Fed Urges Banks Including Goldman Sachs to Control Their Compensation Risk

By James Sterngold and Scott Lanman - Oct 5, 2011 11:48 PM GMT+0700

The Federal Reserve urged Goldman Sachs Group Inc. (GS), Deutsche Bank AG, Citigroup Inc. (C) and 22 other large banks to take additional measures to control employee-pay practices that can put an entire company at risk.

All the banks have made progress based on guidance from regulators, the Fed said today in Washington in a report based on appraisals that began in late 2009. “Yet every firm also needs to do more” in reforming compensation practices that “were a contributing factor to the financial crisis,” policy makers said.

The report didn’t single out any individual company. Most of the banks should do more to account for the “full range of risks” in employee pay, and some are still trying to identify mid- and lower-level workers whose compensation arrangements could generate excessive risks, the Fed said.

A June 2010 statement from the Fed and other U.S. agencies said many big banks were “deficient” in curbing excessive risk-taking that helped fuel the financial panic that began in 2007. The central bank didn’t repeat that word in today’s report.

UBS AG, Switzerland’s biggest bank, last month discovered a $2.3 billion loss from unauthorized trading and New York-based Goldman Sachs agreed in July 2010 to pay $550 million in a settlement after the Securities and Exchange Commission claimed the bank misled investors about the way its investment bankers put together a subprime mortgage security.

Vesting Policies

“Banking organizations in the horizontal review have made progress in improving deferral practices, but many still have work to do on performance conditions for vesting,” the Fed said in the report.

The firms in the Fed review also included Charlotte, North Carolina-based Bank of America Corp. (BAC), New York’s JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS), as well as the U.S. operations of Barclays Plc, HSBC Holdings Plc and UBS.

The report focused on several methods to control excessive compensation and to “promote safety and soundness,” including deferring pay for executives so that eventual cash payouts are based on longer term results, and reducing pay of company officials if they produce profits by creating large risks for their firms.

More than 60 percent of the incentive pay of senior executives at the 25 banks reviewed was deferred on average, and some had more than 80 percent deferred, the Fed said.

‘Imprudent Risks’

Prior to the credit crisis, firms that deferred some pay typically didn’t cut the awards if there were ultimately bad outcomes, according to the report. “Some employees were provided incentives to take imprudent risks,” the Fed said. Now, the deferred pay, typically for three to five years, can be reduced later if there are poor results.

Most of the firms also have claw-back provisions on pay if officials engage in malfeasance or if financial results must be restated, according to the report.

The Fed also noted that, in a change from past practices, risk-management employees are involved in designing compensation arrangements.

“Yet every firm needs to do more,” the Fed said. “As oversight of incentive compensation moves into the regular supervisory process, the Federal Reserve will continue to work to ensure progress continues.”

To contact the reporters on this story: James Sterngold in New York at jsterngold2@bloomberg.net; Scott Lanman in Washington at slanman@bloomberg.net.

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net