Hearing Of The House Financial Services Committee - Compensation Structure And Systemic Risk

Statement

Chaired By: Rep. Barney Frank

Witnesses: Panel I Gene Sperling, Counselor To The Secretary Of The Treasury; Scott Alvarez, General Counsel, Board Of Governors Of The Federal Reserve System; Brain Breheny, Deputy Director Of Coporate Finance Securities And Exchange Commission Panel II Lucien Bebchuk, Professor Of Law, Economics And Finance, And Director Of The Program On Corporate Governance, Harvard Law School; Niel Minnow, Editor And Founder, The Corporate Library, Lynn Turner, Former Chief Accountant, Securities And Exchange Commission Kevin Murphy, TREFFTZS Chair In Finance, Professor Of Business And Law And Professor Of Economics, University Of Southern California J.W. Verret, Assistant Professor, George Mason University

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REP. FRANK: (Sounds gavel.) The hearing will come to order. I am told that the ranking Republican is on his way, so we will begin. We are going to have 30 minutes of opening statements, by agreement between the two sides, and I will begin.

First I want to make a very important distinction that doesn't always get made. We are not here today talking about the pay restrictions that apply to recipients of TARP money. There was a separate set of considerations there. We are talking about entities which received capital infusions from the federal government.

This hearing today is looking forward as to whether or not there should be bills enacted that deal with compensation without regard to whether or not people have taken TARP money going forward.

I believe that it is now clear -- and I am reinforcing that by a number of authorities, Paul Volcker, for example, Chairman Bernanke, people in the British Financial Services Authority -- that the problem with compensation is that it has encouraged excessive risk-taking.

That is, once we leave the area of the recipients of TARP money, it is not any part of my concern as to the dollar amounts that were given, from the governmental standpoint. We are not talking here about amounts; we are talking about the structure of compensation.

And I believe that the structure of compensation has been flawed. Namely, we have had a system of compensation for top decision-makers in which they are very well rewarded if they take a risk that pays off, but suffer no penalty if they take a risk that costs the company money.

Now, risk is a very important part of this business and we are not trying to discourage people from taking risks. That's not the government's job. But it should not be a system in which risk is artificially encouraged, in which excessive risk-taking takes place.

Now, I said, and I should correct myself before someone else does, that we weren't talking about dollar amounts. We are, in one sense. I do think there is a problem with the overall compensation, but it's not one the government should try to solve in any specific way.

What we do instead here is to borrow from our English neighbors and competitors -- because people say you can have a competitive disadvantage -- the system known as say on pay, in which shareholders are empowered to vote.

A number of my friends are great supporters of shareholder democracy until we try to implement it and say that the shareholders, the owners of the company, should vote. No, shareholders should not be running a company day to day. That's why you have a board of directors. But I think the evidence is overwhelming, as is the logic.

The relationship between boards of directors and CEOs is, of necessity, a fairly intimate, ongoing one. They have selected each other. They work together. It simply doesn't work to say that in one or two days a year, this group that works so closely together will now assume the arm's length position of labor and management and bargain with each other as if there was that independence.

Therefore, this is an exception to the normal rule, it seems to me, where shareholders ought to have a role. Board of directors and CEOs are not going to be able to do that, I think, entirely by themselves. Say on pay empowers the shareholders, and that's where any questions about amount would come in.

But what we should do now is deal with the structure, which should diminish the extent to which people get these incentives. I must say, I am somewhat puzzled when some of the most influential, highly paid people in this country, who represent very important institutions, come to me and say they need these bonuses to align their interests with those of the company.

Why the CEO of a major bank or investment firm does not already consider his or her interests aligned with the company is a strange one. They are apparently implicitly pleading to some character flaw that says, unlike the rest of us, the need to be specially incentivized to treat their employer's interests fairly.

Most of us in this society are able to get along without that. That's up to them and their shareholders, but it should not be done in a way that incentivizes too much risk, and I think it is irrefutable that that has happened in the past.

I do differ with the administration in that hope springs eternal, and their position seems to be that if strengthen the compensation committees, we will do better. I agree with what they are trying to achieve there. I agree with their statement of goals. I have less confidence than they that we will be able to find compensation committees among these boards that will have that independence.

So I would go somewhat further. But we do agree on the goals and we do agree with the administration on say on pay, and I would simply say this is the first in a set of hearings that will lead this committee, I hope, to begin marking up in a month a set of financial regulations that I hope we will have before the House before we adjourn for the summer that will put in place rules that derive from the lessons we have learned from the most recent crisis.

And, as I said, we are here not because of concerns over the amount of compensation in general, but fundamentally because we think the incentive structure has contributed to excessive risk-taking.

The gentleman from Alabama is recognized for five minutes.

REPRESENTATIVE SPENCER BACHUS (R-AL): Thank you, Mr. Chairman. Mr. Chairman, I thank you for holding today's hearing on executive compensation, which is the first of a series on regulatory reform and the future of our financial system.

There is no question that there have been some questionable decisions made by some of our major corporations regarding executive pay. However, I strongly believe that it is neither the executive branch or Congress's role to mandate compensation policies or the role of this Congress or the executive branch to determine who sits on the corporate board of directors or interfere with corporate governance in any way.

What we need instead is a strategy to get us out of what we have witnessed in the past six months, and that's government command and control of business. If we need to get the government out of businesses and we -- what we need is no further intrusion into what should be private economic decisions made by corporations or directors and their shareholders.

Mr. Chairman, the series of regulatory reform here in the schedule will, I believe, be among the most important the committee will be holding this year, and perhaps the most important hearings that we will hold in the 111th Congress.

In these hearings we will determine how we rebuild our financial system and whether we lay the foundation for economic growth and prosperity, or whether we repeat the same mistakes that led us the brink of ruin and those we have made since September.

Later this afternoon, the Republican leadership of the Financial Services Committee will unveil a proposal to reform our financial regulatory system. The Republican regulatory reform proposal calls for a return to market discipline and an end to bailouts, government intrusions into business, and the government picking winners and losers.

The government plan addresses the major flaws in our current system, exposed by the financial crisis, and I look forward to working with my colleagues on both sides of the aisle on this and other proposals for reforming our regulatory system.

Over the past year we have witnessed unprecedented government interventions into the financial system and in the corporate governance. Hundreds of billions of dollars have been spent recapitalizing individual financial institutions, some of which were probably insolvent and should have gone into a bankruptcy proceeding instead of being propped up with taxpayer dollars.

The Federal Reserve's balance sheet has more than doubled from roughly 870 billion (dollars) before the crisis to over 2 trillion (dollars) now, according to remarks made by Federal Reserve Chairman Ben Bernanke.

In the short run, government interventions may have stabilized the market, but I fear that these repeated multi-billion-dollar taxpayer bailouts are weakening our financial system and now threaten our economic future.

Combined with the current administrations' borrow and spend fiscal policy, many have come to believe, including myself, that the vast expansion of the Fed's balance sheets in is itself becoming a systemic risk to our national economy far greater than the failure of any private financial institution. It also, I think, fundamentally affects our ability to borrow money and the price at which we borrow that money.

