COMPENSATION
Paycheck Backlash
By Mark Bruno
ichard Fuld never saw it coming. No, not the behemoth bankruptcy filing that sealed the fate of Lehman Brothers in mid-September, but rather the punch to the face he reportedly took—from a subordinate, no less—while running on a treadmill at the company gym.
As urban legend now has it, Mr. Fuld was blindsided by a jacked-up employee within days of being filleted and grilled by hostile members of Congress demanding to know why a chief executive could pocket, by their count, some $480 million in total compensation in the eight years before his company went belly-up.
Lehman disputed that the assault ever took place. But true or false, the story reflects the public fury over mammoth exec-comp packages, particularly those ladled out to leaders of teetering financial institutions. And it’s a major reason why so many lawmakers pushed for provisions to limit payouts to the top executives of any company bailed out by the federal government in the $700 billion rescue package for banks and insurers passed by Congress on Oct. 3.
“The general public is mad as hell at the state we’re in, and they want to take it out on executives who are earning massive amounts of money,” said Steven Barth, a Milwaukee-based partner at law firm Foley & Lardner LLP who focuses on compensation and governance issues. “That will play out well on Capitol Hill, because they can now easily align themselves with Main Street.”
Yet the barons of Wall Street aren’t the only businesspeople in the political crosshairs. Top managers at every publicly traded company can expect lawmakers to push for tighter regulation of corporate pay practices when Congress kicks off a new session next year.
House Financial Services Committee Chairman Barney Frank, D-Mass., promised as much in September, right before Congress passed the Emergency Economic Stabilization Act of 2008. “We do want [compensation limits] to be applied to any company that benefits in any way from this program,” he told CNBC. “We will then be looking at broadening those next year to all public corporations.”
Since pay policies at public companies often serve as benchmarks for private companies, Mr. Frank’s vow suggests that all executives in the United States could be looking at new limits on the tax-deductibility of severance packages and golden parachutes. So-called clawback provisions, which allow companies to recoup executive pay from chief executive officers and chief financial officers, could be expanded to include a broader range of senior-level executives. Deferred-compensation awards, and perhaps even portions of performance-based pay arrangements, could become more tightly regulated as well, since lawmakers went out of their way to specifically address both areas in the bank bailout.
“We’ve clearly been given a template for the changes Washington would like to make,” said Steven Seelig, executive compensation counsel at Arlington, Va.-based consulting firm Watson Wyatt Worldwide.
Golden parachutes may be one of the easiest targets for Congress because there are already laws—see IRS sections 280G and 4999—that address the issue by limiting these executive bye-byes to roughly three times base pay. “It’s on the books already, and it was just revisited in the rescue act,” said Peter Oppermann, a senior executive compensation consultant at Mercer in New York. “With eight- and nine-figure going-away packages being given to failing companies, I’m sure Congress will be tempted to address it again.”
In the rescue package, lawmakers barred financial institutions that sell their ailing assets to the government from awarding any golden parachutes, which typically are payments given to an executive after a merger or any form of change in control. While these packages may not be eliminated completely for every publicly traded company, the limits may be lowered. “Two and a half could become the new three,” predicted Mark Poerio, co-chair of the executive compensation and benefits group in Washington at law firm Paul, Hastings, Janofsky & Walker LLP.
Politicians may also look to expand these limitations to all forms of severance, said Charles Tharp, executive vice president for policy at the Center on Executive Compensation, an advocacy group in Washington. “If it’s relevant to regulate in the event of a change of control,” he explained, “then Congress may deem it necessary to limit payments made to executives when they’re terminated as well. If you’re attempting to prevent pay for failure, it may be a logical target.”
That’s why clawbacks, which allow corporate boards to go after a CEO’s or CFO’s bonus or incentive pay when a company restates its financials, are considered especially tempting for lawmakers. Most large corporations have already adopted clawback provisions, but financial institutions that get bailed out are required by the new law to enact such a policy—and apply it to a wider number of corporate officers.
“If there turns out to be an inaccuracy in a company’s financial results that inflated pay, the top officers shouldn’t be the only ones that can be held accountable,” said Don Lindner, compensation expert at Scottsdale, Ariz.-based WorldatWork, a global human resources association focused on compensation and benefits. “It wouldn’t be unreasonable to expand that to include anyone in a senior management position, regardless of the industry you’re in.”
Mr. Tharp noted that legislators inserted into the bailout package a fresh twist on another piece of existing compensation law—IRS code 162(m), which puts a $1 million limit on the amount of pay a company can deduct for each of its top officers. (The limit does not include, however, pay that is deemed to be performance-based, such as stock options.)
Congress last month lowered this deductibility on pay to $500,000 for financial services executives whose companies buy into the federal bailout—and, interestingly, there are no exemptions for performance-based pay either. Lawmakers also moved to apply the $500,000 ceiling on annual deferred-compensation awards, which were not previously subject to any restrictions.
Bailed-out lenders and insurers can still choose to exceed the new limits; they’ll just have to pay for it. “In this case,” Watson Wyatt’s Mr. Seelig explained, “it’s a punitive decision to raise revenue for the federal government.”
Congress is expected now to broaden these regulations and apply them to other corporations, too. Whether legislators will lower the $1 million limit on tax-deductible compensation, for one, is anyone’s guess, but “everything is on the table at the moment,” said John O’Neill Jr., a partner at Washington-based law firm Venable LLP and a former policy director under one-time Senate Republican Whip Trent Lott of Mississippi.
It’s possible a $1 million limit on deferred compensation could be pushed through, Mr. O’Neill said, since it already has been proposed in recent years. The Small Business and Work Opportunity Tax Act of 2007, for instance, aimed to cap such deferrals at $1 million.
“Everybody else has deferred comp capped, whether it’s your 401(k) or thrift savings plan,” Sen. Max Baucus of Montana, chairman of the Senate Finance Committee, argued last year. “If deferred-compensation limits apply to most Americans, they also ought to apply to top executives—and frankly, $1 million, I think, is sufficiently generous.”
As with any congressional intervention on private-sector pay practices, “the law of unintended consequences almost always applies,” Mr. O’Neill warned.
Consider what happened 15 years ago, when Congress enacted the $1 million cap to put the squeeze on what was at the time considered to be grossly excessive CEO pay. Soon enough, Mr. O’Neill recalled, companies began padding their top officers’ compensation packages with stock options—a practice that many companies began abusing several years later during the dotcom era.
“You never can tell how these things will play out over time,” he said. “But in fixing problems, you can often create new ones.”
The kinds of problems no one may ever see coming.
—Crain's Benefits Outlook Online, November 2008
Mark Bruno is a reporter for
Financial
Week. To comment, e-mail
editors@workforce.com.
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