelson’s letter to Obama, followed by the draft of his legislation:
Dear Mr. President,
I was pleased to learn that you intend to offer a proposal tomorrow to recoup taxpayer bailout funds from the country’s largest financial firms. While this is a positive step, I believe more must be done to restore public confidence in our nation’s financial system.
Like most Americans, I continue to be disturbed by the inflated executive bonuses being paid out by the same banks and Wall Street firms that helped get us into the current economic mess. Meantime, these same institutions have made few meaningful changes to executive compensation and other practices that contributed to the financial crisis.
Therefore, I encourage you to strengthen your proposal by incorporating in your 2011 budget the executive compensation reforms I’ll soon be introducing in the Senate and have attached for your consideration.
This legislation, the Wall Street Compensation Reform Act, would use the power of the tax code and shareholder disclosures to put an end to Wall Street compensation practices that emphasize short-term, unsustainable, and illusory profits and refocus the financial sector on its critical role as a bridge between lenders and borrowers. The proposal pulls the new voluntary executive compensation standards developed by the Financial Stability Board into the tax code and gives those standards teeth.
More specifically, the legislation will create special executive compensation tax rules that apply to “systemically significant” financial institutions. The legislation will condition an institution’s eligibility for tax deductions on ending its reckless compensation arrangements and adopting new, long term-oriented, compensation standards. The bill includes a number of provisions, including: making compensation over $1 million nondeductible unless it is performance based; requiring that at least half of performance-based compensation vest over a period of five years or more; mandating that executives at public companies be paid in employer stock; requiring compensation clawback arrangements; and, prohibiting employees from engaging in personal hedging strategies, such as compensation insurance. These requirements, and others, would apply to high-level executives and other employees whose actions affect the institution’s risk exposure. In order to limit administrative complexity, the rules would be built into an existing provision of the tax code, section 162(m).
Mr. President, I believe the provisions of the Wall Street Compensation Reform Act would put an end to the compensation practices that led us down an unsustainable path and threaten to drive us right back into the ditch.
I look forward to working with you as the budget and financial reform process moves forward.
cc: The Honorable Timothy F. Geithner, United States Secretary of the Treasury
The Honorable Max Baucus, Chairman, Senate Committee on Finance
The Honorable Charles Grassley, Ranking Member, Senate Committee on Finance
Wall Street Compensation Reform Act of 2010
1. Scope. The legislation establishes a new subcategory of taxpayers subject to section 162(m) of the tax code referred to as “Systemically Significant Financial Institutions”. It defines the term as a company or other entity that:
a. Engages primarily in activities that are financial in nature (as defined in 12 U.S.C. § 1843(k)), and
b. Meets one of the following requirements:
i. Owns or controls assets greater than $10 billion, or
ii. Owns or controls assets greater than $1 billion and maintains a leverage (debt-to-equity) ratio greater than 15:1.
c. The definition of a systemically significant financial institution is not limited to publicly held corporations.
i. Once a taxpayer qualifies as a systemically significant financial institution, the taxpayer shall remain classified as such in future tax years.
2. General rules. In the case of all systemically significant financial institutions:
a. Covered employees include the CEO or Managing Partner, the 25 highest paid employees (other than the CEO or Managing Partner), and other employees whose actions have a material impact on the risk exposure of the taxpayer.
b. Employees with applicable employee remuneration exceeding $1 million are presumed to engage in actions that have a material impact on the risk exposure of the taxpayer unless the taxpayer submits an information return to the Secretary that describes the role and responsibilities of the employee and the rationale for why the employee should not be classified as having a material impact on the taxpayer’s risk exposure.
c. No deduction shall be allowed in the case of applicable employee remuneration for any taxable year which is attributable to services performed by a covered employee during such year, to the extent the remuneration exceeds $1 million.
i. The exception for remuneration payable on a commission basis in section 162(m)(4)(B) of the tax code does not apply.
ii. The exception for performance-based compensation in section 162(m)(4)(C) of the tax code is subject to the limitations below.
iii. The timing rules for deferred deductions in section 162(m)(5) of the tax code apply.