To restore our economy we should reject the philosophy that has transformed us into a bailout nation. However, there are some who want to further enshrine this failed government policy of rescuing too-big-to-fail institutions by crafting a resolution authority or systemic risk regulator which would give the government bureaucrats the power to use taxpayer money to prop up certain financial institutions. We may think that we own AIG, the government, but in fact I think AIG and these companies end up owning us.

Mr. Chairman, the appropriate response to this very real problem of handling market failures is we should resolve insolvent non-bank institutions, no matter how large or systemically important, through the bankruptcy system.

Bankruptcy is a transparent and impartial process with well- settled roads and precedents and is far preferable to a vaguely defined resolution authority that encourages moral hazard and further entrenches mega banks and other large institutions as wards of the state.

In conclusion, it is important for the regulators to monitor the interactions of various sections of the financial system and identify risks that could endanger the stability and soundness of the system, but it is unwise for Congress to place the stewardship for our economy in the hands of a super-regulator thought to possess superhero powers despite bubbles and excessive risk-taking before markets crash, given that we have no way of telling whose forecast will be right and whose will be wrong.

In conclusion, I would remind my colleagues of a comment made by the Fed chairman on March 28th, 2007. Quote, "At this juncture, the impact on the broader economy and financial markets on the problem in subprime markets seems likely to be contained." My colleagues know I have the highest respect for Chairman Bernanke, but in this case he obviously could not have been more wrong.

This committee must have the courage to reject calls for a new regulatory regime that depends on the infallibility of the government regulators who have so far shown themselves unable to anticipate crises, let alone prevent them. We must encourage a return to market discipline. Thank you.

REP. FRANK: The gentleman used an extra minute and 10 seconds. I would be glad to add that to both sides, if that's acceptable.

REP. BACHUS: Thank you. I appreciate --

REP. FRANK: Put another minute and 10 on that, okay?

REP. BACHUS: I appreciate that, Chairman.

REP. FRANK: The gentleman from Georgia for two minutes.

REPRESENTATIVE DAVID SCOTT (D-GA): Thank you, Mr. Chairman. I think this is a very, very timely and important hearing as we grapple with the issue of how the compensation structure affects systemic risk.

I think that I can understand pay for performance, but for the life of me I cannot understand pay without performance. I think that gets to the heart of the matter here -- pay without performance. So much of the conversation structure I think is inequitably distributed through salaries and then their bonuses. I think it is within the bonus structure that we have to look very carefully at.

Now, we are responding to an issue that we did not create here in Washington or in Congress. This issue was created by over-exuberant, over-eager executives who were compensated for lack of performance.

The bonus structure is set up so that there is a reward system -- hopefully a reward system for superior performance, but there is no downside to that. There is no reaction for failure. If we look back at the history of our performance we will find that many of these executives were rewarded for driving companies into the ground.

As we, and as the American people, observe this and are looking at this, multimillion dollar bonuses on taxpayers' money while the American people are just hanging on by their fingernails in an economy where the salary and wage disparity has continued to widen and widen and widen.

So, if we look at the history and retrace the unraveling of our economy, there is a very significant role that this out-of-control compensation packaging of executives have led to a degree of the cause of the problem. And, Mr. Chairman, I appreciate this opportunity to explore this issue further.

REP. FRANK: The gentleman from Delaware is recognized for two minutes.

REPRESENTATIVE MICHAEL CASTLE (R-DE): Thank you, Mr. Chairman. I believe we need to be very cautious in the path we are going down. The form of capitalism we've had in this country for decades, generations, even centuries at this point, has worked well. The states have created our corporate laws. The shareholders elect directors and the directors set pay.

Obviously there have been abuses in this area, and I think we all agree on that, and I tend to agree that the compensation structure could have some effect on systemic risk, but does that mean that the federal government should step in with legislation and try to correct this?

Is giving stockholders -- and stockholders themselves can be individuals who are not necessarily a person owning 10 shares or 100 shares, but corporations and others who own tens of thousands of shares, mutual funds or whatever, who may not have the true interest of the future of the corporation in mind, other than the immediate profit possibilities. And so, as a result, that potentially can be dangerous.

I think we need to emphasize to stockholders they have a right to change directors. We need to emphasize to our states that they need to have good laws with respect to the ability to be able to change directors.

And I think we need to be very careful in Washington. We've gone through a bailout situation. I don't think anybody looks at Washington and things, gee, these people really know how to run things, either at the executive branch or at the congressional branch.

And one reason that people are not being penalized because of losses is that we have been willing to step forward with bailouts. And I think we need to be very careful about that. I don't think that government intervention is an acceptable end as far as this is concerned.

So I would encourage all of us to listen carefully, because I think there are some good points to be made, to think deeply about what we are doing, and make sure that we do not upset something which has a history of working pretty well in this country. Maybe we can tweak it, but we need to be cautious about how far we go.

I yield back, Mr. Chairman.

REP. FRANK: Mr. Sherman for two minutes.

REPRESENTATIVE BRAD SHERMAN (D-CA): Thank you, Mr. Chairman. I agree with the ranking member that if we have a risk regulator this should not morph into an agency that could put taxpayer money at risk or engage in bailouts. It should not be permanent TARP.

As to TARP, it provides for appropriate standards of executive compensation. I regret the fact that the administration seems that it will apply this only to those entities that have received three scoops of ice cream. I would think that, if you read the law, it should apply to any company that receives even one infusion of TARP funds.

The people of this country were outraged at executive compensation. That was not only understandable; it was valuable, and it will lead promptly to the return of some $68 billion to the Treasury by various banks that they would not have done if it was not for this outrage and the governmental reaction to it.

As to the proposals we're considering today as the say on pay, I believe we ought to look at that being binding, not just advisory, and we ought to set as many of the standards here in this room rather that just transfer authority to the SEC. We're talking about shareholder democracy. Democracy starts by legislating by the elected representatives of people, not just granting power to an unelected board.

There are those that say that the corporate boards will exercise the authority, and if they don't, well, there can be shareholder elections. The process of picking shareholder boards would make Hugo Chavez blush. After all, corporate funds can be used unlimited quantities to back one side and to fight the other.

As to the pernicious incentives, I think we're all against them. It will be extremely difficult to design a system where an executive's compensation reflects whether that executive actually helped the company in the long-term rather than simply made it look good in the short term.

This will be easier for those who will have company-wide decision-making since we could give them restricted stock in the entire company. But those who led to the success or failure of a single unit, it will be far more difficult. I yield back.

REP. FRANK: The gentlewoman from Illinois for two minutes.

REPRESENTATIVE JUDY BIGGERT (R-IL): Thank you, Mr. Chairman. I'm disappointed that some federal officials are moving in the direction of government-determined pay, not just for senior executives of United States companies, but for their secretaries, the analysts and the janitor.

I think that's a slippery slope, or worse. Don't get me wrong. Financial criminals must be brought to justice. But most importantly, risky behavior in the financial services industry must be addressed. And I think we can do that with smarter, more effective financial services regulations that reign in reckless behavior, risky leveraging, concentrations of capital.

