The scandals were shocking, but at first, they seemed to impact just a few companies. The name Enron became familiar to everyone. The next wave of meltdowns took down some large investment banks, such as Merrill Lynch and Bear Stearns, and more people were affected.
The public outcry over how executives at these companies were paid grew louder, and people began to expect changes in corporate pay practices for executives. Politicians, ever eager to appease their constituents, complied. Surely the situation was limited to faceless institutions located on Wall Street.
Not so. In recent months, public ire over the pay of anyone connected with investing money has reached all the way to some local civil servants. Portfolio managers who work in the less-glamorous environs of Texas and Ohio are also feeling the sting. Charged with investing the retirement funds of their state’s employees, these investment professionals have exchanged sky-high compensation packages for job security and more time with their families. But the anger over the conduct of a few has reached them, too. Some experts are not surprised.
“Much of the public focus on compensation appropriately involves the largest investment banks and so-called universal banks, which combine investment banking with traditional banking activities,” says John Benson, CEO of eFinancialCareers. But the increased scrutiny—not to mention public outrage—is having other, farther-reaching effects on everyone connected with investing.
In an announcement made in February, the Teacher Retirement System of Texas (TRS) said that its chief investment officer had offered to forego the $167,835 bonus to which he was contractually entitled for 2008. “And the Retirement System trustees also decided to withhold all remaining performance pay for investment staff until the fund experiences a year of positive returns,” Benson explains. These actions were a result of public criticism from Texas state senators, he believes.
Should Bonuses Be Tied To Absolute Returns?
One could legitimately ask why a fund manager should receive a bonus in such a dismal year. The TRS experienced a 27% drop in its market value in 2008 (which was actually better than the 40% loss suffered in global equity markets during the same period). So shouldn’t the fund manager’s bonus be directly tied to the fund’s absolute returns?
Jon Jacobs, also of eFinancialCareers.com, says that while the public at large believes it should be so, setting up a compensation plan in this way could actually create fiduciary problems. Instead of sticking to their long-term investment plan, Jacobs believes that tying compensation to absolute fund returns could encourage fund managers to deviate from those plans, as they chase higher—and more risky—returns.
Incentive Comp Changes Impact Employment
The TRS implemented a performance incentive pay plan in 2006 in an effort to attract the highest quality investment professionals to help them with their retirement funds. Other companies and entities use the same strategy. The uproar about executive compensation on Wall Street may be impacting the attraction and retention of portfolio managers in a couple of ways, according to Benson.
Bank management teams, he says, are keeping an eye focused on the public debate over compensation practices. “Although the public ire has an impact in reshaping compensation, we don’t see a broad impact on employment on Wall Street, at least.
“We asked financial professionals, ‘would you avoid working at a TARP (Troubled Asset Relief Program—the government’s 2008 $700 billion bailout) bank due to the compensation restrictions?’ Well, 78% said ‘no.’
“And yet the firm’s perspective may be different. One of the reasons Goldman Sachs is keen to pay back TARP is so that it can be in control of its own compensation policy. In the U.K, RBS [Royal Bank of Scotland] (now 70% owned by the state) is also restricted on compensation, and its CEO has said that it is making it difficult to attract and retain staff for its global markets division.”
The good news? The demand for compliance professionals is up on Wall Street, Benson says. “In fact, compliance was the number one searched-for experience in the eFinancialCareers résumé database in the first quarter,” he said.
Investment Banks Changing Comp Practices
Compensation practices are changing because of the global financial crisis and the scandals that may have contributed to it, especially at investment banks. Benson says, “For the short term, the top global investment banks slashed year-end incentive pay for 2008 by 40% to 50% on average, with bigger declines for their highest ranks. Most global bank CEOs were not awarded a year-end bonus.”
The banks receiving government aid, which includes all major U.S. institutions and many of Europe’s biggest, are all rethinking their compensation programs, Benson says. Many are introducing “clawbacks,” which allow the firm to recoup pay when an individual is found to have acted in a manner detrimental to the firm. Morgan Stanley, a global financial services firm, announced late last year a clawback provision that would allow the company to reclaim the prior year’s bonus from an individual who caused them to need to restate financial results of the firm or who otherwise caused damage to the company’s reputation.
Ohio Public Employees Take Action
Texas is not alone in its attempt to duck from the public scrutiny over the pay of its investment professionals. In Ohio, the State Teachers Retirement Board also took action to limit incentive pay. “The Board suspended performance incentives for investment staff as of February 1, freezing any bonus accruals for the remaining 5 months of the current fiscal year,” says Benson. “It also froze headcount and salaries and lengthened the standard workweek from 37.5 to 40 hours.” The Board’s decision to more closely tie future bonuses to absolute returns on the investment funds again raises fiduciary concerns, according to Benson.
Long term, the impact of all this scrutiny may actually chase more public sector fund managers away from civil service and into private sector investing. Jacobs believes that politicians are targeting and making examples of the public sector investment managers in an effort to win the minds and hearts of angry voters who don’t understand the reality of the financial markets. Some boards will conclude that keeping the investment management in-house is more trouble than it’s worth, and will move their management to an investment bank, he says, where they would end up paying far more in fees than they do in compensation.