d. The size and allocation of the taxpayer’s performance-based compensation pool for covered employees must take into account the full range of current and potential risks, including:
i. The cost and quantity of capital required to support the risks taken by the taxpayer in the conduct of the taxpayer’s financial activities,
ii. The cost and quantity of the liquidity risk assumed by the taxpayer in the conduct of the taxpayer’s financial activities, and
iii. The timing and likelihood of potential future revenues from the taxpayer’s financial activities.
e. Under the material terms of performance-based compensation paid to covered employees:
i. At least 50 percent of performance-based compensation must be payable under vesting arrangements of at least five years.
ii. The proportion of performance-based compensation payable under vesting arrangements must increase based on an employee’s level of seniority or responsibility.
iii. Performance-based compensation payable under vesting arrangements must vest no faster than on a pro rata basis over a number of years.
iv. In the case of publicly traded corporations, at least 50 percent of performance-based compensation must be awarded in employer stock or other instruments that align employee compensation with long-term value creation and the time horizons of risk.
v. Performance-based compensation must be contingent on a formal agreement between the taxpayer and the employee not to use personal hedging strategies, compensation-related insurance, or liability-related insurance that undermines the risk alignment effects of this section.
f. In the case of the CEO of a publicly held corporation (and the Chief Financial Officer, if the CFO is a covered employee), performance-based compensation must be subject to substantial clawback requirements in the event the taxpayer is required to prepare an accounting restatement due to material noncompliance, as a result of misconduct, with any financial reporting requirement under the securities laws.
3. Specific rules for privately held institutions. In the case of a systemically significant financial institution that is not a publicly held corporation, the requirements in section 162(m)(4)(C)(i) through (iii) of the tax code do not apply. In place of these rules, the taxpayer must comply with the following requirements:
a. The taxpayer must provide for an independent or externally commissioned annual review of compensation policies and practices. The review shall include an examination and analysis of the taxpayer’s compliance with the requirements of this legislation.
b. The taxpayer must certify that performance goals and other material terms are satisfied before any payment of deductible, performance-based compensation is made.
c. The provisions of this section shall take effect beginning in calendar year 2011.
4. Specific rules for public corporations. In the case of a systemically significant financial institution that is a publicly held corporation, the requirements in section 162(m)(4)(C)(i) through (iii) of the tax code continue to apply. In addition, such taxpayers shall provide to the SEC and disclose to the public an annual report on compensation policies and practices, which describes:
a. The process used to develop and modify the corporation’s compensation policies, including the composition and the mandate of the compensation committee,
b. The actions taken to comply with this legislation,
c. Additional actions taken to implement the Principles for Sound Compensation Practices adopted by the Financial Stability Board,
d. The most important design characteristics of the compensation system, including criteria used for performance measurement and risk adjustment, the linkage between pay and performance, vesting policy and criteria, and the parameters used for allocating cash versus other forms of compensation, and
e. Aggregate quantitative information on compensation, broken down by senior executive officers and by employees whose actions have a material impact on the risk exposure of the firm, indicating: amounts of remuneration for the financial year, split into fixed and variable compensation, and number of beneficiaries.
- The amount of compensation that was nondeductible in the prior year as a result section 162(m).
g. The provisions of this section shall take effect beginning in calendar year 2011.
5. Date of enactment
- Except as otherwise provided, for taxpayers that meet the definition of a systemically significant financial institution in calendar year 2010, the provisions are effective for services performed in calendar year 2011 and thereafter.
i. Transition period for preexisting compensation agreements. In the case of services covered by compensation agreements entered into prior to the date of introduction, the legislation is effective for services performed in calendar year 2012 and thereafter.
- For taxpayers that meet the definition of a systemically significant financial institution for the first time in a calendar year after 2010, the provisions are effective for services performed after December 31 of the year following the calendar year in which the taxpayer meets the definition (if a taxpayer was an SSFI for the first time in 2013, the provisions would apply to services performed after 12-31-2014).
a. Within 180 days after the date of enactment, the Secretary shall prescribe such guidance, rules, or regulations as are necessary to carry out the purposes of this legislation. The guidance shall: (1) describe the method for valuing assets for purposes of the asset test; (2) describe the method for calculating a taxpayer’s leverage ratio; (3) describe criteria for use in determining whether an employee is treated as having a material impact on the risk exposure of the taxpayer; and (4) set forth anti-abuse rules to prevent taxpayers from using independent contractors to avoid the purposes of the legislation.