In addition, our financial services institutions need to retain the best and the brightest. We need not induce fear in our future financial service leaders or workers, but provide them with improved guidelines that foster competition for the benefit of U.S. consumers, businesses, investors and our economy.

With that, I yield back.

REP. FRANK: The gentleman from Kansas is recognized for one minute.

REP. DENNIS MOORE (D-KS): Thank you, Mr. Chairman. I want to commend you for your leadership on executive pay issues and holding today's hearings so we can review how compensation affects risk-taking for better or for worse as we consider financial regulatory reform.

One of the most important lessons I think we can learn from the financial meltdown is that excessive risk-taking and over-leveraged activity with little or no oversight will lead to instability.

As this committee considers financial reg reform, we need to guard against destabilizing activity and identify the proper role of risk in a thoughtful way by improving compensation, risk management and corporate governance practices.

I look forward to hearing our witnesses' testimony of these important issues. And, again, thanks, Mr. Chairman.

REP. FRANK: The gentleman from Texas, Mr. Hensarling, for two minutes.

REP. JEB HENSARLING (R-TX): Thank you, Mr. Chairman. Executive compensation limits to address systemic risk are the wrong remedy for what is probably a non-existent problem.

Any compensation legislation considered by Congress ought to be driven by two key principles. Number one, executives of failed companies who come to taxpayers with tin cup in hand must be subject to compensation limits, period, paragraph, let there be no doubt.

Principle number two: Except for the first principle, Congress has no business setting artificial and mandatory limits on anyone's pursuit of their American dream. If someone aspires to be the next Bill Gates, Oprah Winfrey, Warren Buffet or Charles Schwab, we should tell them the sky's the limit; go for it, not, we're the U.S. Congress; you will not be allowed to go beyond the 10th floor, and, oh, by the way, take the stairs.

Now, I'll be the first to admit that many compensation arrangements strike me as risky, illogical, unreasonable, if not downright offensive. But the solution to any concerns regarding executive compensation practices is, for number one, the shareholders to vote for a change in management or to take their investment dollars elsewhere, and for Congress to reexamine the tax code, which probably helps drive a lot of these arrangements in the first place and, even more importantly, to quit bailing out companies who fail in part due to flawed compensation systems.

Finally, I hope -- I hope that in America the term "systemic risk" is not now being used the way the term "internal securities" was once used in the former Soviet bloc; a justification for almost any and all government intervention. For those who truly want to reduce systemic risk, I suggest a first look to Fannie and Freddie.

I yield back the balance of my time.

REP. FRANK: The gentleman from Indiana is recognized for three minutes.

REP. ANDRE CARSON (D-IN): Thank you, Mr. Chairman, for your tremendous leadership on the issue of executive compensation and for holding this hearing. This issue promises to be one of the most important in upcoming regulatory reform legislation.

Recently there have been a number of interesting characterizations of efforts to reform executive compensation structures on Wall Street. In the wake of the worst economic crisis since the Great Depression, many financial industry leaders have insisted that CEO compensation is self-correcting.

They urge inaction on reform, insisting that shareholder and media scrutiny has already moderated pay for leaders of poorly performing companies. They claim if we enact stronger reforms, our financial talent will be driven overseas and our economic recovery will be delayed.

What is missing from that argument is both clarity and reason. For the 175 executives whose companies helped fuel the current economic crisis that ultimately required hundreds of billions of dollars in taxpayer assistance. I believe a capable compensation overseer should have the discretion to determine whether or not these companies' compensation packages are reasonable.

In any other industry, when someone takes excessive risks that lead to monumental failures, there are repercussions. Wall Street seems to expect a separate set of rules. For my constituents, this double standard is nothing new. They know that 30 years ago CEOs took home 30 to 40 times what average workers made, and now that number has exploded to 344 times an average worker's pay.

They know that while the average CEO pay dropped by a million dollars last year, many average workers were laid off. They know that the average bonus payments to Wall Street executives represents more than they hope to earn over a lifetime. And they know that, once again, "Main Street" is paying for the actions of Wall Street.

My hope is that industry leaders understand that calls for executive pay reform are not a retaliation for our current economic reality, but rather an attempt to usher in a new era of real corporate responsibility.

I hope that executives realize that performance incentives that are tied to the long-term success and soundness of an institution are essential if we hope to monitor systemic risk and restore confidence in our markets.

With that in mind, I look forward to working with the administration, the chairman, and my colleagues on this committee.

Thank you, Mr. Chairman. I yield back.

REP. FRANK: The gentleman from New Jersey is recognized for two minutes.

REP. SCOTT GARRETT (R-NJ): Thank you, Mr. Chairman. I appreciate the gentleman who just spoke, his comments, and I appreciate the witnesses here today and the chairman's holding this hearing.

You know, today we're exploring compensation structure and systemic risk, but to me, as I look at it, the federal government really is the one that poses the single biggest systemic risk, and it's really not even close.

You know, part of the reason the government poses such as large systemic risk is because of the often-misguided federal government policies you've seen. Yet government officials, with their long-term track record of success, continue to come forward with proposals that, to one degree or another, dictate to private firms about how they should properly compensate executives and measure performance.

Look, there's certainly room for improvement at particular individual companies in putting together compensation packages, and to the extent this discussion today -- just as the gentleman from the other side just made his comments just now -- helps to inform boards as they take a closer look at their compensation policies, that could be all be a positive development.

But, you know, I have a problem. I believe the American people are growing weary of recent government overreach into the private sector. With the government now owning GM and with the way the rule of law was disregarded in the Chrysler bankruptcy case, dangerous actions are taking place, which will create uneven playing fields and increasingly inject political decisions with so many unintended consequences into our economy.

So individual boards from companies have a responsibility for establishing compensation packages that not only take into account the long-term best interests of a company and its shareholders, but also allow them to attract the best available talent.

This is a fundamental underpinning of our free market economy and it should not be put in the hands of government bureaucrats. With that, I yield back.

REP. FRANK: The gentleman from Florida for two minutes, Mr. Klein. Is he here? Oh, we'll hold off then. Let me go to the gentleman from Texas, Mr. Neugebauer, for two minutes.

REP. RANDY NEUGEBAUER (R-TX): Thank you, Mr. Chairman.

One of the things that's happened over the last few months is we've formed new entities called TSEs. That's taxpayer-supported entities. And that's where the American people were impressed to be shareholders in companies that in many cases they wouldn't have invested on their own. But unfortunately that marriage was made.

And I would guarantee you that if you think the marriage isn't working very well, wait until you see the divorce as we try to unravel these. But yet this looks like we're moving in the direction of increasing the consequences of this marriage.

One of the things that I think is ironic is we're focusing on compensation rather than performance. And one of the things that's most embarrassing, I think, about all of this is that we have people that have never run anything trying to tell companies how to run their own business. We have people that the only risk they may have ever taken is to buy a lottery ticket trying to tell companies how they should move forward with their business plans.

I think it's a poor direction for us to move. If we really want to help the shareholders and help the American people, one, we need to get them out of these businesses. Secondly, we need a regulatory structure that ends these bailouts, ends the government picking winners and losers, and more importantly begins to put a market discipline into these companies, letting them fail, knowing that there is consequences.

