The fervor surrounding executive compensation heated up once again, as news surfaced that the financial firms that were so instrumental in the economic meltdown and continuing recession shelled out record levels of pay in 2009 and resumed the long-standing tradition of awarding lucrative bonuses to their executives. Lawmakers and taxpayers were particularly disturbed by the banks' largesse as it comes only a year after the same banks required $700 billion in government bailouts to stay afloat and while the rest of economy still struggles toward recovery.
According to a Wall Street Journal analysis of 38 major U.S. banks and securities firms, these companies were expected to report $449.6 billion in revenue in 2009, up from $306.2 billion in 2008 and $359.7 billion in 2007. Compensation for their employees was anticipated to reach $145.8 billion dollars in 2009, an 18% increase from 2008's $123.4 billion and a 6% increase from 2007's $137.2 billion. Not only that, but according to Equilar, an executive compensation research firm, 25% of the companies that reduced executive salaries in 2008 reinstated or increased those salaries in 2009.
While financial firms have insisted that lavish salaries and bonuses are necessary to entice valuable personnel to stay with their companies in a time of crisis, many critics feel that they are not only so out of proportion with what the rest of the world makes but that they are simply rewarding incompetence-and using taxpayer money to do it.
The fact that some of these institutions have not yet reimbursed the government for $117 billion in TARP money that they received has raised the ire of President Obama, who has stated that he is determined to see that every dollar spent on bailouts is repaid one way or another.
"My determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at the very firms who owe their continued existence to the American people who have not been made whole, and who continue to face real hardship in this recession," said Obama.
The President proposed a so-called "financial responsibility fee" in the form of a tax on financial firms with assets of more than $50 billion, regardless of whether they accepted bailout money, that would help recoup unpaid bailout funds and encourage fiscally responsible behavior in the future. Other lawmakers in Congress have proposed legislation that would give shareholders a say on how executives are compensated. And at the annual World Economic Forum in Davos, Switzerland, in January, Philip Jennings, general secretary of the UNI Global Union, an international federation of trade unions, proposed that executive pay be capped at 20 times that of the average worker. Jennings pointed to the huge disparity between the pay of executives and the average employee-according to a study by the Institute for Policy Studies, in 2008, top executives in the United States took home salaries that were 319 times greater than the average worker. Meanwhile, the UK has implemented a new rule that would require banks to pay a 50% tax on any bonus money above a certain threshold.
The anger over the compensation at financial firms has not been entirely ignored. Many banks and financial firms have instituted clawback provisions that would allow them to take back pay from employees that do not perform to expectations or that have engaged in misconduct. Almost 73% of publicly traded Fortune 100 companies had such provisions in place in 2009 compared to just 17.6% in 2006, according to Equilar. Many firms have also cut pay, including Goldman Sachs, Morgan Stanley and JPMorgan Chase, which collectively set aside almost $5 billion less for pay than they did in 2007. At Goldman, in particular, compensation was set at its lowest percentage of revenue since 1999.
Bonuses have also been adjusted or cut back. Barclays executives planned to defer up to 100% of their bonuses for up to three years while employees in AIG's financial products division agreed to forgo 10% of their retention bonuses in return for early payment. The company, which was obligated to pay nearly $200 million in bonuses to its financial products staff by March 15, was also looking to recoup $26 million of 2008 bonus money that employees had pledged to return after the issue first surfaced in March of last year.
But not all bonuses are created equal. Although UBS CEO Oswald Gruebel has said he will not receive a bonus this year, his employees will. On the other hand, while Goldman Sachs capped the salary and bonuses of its London partners at £1 million, initial reports indicated that CEO Lloyd Blankfein could be receiving a staggering $100 million bonus. Common sense, or at least an acknowledgement of populist pressure and the spectre of possible legislative action, prevailed, however. Blankfein was awarded "only" $9 million in deferred stock.
Morgan O'Rourke is editor in chief of Risk Management.
D&O Insurance and Executive Pay
by Neil B. Posner and Daniel J. Struck
As executive compensation issues draw increased scrutiny and place executives and their companies under greater risk, they are becoming more important factors in determining corporate strategies for D&O insurance coverage. One of the most challenging duties may be trying to identify and assess these new exposures, which may be further triggered by new legal or regulatory obligations, changes in accounting rules, market pressures, shareholder concerns and demands imposed by both lenders and investors.
Already, new compensation laws have led to increased D&O insurance premiums for companies in Germany. Meanwhile, in the United States, recipients of Trouble Asset Relief Program (TARP) bailout funds are exposed to limitations on executive compensation and the possible return of previously awarded compensation. In addition, bailout-imposed restrictions on executive pay may force companies to rewrite pre-existing compensation agreements or create difficult choices concerning employee retention. Certainly, this is why financial businesses that are experiencing successful results now are scrambling to repay bailout funds. In some segments, the compensation pressures created by government ownership and oversight may be a reality for some time to come.
Looking beyond legislative or regulatory uncertainty, many publicly traded companies have a very real concern that following compensation "best practices" (such as creating a special compensation committee of the board composed of outside directors) may no longer be adequate to ward off shareholder claims. Shareholder pressures-and in some cases, highly charged shareholder activism-are increasing the demand for changes in compensation practices.
As a result, several high-profile companies have gone through considerable public hand-wringing about how they will handle executive pay going forward. These kinds of scenarios are likely to continue to increase, especially if the economy does not improve significantly-and quickly.
Even those companies that are neither subject to TARP nor publicly traded might face provisions imposed by lenders, venture capital providers or strategic investors that result in constricted compensation structures. In closely held corporations, particularly in a difficult economic environment, compensation-related disputes may arise between majority and minority shareholders, or between active shareholders and those who are more passively engaged.
For small businesses and S corporations, there is also considerable fear that any number of potential governmental, tax or regulatory obligations will pose a direct threat to the income of owners and proprietors.
Given the levels of attention public and government officials pay to executive compensation, we should also expect compensation and the way it is determined to become grist for significant increases in future litigation and other enforcement actions. Potential scenarios could include fines, penalties, shareholder or creditor lawsuits, lawsuits brought on behalf of employee-pension or stock-ownership plans, whistleblower claims, lawsuits brought by employees whose compensation packages have changed, and lawsuits brought by former employees whose stock has lost value.
In light of the current regulatory and economic environment, businesses should expand their thinking about D&O insurance. The uncertainty surrounding executive compensation provides an opportunity to look at D&O insurance as a corporate asset that should be actively managed and structured to respond to potential risks.
But D&O policy forms certainly were not written with the current changing climate in mind. This means that: (1) it may not be immediately clear-cut whether a claim involving executive compensation issues is covered, (2) a claim's viability may well hinge on varying or conflicting legal interpretations and applications of policy terms, and (3) if there can be a dispute about whether a particular claim or category of claims is covered, chances are there will be a dispute.
Instead of waiting for compensation-related claims to develop and then turning to your existing policies in the hope that they are covered, corporate policyholders should take a far more active role in understanding how their current insurance policies are likely to perform in the present environment, and what options should be considered upon renewal. Even now, it is foreseeable that questions being raised about current practices could result in litigation and D&O policy vulnerabilities.
Neil B. Posner is chair of the policyholders' insurance coverage group at Chicago-based law firm Much Shelist. Daniel J. Struck is a principal in Much Shelist's litigation and dispute resolution group and its policyholders' insurance coverage group.
