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Will Congress Make Failed Bank Execs Pay?

The notion of empowering regulators to claw back failed banks’ executive compensation is gaining traction on Capitol Hill.

“I've been in and out of Wall Street since 1949, and I’ve never seen the type of animosity between government and Wall Street.”

Those words were spoken by former Federal Reserve Chair Alan Greenspan in August 2010 on NBC’s “Meet the Press” a couple of years after the the 2008 financial crisis. President Barack Obama had signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law just 10 days earlier, and Americans were still quite angry with the bankers and investors they believed had caused the crisis. While Dodd-Frank included significant new rules for bank governance going forward, there was little in the way of personal punishment for the people who ran the companies that collapsed. Progressive activists have become fond of saying that not enough people went to jail for a crisis that cost hundreds of thousands of Americans their jobs and diminished the household equity of millions more – an idea echoed by quite a few Democratic lawmakers to this day.

When three banks collapsed earlier this year, we heard the same calls for retribution. One idea lawmakers currently are debating is whether to claw back executive compensation for the leaders of failed financial institutions. We have seen similar ideas floated during past economic crises. Did they go anywhere? And will the current proposals become law?

Let’s take a look.

Bipartisan Support for Taking Back Executive Compensation

This week, the U.S. Senate Committee on Banking, Housing, and Urban Affairs debated a bipartisan bill that would allow regulators to claw back compensation for executives at failed financial institutions. The bill, called the Recovering Executive Compensation Obtained from Unaccountable Practices (RECOUP) Act, was written by Banking Committee Chair Sherrod Brown (D-Ohio) and Ranking Member Tim Scott (R-S.C.) in response to the fact that executives at both Silicon Valley Bank and First Republic Bank got to keep their compensation even as the Federal Deposit Insurance Corporation (FDIC) fund — and ultimately, the rest of the banking sector — bore responsibility for protecting depositors.

Some lawmakers prefer more aggressive approaches, and these proposals also enjoy support from both Republicans and Democrats. Three months ago, Sen. Elizabeth Warren (D-Mass.) released the Failed Bank Executives Clawback Act. Five GOP senators — Mike Braun (R-Ind.), Katie Britt (R-Ala.), Kevin Cramer (R-N.D.), Josh Hawley (R-Mo.), and J.D. Vance (R-Ohio) — have signed on as cosponsors. Sen. Warren has said her bill is “the toughest proposal in Congress to ensure failed executives who blow up their banks don’t walk off with huge bonuses.”

The key difference between the two pieces of legislation is that Sen. Warren’s bill would require the FDIC to claw back executive compensation over a three-year period prior to a bank failure. The Brown-Scott makes claw backs discretionary.

President Joe Biden clearly wants lawmakers to do something. When Silicon Valley Bank collapsed back in March, President Biden said, “I’m firmly committed to accountability for those responsible for this mess. … When banks fail due to mismanagement and excessive risk taking, it should be easier for regulators to claw back compensation from executives, to impose civil penalties, and to ban executives from working in the banking industry again. Congress must act to impose tougher penalties for senior bank executives whose mismanagement contributed to their institutions failing.”

Clearly both clawback bills have momentum, but we have seen similar proposals before. How did they fare?

The Origin Executive Compensation Clawbacks

As noted in a 2021 Harvard Business Review column, the idea of “clawing back” executive pay for leaders of failed financial institutions debuted during congressional debate on the passage of the Sarbanes-Oxley (SOX) Act in 2002.

In fact, the clawback idea made it into the final version of that bill rather easily.

According to lawyers at Willkie, Farr & Gallagher, LLP, there was little discussion of the provision and it was adopted as originally drafted by the Senate. The conference committee that hammered out differences between the House and Senate versions of SOX made “no substantive comment” on the clawback provision either. So what did this provision do? Section 304 of SOX allows the U.S. Securities and Exchange Commission (SEC) “to order the claw back of bonuses and incentive-based compensation earned by a CEO or Chief Financial Officer in the year after a company filed a financial statement that the company is required to resubmit due to misconduct.

