Executive Pay Scrutiny Spreads

While the American Recovery and Reinvestment Act signed by President Obama on Feb. 17 aims in part to appease the furor over excessive pay for the financial services executives who engulfed the world in economic turmoil, the $787 billion package also serves as a warning to all companies, especially their board compensation committees, to re-evaluate their own executive pay structures. "They would be smart to behave like they, too, are under the gun," says Alexander Cwirko-Godycki, research manager at Equilar Inc., a Redwood Shore, Calif.-based compensation research firm.

"Absolutely obscene," is how David O'Brien, former director of treasury operations at Fidelity Investments, describes the bonus bonanza in financial services. "These firms have senior managers making tens of millions of dollars who failed miserably in doing their jobs. This was supposed to be `pay for performance.' These people drove their companies into the abyss. I see the `pay,' but where was the `performance?'" says O'Brien, now president of treasury management consultancy Enlightening Enterprises.

The new legislation imposes stiff restrictions on firms that have deposited federal TARP (the $700 billion Troubled Asset Relief Program passed in September) dollars, prohibiting cash bonuses and incentive compensation (other than restricted stock) for the five most senior officers and the 20 highest-paid executives. Until the banks and insurers like American International Group (AIG) have repaid all the money owed, they are barred from awarding bonuses exceeding one-third of the annual cash compensation of the 25 top executives, a group that would likely include CFOs, treasurers and other finance professionals.

While the new regulations do not cap salaries at $500,000 for TARP recipients, as originally sought by the Treasury Department, President Obama continues to hold firm to the idea for troubled firms seeking federal assistance down the line. "Nobody knows if the $500,000 cap will become law," says Paul Ritter, head of Kramer Levin's executive compensation practice. "Enough people are saying that the big loophole is that there is no limit on salaries, and that one may indeed be imposed at some future date."

Congress also is considering extending the new legislation to apply to all companies and not just TARP recipients, a stated goal of House Financial Services Committee Chairman Barney Frank, who cited "deeply rooted anger on the part of the average American" about excessive executive pay. Frank has an ally in U.S. Treasury Secretary Timothy Geithner, who stated that he would consider "extending at least some of the TARP provisions, and features of the $500,000 cap, to U.S. companies generally."

The new rules also tighten up a component of Sarbanes-Oxley--so-called clawback provisions giving companies recourse to recoup compensation from executives in situations where a significant restatement of financial results is linked to acts of fraud or intentional misconduct. Under the new law the provisions will apply to the 25 highest paid executives of a company receiving federal assistance. A performance-based bonus to these executives that turns out to have been based on fraudulent financial statements must be returned. "The message to board compensation committees is clear--do not incentivize executives to take unreasonable, unnecessary or excessive risks," says Ken Kopelman, head of the corporate governance practice at Kramer Levin Naftalis and Frankel, a New York-based law firm with a significant executive compensation practice.

O'Brien has a slightly different take. "Pay that equals true quality performance and not risky behavior will put companies back in touch with reality," he says. Cwirko-Godycki concurs, offering this caveat: "Now is the time to put all your compensation decisions under the microscope."

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