If you think shareholders will have an uprising, wait until they think that they're about to lose their investment. Today we send the signal, hey, you may not lose your investment, or, more importantly and more sadly is we say to the American people, guess what, you didn't buy shares in that company; well, we're going to buy them for you because we're the government and we think we know what is the best investment of the American taxpayers' money.

And, by the way, we don't have any of this money. This is all money that we're borrowing. We're borrowing from China and Japan and from people that we are selling -- we're having to buy energy from on a daily basis.

The American taxpayers are sick and tired of being shareholders. Let's get them out of that. Let's get an exit strategy. And, more importantly, let's don't let the federal government encroach in the business any more than it already has.

REP. FRANK: The gentlewoman from California for two minutes.

REP. MAXINE WATERS (D-CA): Thank you, Mr. Chairman. I would like to begin by thanking you for facilitating this hearing this morning. Executive compensation has been a complicated and reoccurring issue in our discussions on financial reform.

As you yourself have mentioned, compensation that promotes excessive risk is a systemic concern. To that end, what occurs in financial centers such as Manhattan and Charlotte affects everyone across the country, including residents from my district in California.

Some of the compensation packages that were lavished on top executives are mind-boggling. Former executives such as Merrill Lynch's John Thain or Countrywide's Angelo Mozillo were collecting salaries and bonuses into the multimillions while running their companies into the ground.

To the extent these CEOs and others were incentivized to produce short-term profit, they were equally as incentivized to flood the market with predatory loan products such as subprime mortgages, weaken their shareholders' long-term prospects for financial gain, and increase systemic risk.

As a result of this increased systemic risk, the American taxpayer has been asked to bail out financial institutions through liquidity tools such as the capital purchase program and the Term Asset-Backed Securities Loan Facility, or TALF.

That money is not a gift, but rather a loan from the public, and as such requires certain protections. One of these protections is the special master or pay czar, who will place transparency into the system so the public and shareholders are properly informed.

To the extent bonus compensation poses a systemic risk, it too merits some limits. I thank our witnesses today for helping us to frame a discussion on which bonus compensation limits may be appropriate to rein in systemic risk. That said, I do not believe non-TARP recipients should have their salaries capped by the president or the Congress.

Thank you, Mr. Chairman. I yield back the balance of my time.

REP. FRANK: We'll do one minute now for Mr. Moore and then Mr. Campbell, and then Mr. Peters will be finished.

One minute, Mr. Moore. One minute? Oh, I apologize. All right, then we'll go to Mr. Campbell for a minute.

REP. JOHN CAMPBELL (R-CA): Thank you, Mr. Chairman.

You know, there's no argument that there have been instances, a number of them, in which people and companies have been paid a great deal for not very much performance. The question is, what do we do about it?

As someone who has designed incentive compensation plans for hundreds of employees in my own business over a 25-year career, I will tell you that it's not easy, that sometimes you pay people too much for too little performance, and sometimes you pay people too little for too much -- for a lot of performance. And the idea that somehow that some Washington bureaucracy, distant Washington bureaucrat, can do this better than people in the business and in the company is simply ludicrous.

Also, I believe the idea of having a direct shareholder vote opens up the idea of direct democracy within corporations, which leads to the question of, well, should we also have them approve union contracts, approve major expenditures, et cetera, all of which arguably have done more to bring companies down over the years than excessive compensation?

Instead, in my view, the SEC is moving in the right direction by giving shareholders greater rights to make nominations for and changes in the board of directors when they get too cozy with management.

And I yield back.

REP. FRANK: Finally, the gentleman from Michigan, Mr. Peters.

REP. GARY PETERS (D-MI): Thank you, Chairman Frank, for holding this hearing and for your leadership on this issue.

It's estimated that as many as 100 million Americans own stock, either in individual accounts or through a mutual fund, and those investors have lost trillions in the current stock market decline. There's no doubt that one of the causes of the current financial crisis was executive compensation schemes in place at many of the largest financial institutions, from the top executives to the traders on the floor, people who were receiving compensation packages that emphasized short-term gains rather than rewarding long-term growth and shareholder wealth.

I'm happy that the Obama administration has announced that they are taking steps to address this issue by calling on Congress to pass legislation that requires companies to hold an advisory shareholder vote on compensation and mandating that corporate boards use independent compensation advisers.

Tomorrow I'll be introducing legislation that will do that and more. It will also include a number of other provisions that I believe will reform corporate governance practices by empowering shareholders to have a greater oversight over the management of the companies that they own. I look forward to hearing testimony today.

Thank you, Mr. Chairman.

REP. FRANK: I thank the members.

And we will begin with the witnesses. Let me say, we have an important subject. We have, as always, too many members on this committee, and I am going to hold everybody strictly to the five- minute rule. No one will be recognized as a member after the five minutes. We will allow witnesses to give a short answer to finish up. And if you ask a complicated question with 30 seconds left, it will be your fault if you don't get a serious answer.

We'll begin with Mr. Sperling.

MR. SPERLING: Thank you, Chairman Frank, Ranking Member Bachus. It's very good to be here. I appreciate that you're holding this hearing.

I think there is little question that one contributing factor to the excessive risk that was central to the crisis was the prevalence of compensation practices at financial institutions that encouraged short-term gains to be realized with little regard to the potential economic damage such behavior could cause, not only to those firms but to the financial system and the economy as a whole down the road, compensation structures that permitted key executives and other financial institutions to avoid the potential that long-term (down sides ?) of their actions discouraged a focus on determining long-term risk and underlying economic value while reducing the number of financial market participants who have an incentive to be the important canary in the coal mine.

I want to make clear, and as Secretary Geithner said yesterday, our goal is to help ensure there is a much closer alignment between compensation, sound risk management and long-term value creation for firms and the economy as a whole. Our goal is not to have the government micromanage private-sector compensation. As Secretary Geithner said yesterday, we are not capping pay. We are not setting forth precise prescriptions for how companies should set compensation, which can be counterproductive.

And we come to this with a clear-eyed sense of both the seriousness and the humility one must bring, both the importance of the issue but also the care and rigor one must take to ensure that well-intentioned actions do not lead to unintended consequences.

I will mention just a few of the principles that Secretary Geithner laid out yesterday, a couple of examples. And then I look forward to the discussion.

One, compensation should accurately measure and reward performance. And I think this is an important issue. It is a lot easier to get everybody to agree that pay should be performance- related. But it is a lot more complex to find out what is that right mix of metrics that ensures that it is true performance.

Simply using stock, as they say, can confuse brains for a bull market, and on the other hand, not properly rewarding executives who may be doing enormously well in a difficult economic time. I think one of the things we should study carefully is what is the careful mix of metrics that truly rewards performance in fact, and not just in name.

Secondly, compensation should be structured in line with time horizons, the right time horizons. A friend of mine said to me recently it is like there is an entire industry which is -- entire sets of financial actors which are able to realize private gains in a single year for risks they are creating over a 30-year period, which could be externalized to either the firm or, as we've seen, the economy as a whole.

