Monday, November 15, 2010

Two Sets of Rules

In ancient times, kings and government officials cast die or used sorcery or astrology to try to determine the dates for an important action to take place.  Using this method, they decided when wars should be declared and when new laws should go into effect.

In the twenty-first century we are supposed to be more sophisticated, so I wonder what method the government is using to determine the implementation date for its new policies. For instance, who decided that April should be the month to cut pay for everyone working in the various aspects of financial services? Not only will residential loan officers see their compensation change in April of 2011, but the Securities and Exchange Commission is expected to release new compensation rules for investment advisers that same month.

Just as the Federal Reserve wants to change/slash loan officer compensation to make sure that loan officer pay is not tied to interest rates or credit scores, so the SEC wants to change investment adviser compensation to limit incentive-based pay that "rewards risk taking."  The SEC wants to determine whether officers and employees of investment firms are receiving "excessive compensation or benefits" which may endanger the financial institution.  Mary Schapiro, chairman of the SEC,  has stated that the SEC is going to focus on compensation plans that reward risk taking.  She wants to implement TARP-like rules which will limit executive compensation and bonuses.  According to Schapiro, sign-on bonuses and compensation tied to risky behaviors such as "higher levels of compensation for higher levels of turnover in the portfolio...are things that absolutely have to change."  The SEC under Schapiro's watch is committed to writing new rules that will create "compensation programs that incentivize the right kinds of behavior."

The supreme irony of Schapiro's SEC writing rules limiting how executives can be paid is that she herself has been the subject of heavy criticism for receiving $9 million in payouts and bonuses from the Financial Industry Regulatory Authority Inc (FINRA) when she left her post as the chief executive last year to become the chairman of the SEC. (Included in that $8.98 million figure was $7.6 million in vested retirement benefits).  According to an October 10 article in Investment News Daily, FINRA paid Schapiro and other managers $35 million in salaries and bonuses in 2008 even though the non profit suffered $567 million in investment losses. The payout to Ms. Schapiro became public when Amerivet Securities Inc. asked that FINRA be investigated for excessive pay to its board members, legal advisers and consultants.  According to the article, Amerivet brought action against FINRA because FINRA paid lavish salaries and bonuses to board members who had failed to provide adequate supervision to uncover Bernie Madoff's Ponzi scheme, or to prevent the failures of Bear Stearns or Lehman Brothers.

Fortunately for Ms. Schapiro, the investigation concluded that she and her fellow officials did not do anything wrong in taking the bonuses since the pay levels of FINRA needed to be comparable with those of brokerage firms, investment banks and insurance companies.  This compensation was necessary since, according to the report, FINRA "competed primarily with the financial services industry for talent."

In Schapiro's new capacity as the chairman of the SEC she earns about $165,300 per year, which is a major pay cut from her 2008 FINRA compensation which included $937,961 in salary, bonuses and incentives worth $1.75 million, and "additional compensation" totaling $565,995.00.  Having taken a major cut in pay herself, she is now prepared to make sure that she gives the rest of the financial services world a pay cut as well.

The bonuses paid by FINRA are symptomatic of what is wrong with the entire financial regulatory system.   There are two sets of rules--one for the chosen and the other for everybody else.  If the bonuses and severance packages are being paid to officers and executives of non-profit regulatory agencies who failed to guard the financial system, no wrongdoing has taken place because these agencies have to compete with Wall Street Firms for talent.  But it is perfectly okay for Schapiro in her new role as SEC chair to impose limits on pay for executives of private firms who have not taken bail out money from the taxpayers to insure that they are not being compensated for risky behaviors.  Schapiro conveniently forgets that one of the ideals of capitalism is that risk determines reward--without risk takers we have no growth and no innovation.

It will be interesting to see what Schapiro defines as the "right types of behavior," since she is dedicated to creating compensation rules that incentivize "good behavior" and punish risk taking.  We won't have that long to find out--if the SEC has its way, April of 2011 will see a whole new set of rules.

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