Good afternoon. It is great to be with all of you here today. I appreciate the opportunity to be a part of this event and would like to extend my sincere thanks to Americans for Financial Reform for the invitation. I am fortunate to have a long history of working with AFR and the other sponsors of today’s event: Public Citizen, Institute for Policy Studies, AFL-CIO, AFSCME, and the Committee for Better Banks, spanning my time as a staffer for Chairman Barney Frank on the Financial Services Committee, and later in Speaker Pelosi’s office – and especially during the 2008 financial crisis.
Today, in my current role as a Commissioner at the Securities & Exchange Commission, I’d like to offer my personal thoughts on an important provision of the Dodd-Frank Act that unfortunately, remains unfinished business.
Section 956 of that landmark legislation requires federal financial regulators, including the SEC, to promulgate a joint rulemaking prohibiting any type of incentive-based compensation arrangement that encourages inappropriate risks by a covered financial institution. This includes compensation structures that (1) provide officers, directors, and employees with excessive compensation, fees, or benefits, or (2) could lead to material financial losses.
One of the criticisms we sometimes hear is that our rulemakings represent a solution in search of a problem. That is anything but the case with this rule. It has been well documented that in the lead up to the financial crisis, pay structures often encouraged big bets that maximized short-term profits but ignored bigger longer-term risks that threatened to take down our entire financial system.
And when the financial crisis hit, working families paid the price, with trillions of dollars of losses in hard-earned wealth in just a few short years. In fact, between 2007 and 2011, one fourth of American families lost at least 75 percent of their wealth, and more than half of all families lost at least 25 percent of their wealth. Unemployment peaked at 10 percent, and home values dropped by an average of 20 percent. Families’ hard-earned nest eggs, their kids’ college savings, and their rainy-day fund for medical and other emergencies disappeared almost overnight. Millions experienced home foreclosures and taxpayers funded massive bailouts.
Former SEC Chairman Mary Schapiro told the Financial Crisis Inquiry Commission that: “Many major financial institutions created asymmetric compensation packages that paid employees enormous sums for short-term success, even if these same decisions result in significant long-term losses or failure for investors and taxpayers.”
The bipartisan Senate subcommittee investigating the origins of the financial crisis found that lenders created compensation incentives that valued speed and volume over quality when it came to originating loans.
As an illustration of just how broken the system had become, even the former chief risk officer for home loans at the now defunct lender Washington Mutual had a 2007 performance evaluation that placed the growth of home loans as her number one performance goal for the year, a goal that included specific sales targets.
And in April 2009, the predecessor to the Financial Stability Board released its Principles for Sound Compensation Practices, which noted that “Multiple surveys find that over 80 percent of market participants believe that compensation practices played a role in promoting the accumulation of risks that led to the current crisis.”
Although fifteen years have elapsed since these events, the lessons they offer do not recede with the passage of time. If they do, history shows that we will be doomed to see a repeat of the same problems again.
Now some have argued that, even if there was a need for this rule at one point, it’s no longer needed today.
But this is not how Congressional mandates work. Of 330 rulemaking provisions in the Dodd-Frank Act, only 148 were mandatory. And of those, only 22 had a deadline of less than a year after enactment. Section 956 was one of them.
And just because the SEC has implemented other mandatory Dodd-Frank rulemakings over the years, including reforms to make compensation committees more independent, allowing shareholders to have their voice heard through say-on-pay votes, clawing back erroneously awarded compensation, and requiring companies to tell shareholders about the relationship between pay and performance, that doesn’t mean we don’t need this one.
Different rules have different functions. Some are about transparency and disclosure, others about good governance hygiene, or holding bad actors accountable. And while supervising financial institutions and conducting exams are essential, it helps to have clear bright line rules, and not just principles-based concepts.
Section 956 is about ensuring sound compensation practices that ensure there is sensitivity to downside risks. It will benefit investors and contribute to the financial stability of our very interconnected system.
And to dispel some myths about what this provision isn’t about: it isn’t about naming-and-shaming executives or going after small community institutions. It’s not about the government trying to set executive pay, and it’s not about rank-and-file employees.
Finally, the regional banking crisis our country experienced last year, with the failures of Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank, again illustrates why this rule is so essential.
The Federal Reserve Board’s April 2023 report examining the factors that contributed to SVB’s failure found that its compensation packages for senior management were tied to short-term earnings and did not include any risk metrics, which may have contributed to an excessive focus on growth and short-term profitability at the expense of effective risk management. We’ve seen this movie before and I commend our banking regulators and the Treasury Department for moving swiftly to contain the damage and avoid a wider crisis of confidence throughout the sector.
With over thirteen years past the mandatory deadline set by Congress, this rulemaking is long overdue but encouraging to see on our agency’s short-term agenda. This is a joint rulemaking with a number of our sister agencies so it will take a lot of cooperation and coordination, but I am hopeful we can get there.
One of the three pillars of the SEC’s mission is to protect investors, and implementing this rule will do just that. It will also contribute to reducing the excessive risk-taking that could prevent, or reduce the adverse impact of, a future financial crisis. Thank you again for the opportunity to share a few thoughts with you today. I look forward to learning from each of the panelists and from the ensuing discussion.