We need to have structures that help internalize those risks to make sure that we are having -- that it is not easy for financial actors to simply put off the potential harm they could be leaving to their firm, their shareholders, and the economy as a whole.

Third, compensation practices should be aligned with sound risk management. Now, this authority independence of risk managers within firms, ensuring they are independent, compensated well, is most important when you're going through a period of excessive optimism, where asset appreciation can temporarily make the reckless look wise and the prudent look overly risk-averse.

Former Federal Reserve Chairman William McChesney Martin once said, "The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting." Likewise, risk managers must have the independent stature and pay to take the car keys away when they believe a temporary good time may be creating even a small risk of a major financial accident down the road.

Fourth, we should examine whether the prevalence of golden parachutes in supplemental retirement packages truly align the interests of executives with shareholders. Lucien Bebchuk, who will be speaking to you, has written, "The firms use retirement benefits to provide executives with substantial amounts of stealth compensation, compensation not transparent to shareholders, that is largely decoupled from performance."

And concerning golden parachutes, there is more evidence that they are prevalent, not tied to performance or even mergers and acquisitions. And I fear that they leave the understandable impression that there is a double standard in our economy when top executives are rewarded for failure at the same time working families are forced to sacrifice.

Finally, we believe it's very important to have greater transparency and independence. The say-on-pay legislation that Chairman Frank has long sponsored and which President Obama, as Senator Obama -- that Senator Obama was a co-sponsor in the Senate -- would be a very significant move forward in terms of transparency, accountability. The evidence in the UK shows that it has had a positive impact.

And in terms of the independence of compensation committees, I will just say briefly we start with the same premise as Chairman Frank, that independence in name does not mean independence in fact. But we do believe that if you gave the comp committee the funding and authority to be the sole hirers of the compensation consultant and the council and that you had the SEC go forward to ensure a reduction or elimination of conflicts of interest for compensation consultants, it is our hope that we would at least make progress and move the ball forward.

Thank you very much.

REP. FRANK: Thank you.

Mr. Alvarez.

MR. ALVAREZ: Thank you, Chairman Frank, Ranking Member Baucus, and other members of the committee for the opportunity to offer the Federal Reserve's perspective on compensation in the financial services industry.

Compensation practices at financial firms and other business organizations can have a significant effect on the safety and soundness of banking organizations and on financial stability. Compensation arrangements, which include salary, bonuses, retention payments and other forms of compensation at any type of organization, serve several important and worthy objectives. For example, they are important for attracting skilled staff, promoting better firm and employee performance, promoting employee retention, providing retirement security to employees, and allowing the firm's cost base to move along with its revenues.

It is clear, however, that compensation arrangements can also provide executives and employees with incentives to take excessive risks that are not consistent with the long-term health of the organization. This misalignment of incentives can occur at all levels of a firm and is not limited to senior executives.

In addition, incentives built on producing sizable amounts of short-term revenue or profit can encourage employees to take substantial short- or long-term risks beyond the ability of the firm to manage, just as the employees can increase their own compensation.

Risk management controls and frameworks have proved incapable alone of acting as a break on excessive risk-taking where compensation programs have created overly strong incentives to take risks.

These and other weaknesses in the ways that firms have thought about and implemented compensation programs have become apparent during this period of economic stress. As a result, many financial firms are now re-examining their compensation structures to better align the interests of managers and other employees with the long-term health of the firm.

The Federal Reserve is also actively working to incorporate the lessons learned from recent experience into our supervisory activities. The Federal Reserve played a key role in the development of the principles for sound compensation practices issued by the Multinational Financial Stability Board in April 2009.

In addition, we are in the process of developing our own enhanced guidance on compensation practices at U.S. banking organizations. The broad goal is to make incentives provided by compensation systems at these institutions that we supervise consistent with prudent risk- taking and safety and soundness.

In developing this guidance, we are drawing on expertise within the Federal Reserve, as well as on research from the broader academic community and other compensation and industry experts. Our investigations suggest that there are certain key principles that should guide efforts to better align compensation practices with the safety and soundness of financial institutions.

First, to be effective, compensation practices must be properly aligned throughout a financial firm. This includes careful review and construction of compensation programs at the level of middle management, traders, and other individuals who can alter the risk profile of the firm. Firms' boards of directors and supervisors must broaden the scope of their review of compensation practices beyond the traditional focus of senior executives.

Second, compensation practices must take account of the risks of the activities and transactions conducted by the firm and not simply be based on targets for short-term profits, revenues or volume. Substantial financial awards for meeting or exceeding volume, revenue or other performance targets without due regard for the risk of the activity can create incentives to take unsound risk.

Moreover, incentives that reward good performance but that do not adjust compensation downwards when risks are increased or performance targets are missed are not effective in limiting risk.

Third, more can and should be done to improve risk management and corporate governance as it relates to compensation practices. This will involve more active engagement by boards of directors and risk management functions in the design and implementation of compensation arrangements firm-wide.

Improvements in compensation practices are likely to be harder to make and take longer than anyone would like. One size will not fit all firms. However, well-crafted supervisory principles can play an important role in moving practices in the right direction.

I appreciate the committee's interest in this important topic and am happy to answer any questions you may have.

REP. FRANK: And finally, on behalf of the SEC, Mr. Breheny.

MR. BREHENY: Good morning, Chairman Frank, Ranking Member Bachus and the other members of the committee. I'm pleased to be with you here today to testify on behalf of the Securities and Exchange Commission so that I may share with you our thoughts on the topic of executive compensation.

As an initial matter, I think it's important to note that as the landscape of compensation practices continues to change, the commission is committed to keeping the disclosure rules we administer up to date so that investors have the information they need to make informed investment and voting decisions.

As we all know, in recent years the issue of executive compensation has garnered significant public attention. As revelations about executive compensation come to light, claims have been made that bonuses and severance packages at some companies have been exorbitant. Indeed, executive compensation has been a lightning rod, amplified by the recent financial crisis, with concerns about the accountability and responsiveness of some boards of directors to the interests of their shareholders.

We believe that in order for public markets to function properly, it is crucial that shareholders, the owners of the company, be able to make informed decisions about their investments and that shareholders can hold the members of the board of directors accountable for their decision.

Notwithstanding the commission's current rules, we recognize that there is an ongoing vigorous debate between those who believe that there should be more substantive constraints on pay and those who believe the federal government should never or rarely set pay parameters.

It is important to note, however, that this debate is significantly more meaningful as a result of our disclosure rules. However, the challenge the commission has always faced in promulgating and administering its executive compensation disclosure rules is that compensation practices are not static.

As a consequence, the commission has revised its disclosure rules as necessary to keep pace with new developments in compensation practices. Most recently, in 2006, the commission adopted a comprehensive package of amendments to its rules that was intended to significantly improve the existing regime of executive and director compensation disclosure.

While the adoption of the 2006 rule revisions significantly expanded the extent and strengthened the caliber of compensation disclosure, the commission is once again considering further possible enhancements.

It has been suggested that at some companies, executive compensation has become disconnected from long-term company performance because the interest of management in the form of incentive compensation arrangements and the interests of shareholders are not sufficiently aligned.

