Restoring American Financial Stability Act of 2009: Federalizing the Compensation Standard

The Financial Stability Act largely seeks to "solve" the compensation problem through process.  It would require listed companies to rely on independent directors and independent consultants.  The Act allows the SEC to impose a stricter definition of "independence."  With respect to financial institutions, however, the Act is much tougher and arguably federalizes the standards for determining compensation. 

The Act does two things.  The least important is that it provides bank regulators with some additional room to penalize banks deemed to be paying excessive compensation short of shutting them down.  The Act allows the appropriate banking regulator to impose higher capital requirements on banks where the agency determines that the insured institution has in place compensation practices that "pose a risk of harm to the depository institution."

Far more significant, however, the Act provides that the relevant agency "shall prohibit" the payment of "executive compensation that is excessive or could lead to material financial loss."  Adoption of this requirement, therefore, will likely result in the federalization of the compensation process, at least for FDIC insured institutions.  Boards will be less concerned about the limits imposed on compensation under state law (which really do not exist) and more concerned about the federal definition of excessive.

The determination of "excessive" compensation should be federalized for all companies, not just those subject to deposit insurance.  Nonetheless, development of a federal standard for financial institutions may well become the norm in other industries.  Moreover, the standard provides the possibility of a contrast.  To the extent that the federal limit slows the crazy upward spiral of executive compensation, it will make the state law approach appear that much more unreasonable and facilitate eventual federal preemption of the entire standard.  

In the meantime, the bill and a summary are posted at the DU Corporate Governance web site.

SEC. 959. COMPENSATION STANDARDS FOR HOLDING COMPANIES OF DEPOSITORY INSTITUTIONS.

The appropriate Federal banking agency, as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813), shall prohibit the payment by a depository institution holding company of executive compensation that is excessive or could lead to material financial loss to the institution controlled by the depository institution holding company, or to the consolidated depository institution holding company.