Are the Wall Street bankers, traders, and brokers really starting to do the right thing when it comes to controlled greed and compensation?  If you ask the poor Wall Street protesters, probably not.  If you ask the Federal Reserve, the answer is for most part “YES!”

The Federal Reserve has released a report that shows significant improvement in oversight of individual risk, incentive, and compensation.  This matters at firms like Citigroup, Inc. (NYSE: C), J.P. Morgan Chase & Co. (NYSE: JPM), Wells Fargo & Co. (NYSE: WFC), Bank of America Corporation (NYSE: BAC), Goldman Sachs Group Inc. (NYSE: GS), Morgan Stanley (NYSE: MS), or any of the other top financial firms.

The top 25 largest financial institutions have shown that over 60% of the pay for senior executives now have their financial incentive on a deferred basis.  The Fed still sees more for room for improvement to avoid incentives that actually put the firms or their capital at risk, but the note is that these financial firms actually went above what was required of them per compensation regulations.  Of those top firms, more than 80% of the pay of the most senior executives has been deferred with added stock restriction periods even after their shares vest.

The 34 page study from the Federal Reserve measured the risk-adjusted incentive plans, the deferred payment methods, and the use of longer performance metrics to base around payouts, and aimed to reduce short-term incentives.

There is a scary, and perhaps even unfair angle to this deferred compensations.  The most common deferred compensation is shares of stock, stock options, or a firm’s earnings or return-on-equity during a deferral period.  The protesters won’t care, but let’s use a basic scenario:

• You are a financial advisor or trader at a TBTF Bank/Broker (take your pick).  You are 57 years old and your deferred pay and your stock options (both tied to company stock in this case) are locked up for three years longer after you “retire” from the firm in a year.  You have $1.8 million in these today.  It is possible to create a collar or a floor with options or derivatives for at least a part of your deferred compensation, but some firms discourage (or worse) the practice and often it may be too expensive.  what if we have a recession (another one) in 2013 or 2014?  What if the states and the federal agencies and counterparties keep suing for things not tied to you at all that were for actions and investments made by others from 2003 to 2008?  The bulk of your nest egg, which you were forced to keep in stock or in financial metrics tied to stock or future earnings.  You have no control over what management does now over what regulations cap the actions and profits of your firm.  What if the stock gets cut in half, or worse?  In many cases, the nest egg is close to being wiped out.

Sure, this was a hypothetical case and the firm name should not matter.  It is not unlike what many described as the deferred compensation plans discussed.  The Europeans have some rules about 60% being tied to the firms’ stocks or the company metrics and the exact methods of deferred compensation vary from firm to firm and often vary from individual to individual.

So, take your anger against wealth or your anger against Wall Street out of the scenario.  Now go back to the lessons of Worldcom and Enron.  Those employees were duped over and over by management to keep buying more company stock.  This wiped innocent workers’ retirements and their cash investment accounts out entirely.  The push from 2002 all the way up until the regulation on financial firms’ compensation was always to encourage employees of a company to diversify away from just investing in the company’s stock.

No one on Main Street will care, but there are too many cases at large financial institutions where this new environment is a double standard.  Imagine you work at one of the Too Big to Fail money-center banks.  Politicians routinely press for the break-up or ask about the possibility of a break-up of the largest banks to reduce systematic risk.  Ben Bernanke said that the authority is more or less already there if needed.  Then what happens to the employees there.  Bankers and brokers and the employees of those companies are probably not thought of well by many, but are these people all bad and did they all contribute to the meltdown?

The regulatory pay covers the big earners of these firms.  They are referred to as senior executives, or employees able to take or influence material risks, or those similarly compensated individuals who can take or influence material risks.

The Fed also admits that this is simply a work in progress and that the full verdict remains unknown.  It noted, “the effectiveness of such practices will not be known until some years of experience have been accumulated. Effectiveness will depend on the attentiveness of members of compensation committees to risk-taking incentives.”

This should only be considered work-in-progress, regardless of what the Fed (and the public) says.

JON C. OGG

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