Critics have complained that in some cases the incentive structure created by executive compensation may have driven management to make decisions that significantly and inappropriately increase company risk without commensurate risk to management's compensation, should the decision prove costly to the company. Indeed, one of the many contributing factors cited as a basis for the current market turmoil is the misalignment at a number of large financial institutions of management's financial interests with those of shareholders.

Compensation policies and incentive arrangements represent just one of the issues that the commission plans to take up next month when it considers a broad package of proxy disclosure enhancements. Many of these enhancements are designed to provide shareholders with additional information about their companies' key policies, procedures and practices.

For example, the commission plans to consider whether greater disclosure is needed about how a company, and the company's board in particular, manages risk, including within the context of existing compensation plans and setting compensation levels.

The commission also plans to consider whether greater disclosure is needed about a company's overall compensation approach, in particular as it relates to the company's risk management and risk- taking, beyond decisions with respect only to the highest-paid executive officers. The commission further plans to consider proposing new disclosure requirements regarding compensation consultant conflicts of interest.

In addition to these executive compensation disclosure enhancements, the commission plans to consider proposals related to the directors themselves. For example, it plans to consider whether to enhance disclosure of director nominee experience, qualifications and skills, so that shareholders can make more informed voting decisions.

The commission further plans to consider proposed disclosures to shareholders about why a board has chosen its particular leadership structure, such as whether that structure includes an independent chair, or perhaps combines both the CEO and the chair in one position, again, so that shareholders can better evaluate the board when making a voting decision.

Notwithstanding the commission's executive compensation disclosure requirements, however, it has been argued that, absent a more effective way for shareholders to exercise their fundamental right to nominate and elect directors to the companies' boards of directors, board accountability to shareholders cannot be maximized.

Accordingly, on May 20th the commission voted to approve for notice and comment proposals that would give shareholders a more effective way to exercise their state law rights to nominate directors. Under the proposal, shareholders who otherwise have the right to nominate directors at a shareholder meeting would, subject to certain conditions, be able to have a limited number of nominees included in the company proxy materials that are sent to all voters.

To further facilitate shareholder involvement in the director nomination process, the commission also proposed amending its shareholder proposal rule to require companies to include proposals related to the nomination process in their proxy materials, provided that certain other requirements of the rule are met.

If adopted, we believe these new rules would afford shareholders a stronger voice in determining who oversees management in the companies that they (own ?).

Thank you again for inviting me to appear before you today. On behalf of the agency, we look forward to working with Congress and with this committee going forward on these issues.

I'd be happy to answer any questions you may have.

REP. FRANK: Thank you.

Before I get to questions, I do want to comment some on what we've heard earlier from my Republican colleagues. I think what we have heard today is the final repudiation of the Bush administration by many of my Republican colleagues, because we have heard a fairly vigorous and thorough denunciation of various actions of that administration -- no more bailouts, no more taking over companies.

Well, AIG -- I remember, in September of 2008, being told by Secretary Paulson and Chairman Bernanke, two Bush appointees, that they had decided, with no congressional input or even advice, to advance $82 billion to AIG. Two days later we were asked by the same two Bush appointees to initiate the TARP program of $700 billion.

Subsequently, we worked with the Bush administration, and after we were unable to pass the bill, because the House passed it and the Senate didn't, involving the auto companies, the Bush administration initiated it. So we are talking now about a Bush administration initiation of funding for AIG, a Bush administration request to Congress to create the TARP, and the Bush administration intervention without congressional final action in the auto companies.

How that became a Democratic agenda puzzles me. Perhaps I will be enlightened later on. I do know that I have colleagues who believe that the world was created only 4,000 years ago. I had not seriously known there were some who thought it was created on January 20th, 2009.

So I do want to say we are engaged in this, and we are engaged and have been engaged for months in dealing with the consequences of decisions made by the Bush administration, some of which I agreed with; some of which I agreed with although thought they weren't well carried out.

I would note, on the TARP money, that, thanks in part to an increase in the conditions that have been imposed on TARP recipients, both by the Congress and the Obama administration, more than one-third of the money advanced to banks has already been repaid to the Treasury.

Now, we have to decide what we do with that. But those who consider the whole $700 billion gone have to cope with the fact that of approximately $200 billion advanced, in less than a year more than $70 billion has come back, some of which exceeded the loans because there was some interest.

Now, these are complicated questions to be worked out, and I would not ordinarily have brought this up, but listening to what I heard before, it did seem to me the history was relevant. Yes, we have had a problem with bailouts.

The second point I would make is that say on pay comes from England. It is not some intervention. It is not a bailout.

The compensation matters we were talking about -- let's be very clear. It's one thing to have fairly inclusive compensation restrictions when people are getting money directly. It's another when we are talking about risk assessment, so I will now ask my question of these three gentlemen.

One of the arguments we've heard is that if we restrict compensation, it will contribute to capital flight, that people will flee America. It has been my experience that, in the first place, American corporate executives were rewarded far better, in dollar terms and other ways, than others. Sometimes I think the Japanese executives and American executives are paid the same amounts except in our case it's dollars and their case it's yen and so the yen/dollar difference means that ours are getting a hell of a lot more.

But I would ask all three of you: is there a danger if we were to adopt, say, on pay or some of the other rules that you're proposing that we would anti-capital flight, that some of the best and brightest who have run the financial system with such elan would now decide that they were not sufficiently appreciated and would move to other countries? Let me begin with Mr. Sperling.

MR. SPERLING: Chairman Frank, I suppose if one were to put a hard and arbitrary cap on the top talent at a firm, that could lead to flight and the kind of deterioration that you mentioned, but as far as I know, I can say with certainty that there is nobody in the Obama administration who is proposing such things. What we are proposing in the legislation we put forward yesterday is greater transparency and accountability to the owners of the company. We find, and I think practice has shown, that sunshine and transparency does have a powerful deterrent effect on improper or ill-advised behavior, and I think, even more important, it starts an important dialogue about --

REP. FRANK: I want to talk specifically about the competitive piece, whether --

MR. SPERLING: I do not believe that anything that we are proposing today or that you have proposed would have a deterrent impact --

REP. FRANK: Let me ask Mr. Alvarez.

MR. ALVAREZ: Mr. Chairman, I think one good piece of information here is that the world is looking at this problem, as well, so -- the British have already begun to consider it. The Swiss have proposed some principles similar to what we've discussed today. As I mentioned, the board has worked on an international panel with a financial stability board, so this is a global issue with a global set of solutions that the globe is coming to consensus on.

REP. FRANK: Thank you. Mr. Bachus.

MR. BACHUS: Thank you, Mr. Chairman. Mr. Chairman, your earlier remarks, I would just say that whether we tag this on Bush, sort of pin the tail on the donkey or whether we pin it on the elephant, it's now all our problems and it's now, not then. And I just ask that we all work together to get us out of these bailouts and these government-funded programs and that we extricate ourselves from that and the deficit spending that we've witnessed. We'll work together on that, I hope.