According to the law firm Holland & Knight, in the first several years after SOX’s enactment, the SEC did not use Section 304 that much. In fact, its first Section 304 action did not come until 2007, a full five years after the provision was signed into law. While enforcement increased during the Obama administration, Holland & Knight explained, “under prior SEC Chairman Jay Clayton, the SEC utilized the provision far less, bringing only a dozen SOX Section 304 claims and pursuing only one standalone claim during his three-plus years at the helm.” Current SEC Chair Gary Gensler has been far more willing to leverage Section 304, Holland & Knight said.

While 2002 was the first time Congress considered a clawback provision, it was not the last.

Dodd-Frank and Executive Compensation Clawbacks

The Dodd-Frank Wall Street Reform and Consumer Protection Act also contained an executive compensation clawback provision. It took until 2022 for the SEC to finalize the regulation, however, so regulators have yet to utilize it.

As the law firm Davis Polk explained, once fully implemented, the Dodd-Frank clawback provision will require any incentive compensation, including cash and equity compensation, paid to any current or former executive officer to be subject to recoupment if:

  • The incentive compensation was calculated based on financial statements that were required to be restated due to material noncompliance with financial reporting requirements without regard to any fault or misconduct; and

  • That noncompliance resulted in overpayment of the incentive compensation within the three fiscal years preceding the date the restatement was required.

This policy should, by sheer coincidence, go into effect this August.

Do American Support Executive Compensation Clawbacks?

While we could not find public polling on whether Americans support efforts to claw back executive compensation for failed institutions, we do know that, in general, Americans think corporate executives earn too much. (That sentiment could be because executive pay has increased 1,480 percent since 1978.)

Specifically, according to a poll by the nonprofit organization Just Capital taken in early 2022, 81 percent of Democrats and 71 percent of Republicans said the CEOs of the largest U.S. companies were paid “too much.” Those numbers have risen over the past few years, particularly among GOP voters. A HuffPost/YouGov survey fielded in 2014 found 79 percent of Democrats, 61 percent of independents, and 58 percent of Republicans thought executives were paid too highly.

We also know that, in general, Americans distrust large corporations generally and those on Wall Street specifically. According to polling by Morning Consult, only 35 percent of Republicans and 44 percent of Democrats say they have “some” or “a lot of” trust in Wall Street. (If you did a double take after reading those numbers, know we did as well. While Democratic lawmakers like Sen. Warren are some of Wall Street’s toughest critics on Capitol Hill, Democratic voters actually have better views of Wall Street than do Republican voters.) At the same time, Gallup has found overall trust in banks by U.S. voters fell from 33 percent in 2021 to 27 percent in 2022. Americans have more trust in public schools and the health care system.

When it comes to the question of whether lawmakers should intervene to limit pay, even for executives who have never been accused of wrongdoing, the picture is mixed, however. A 2018 Gallup poll found 48 percent of Americans opposed the idea of federal rules to limit pay while 47 percent supported the idea. Those findings are similar to what researchers found a few years earlier. That 2016 poll, which was fielded by Rock Center for Corporate Governance at Stanford University, found 49 percent of respondents said the federal government should change current CEO pay practices; 35 percent said they should not. (The rest had no opinion.)

Stanford researchers also found public opinion varied widely regarding whether executives should earn more if their company does well. When given a hypothetical situation in which a company’s value rose by $100 million over a single year, the median respondent said the CEO should receive only $500,000 in compensation — a number that is, of course, far lower than what top U.S. CEOs (especially those in banking) typically earn. Researchers found responses did not vary much by party.

“This gets to the heart of the issue of ‘pay for performance,’” Nick Donatiello, a lecturer in Corporate Governance at Stanford Graduate School of Business, said. “Either the public is not sold on the idea that CEOs should share in value creation to the extent that they do. Or they do not believe that CEOs play an important role in value creation.”

If Americans believe CEOs are overpaid when their companies do well, are Americans likely to support provisions to take away pay when executives do bad things?

That remains to be seen. But it may not matter. Not only does current clawback legislation have bipartisan support on Capitol Hill, there is precedent for Congress to impose these type of rules, steeped in financial crises of yesteryear.

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