Let me say this. Gene, you and I have worked on several things. I have a deep respect for you, and I very much agree with you that one of the contributing factors to the excess risk taking -- it was central to the crisis -- was compensation that was linked to short- term gains without any consideration of the long-term risk. And as you say, across the subprime mortgage business brokers were compensated in ways that placed a high premium on volume without regard to whether the borrowers had the ability to make those payments. That's pretty clear.

I associate myself with all those remarks. I also associate myself with the remarks you've made that top executives -- often those golden parachutes weren't aligned with shareholders' interest and, in fact, what you said: it creates the impression-- a lot of my constituents have this impression -- that there's a double standard in which top executives are rewarded for failure at the same time that working families are forced to sacrifice. We've seen instances in a lot of cases where executives received these tremendous salaries as they went out the door on failing corporations and at the same time most of the workers were being given pink slips or their retirement benefits or health care was being cut back.

Having said that, you know, I take those as givens. You say the goal of the administration now is to move compensation committees from being independent and named being independent. In fact, not only would committee members be truly independent, but they would be given authority to appoint and retain compensation consultants and legal counsel, along with the funding necessary to do so. This legislation was -- (inaudible) -- and I think we've had testimony from the SEC to create standards for ensuring the independence of compensation consultants, provide, you know, shareholders with confidence that the compensation committee is receiving objective expert advice. Now what that is, I think, would all you gentlemen admit that is a major mandate by the government into corporate government?

MR. SPERLING: Thank you, Congressman. I feel that this is just simply trying to ensure that the independence of comp committees is as it as advertised, which is independent, and the reality is, and I say this as a person who has participated in a board of directors, if the CEO controls the compensation consultant, you can have an independent compensation committee, but the power and the information that is being gathered is being gathered by somebody who almost inherently has a conflict of interest in this situation.

And I think one of the things that you try to do is not to intervene or micromanage, but I think when you can have transparency and reduce conflicts of interest, then you are laying foundations for capital markets to work more efficiently and --

REP. BACHUS: But you're actually putting independent people within the corporate governance, you're mandating that they be independent and that they be compensated. And, I mean, that's a type of corporate governance. I guess what I'm saying, 95 percent of the corporations never made a mistake or never performed in a risky manner, so you're basically taking, you know, and you're saying to all those corporations: we're going to change the rules.

MR. SPERLING: Well, you know, as we've seen, it doesn't take that many types of excessive risk taking to do a lot of damage that goes not only to the shareholders but to the economy as a whole. But we believe that if we have -- we advertise to shareholders and the public that compensation committees are independent and yet we know that if the company itself hires the compensation consultant, if that compensation consultant can also be taking other fees and being paid by the company, then you have a bit of false advertising. And so I think that what we're doing here, far from being intrusive, is simply ensuring that the independence of compensation committees, as advertised, is independent in fact.

REP. BACHUS: I guess I'm just --

REP. BARNEY: Okay, thanks. The gentlewoman from California.

REP. MAXINE WATERS (D-CA): I'd like to thank our panel for being here today to help us wrestle with one of the more serious problems in the financial services community dealing with compensation and bonuses, et cetera. There are some things that we have learned about actions that were taken that are very disturbing, and I don't know that we have gotten any information to help us understand what went on in some of these actions.

For example, I want to know what you have discovered, starting with Mr. Sperling, about the authorization for $5 billion in bonuses to be given to Merrill Lynch employees at the time that the merger took place between Bank of America and Merrill Lynch. I've read accounts in the paper and I've heard information that Bank of America knew and signed this agreement that these bonuses could take place.

Later, I'm told that the CEO said that he was made to sign the agreement, understanding that these bonuses were going to be given. Normally, these bonuses were given at the beginning of the year. They rushed them so that they would be given toward the end of the year and prior to the signing of the agreement. What do you know about this?

MR. SPERLING: Congresswoman, this has obviously been a very contentious discussion, as you know, that has gone out to the public between former Secretary Paulson and the chairman of Bank of America over what transcribed during that transaction which, as you know, was months before I entered the Obama administration.

REP. WATERS: Yes.

MR. SPERLING: I would need to go back, and would be happy to do so, to get what our administration's best understanding is of that dispute, but it is an ongoing dispute, with, I believe, our own Justice Department engaged in it, so I do not have intimate knowledge of where that is right now, but I would be happy to get back to you.

REP. WATERS: Well, as we try and create public policy around some of these issues, what would any of you suggest that we should include in legislation that would prevent this kind of action?

MR. SPERLING: Well, one thing I would mention is that with the legislation that you -- that you all have already passed, let's remember that -- that for -- in the situation of TARP recipients -- and I know we're going well beyond -- but it -- but, obviously, the legislation you've passed would have limited those type of bonuses to one-third of overall salaries. So, in the -- in the case of somebody receiving -- a TARP recipient had -- had Merrill been a TARP recipient at that point, it would not be -- it would not be -- have been permitted under the law.

But, more generally, again, our view is very much to try to -- to have greater transparency on the practices, greater independence, and we feel very much that these type of practices when brought to light -- that the transparency is often decisive, and so when people say, for example, "Stay-on pay is non-binding," I don't think that's the way it works in fact. I think that it is very, very troubling for a company to face a negative vote in those areas and that -- and that few want to take that type of public risk.

REP. WATERS: Any other comments on this issue?

MR. ALVAREZ: So -- Madam Congresswoman, the -- the one issue I would add to what Gene has said is that it -- it's important when an organization has not performed well that bonuses be adjusted for that. There has -- one of the principles that we think is very important and that the Federal Reserve will incorporate in its guidance going forward is that the -- the compensation should be risk sensitive. It -- it should reward good performance, but then when performance is -- doesn't meet goals or when there are losses, then the compensation has to be adjusted in the other direction to --

REP. WATERS: That's the Barney Frank law. He's the first one that emerged with the risk assessment relative to the management of -- of risk basically. He maintained from the beginning that those persons responsible for creating the risk would have to accept the responsibility for the failures. And so I think we're on that path for sure, but I just want to make sure that I understand when mergers are going or buyouts have taken place, what -- you know, the purchasers are being forced to do by anybody. I want to understand that better, and I'll continue to try and pursue that.

MR. SPERLING: I don't want to -- Mr. Chairman?

REP. FRANK: Very quickly. Quickly.

MR. SPERLING: Oh, I think, as the chairman would say, that in the stay-on pay legislation, there is often a -- in different proposals, there is often a separate vote on the golden parachutes in exactly that merger transaction.

REP. FRANK: The gentleman from Texas.

REP. RANDY NEUGEBAUER (R-TX): Thank you, Mr. Chairman.

Mr. Sperling, it -- in your testimony, you said that the -- now we're going to put the president's working group and -- will provide an annual review for compensation practices so the government can monitor whether they are creating excess risk. How will that work? How -- how will you determine compensation is actually creating excess risk?

MR. SPERLING: I think the reason Secretary Geithner felt that it was good to put this on the agenda -- and it's the same reason that you hear Mr. Alvarez talking about it from the Federal Reserve's perspective -- that we have all learned painfully that compensation is closely related to the safety and sound obligation that -- that not only the Federal Reserve, but the -- but all of us have, and I think we also are aware that one also always has to be worried about fighting yesterday's war.

New practices, new trends can emerge, and I think to ask the major supervisors in the U.S. government to take a yearly look or an annual review of what those trends are could be, again, one more check against the type of excessive risk-taking that we've seen which too often can get a path in exactly a bubble atmosphere where, again, everybody looks smart because assets are all going up year after year. These are exactly the times when you need to have more risk management in place and incenting companies, but perhaps at the -- at the federal level as well.

And one of the things Secretary Geithner did was to actually invite many of the major organizations -- non-profits, business groups -- to be part of that process so that we are reviewing not just what may be going wrong, but also best practices, and I think one of the positive things that's coming out of this discussion, when we heard in the expert meeting that we did, which was a very wide group that went from Nell Minow who you have speaking today to the business roundtable, was that there was enormous optimism that there could be an emerging sense of best practice, if this discussion is rigorous enough and if there's enough of a spotlight shined on it.

REP. NEUGEBAUER: You know -- and one of the things in your testimony you said early on, you said you think one of the major causes of the financial crisis that we're in today was -- was based on compensation. The problem I have with the -- going down this compensation road is where in the chain was the compensation inappropriate for the risk being taken?

Was it the young originator of that loan, or was it the person that was at the financial institution that was packaging that loans, or was it the -- the securities company that was securitizing it, or was it with the investment company that was buying those loans? I mean, where in that process was the person being overcompensated and the risk and compensation out of proportion?

MR. SPERLING: I think it's less kind of how much, but it's more can you -- you know, what -- what you don't want, whether it's the person originating the subprime mortgage or the executive, is you don't want to encourage compensation practices where one gets to internalize the gain short term and externalize to others the potential risk and harm down the road.

So, for example, if a subprime mortgage originator -- if part of their compensation might be based on how the mortgages were being paid, that would be a way that you would ask that person to think not just about how much volume that I can push this year, but whether or not you give them an incentive or their unit an incentive to consider how it's going to perform.

You know, some firms are now doing bonus things, and what they're saying basically is that if everybody knew their bonus was going to be held for a few years before they got all of it, well, then if people said, you know, "We're doing some excessively risky things here," there would be a lot greater incentive for people to be self-checks in their own businesses because they would see their -- their compensation would be reduced.

Across the system, too many people could internalize private gain by the volume of what they were doing regardless of its quality or the risk it was externalizing to their firm, the shareholders or, as we've painfully learned, the economy at large.

REP. NEUGEBAUER: Okay. I have a quick question for the three panelists. It's a yes or no answer. If you gave me $1,000 and, in two years, I had made that into $1 million, would it be fair for me to get $10,000 fee for doing that? Yes or no?

MR. SPERLIKNG: It depends.

MR. ALVAREZ: We don't know the --

REP. NEUGEBAUER: Mr. Alvarez, would it be fair for me to get $10,000 if --

MR. ALVAREZ: I don't know. I couldn't say.

MR. BREHENY: I couldn't say.

REP. NEUGEBAUER: Yeah. So -- so the -- what the answer is here is you all are going to set compensations for companies, yet you do not know what an adequate compensation for a return is, and that's the problem.

REP. FRANK: Just to reassure people, the House is in recess so we are not going to have to disrupt this.

The gentlewoman from New York.

REP. CAROLYN MALONEY (D-NY): Thank you, Mr. Chairman.

And I thank all of the panelists.

I would like to note for my colleagues that I Have worked closely with Kenneth Feinberg during the recovery for 9/11 for New York City. He took on a -- an incredibly difficult task determining what the compensation would be for families that had lost their loved ones. It's -- was a very difficult task, and he won applause from everyone. He did a magnificent job with a very difficult, murky, confusing problem. So I compliment the Treasury Department on your selection, and I -- I wish him great success and that he will be as successful as he was with the 9/11 compensation fund.

My question really to Treasury is how did you determine the seven companies that are going to have their compensation determined or guidelined by Mr. Feinberg. Some people have said it was-- if there was 40 percent ownership by the taxpayer -- was that the standard? What was the standard that determined who the seven companies were?

MR. SPERLING: In the regulation itself, it actually mentions the specific names of the programs that they're under, but I think your question more goes to what's the logic and rationale, and I think our feeling is that some of the things we've done, some of the facilities that were set up, are set up to be generally accessible to companies, financial institutions at large, and they are often set up because we think that there is a positive public purpose in them participating. We think whether a community bank -- you know, if community banks wanted to not have more capital, if they wanted to do less loans, we believe that it is in the interest of recovery to have stronger capitalization of banks and a stronger lending profile. So those are generally accessible programs.

Where a company comes to the U.S. government and the U.S. taxpayer and requires exceptional assistance that is not being offered to their peers because they face an enormous threat to their fundamental financial stability that we find to have such an impact on the economy as a whole that we have to intervene, that is an exceptional case, and that gives -- that requires of us at the Treasury Department to have a stronger fiduciary duty to the United States taxpayer, and so even though the legislation -- Congress has spoken.

There is a -- the law of the land in the Recovery Act -- we felt that -- that the law as stated does not have a limit on salary, and we felt that in the case of companies who receive such exceptional taxpayer assistance that we had to have a stronger fiduciary duty, and we spent a lot of time trying to think what was the best way to do that.

And in the end, we felt that if we could find somebody of the judgment and statute of Ken Fineberg who could look across these companies, looking at a set of principles on risk, on performance but also on what is likely to lead taxpayers to get return on their dollar, that that extra level of protection for the taxpayer was necessary and important there in the way it would not be if simply a community bank in your district chose to participate in the capital purchase program partly because their government thinks it is a good thing for them to have stronger capital and be in a stronger position to lend.

REP. MALONEY: Well I think everyone understands that if you take taxpayer money you are subject to a higher form of oversight and accountability, but the question basically that I'm hearing from my constituents is what was the standard? It would be helpful if it was more clear, is it 40 (percent), 50 (percent), 60 (percent), 80 percent of taxpayer dollars? If it was a standard that the public could understand -- and connected to that question is what would trigger the eighth company to come into the fold? I certainly don't think it will be totally the discretion of one individual, it should be some form of public standard that people can understand and hopefully support.

So my second question is what would trigger say an eighth company to be under the same type of supervision as the seven companies named in the legislation? And I'll go back to the legislation but I'm still a little unclear as to what was the standard and I think it'd be helpful if the standard was clearer to the public and to members of Congress on who these particular companies were selected. I would think the easiest form is what is the degree of public funding that has gone into --

REP. FRANK: The gentlewoman's time has expired.

Is there a brief answer anyone wants to -- brief.

MR. SPERLING: Well the reason why I feel that the exceptional assistance is the right standard as opposed to ownership is let's say we decided that we did not want to lever up GM and put them in the situation of having extremely high debt which was the problem they had. So we gave our assistance through equities. But had we done so through very exceptional lending on attractive terms, that would not have given us a certain ownership perspective but you would have looked and thought they are receiving exceptional taxpayer assistance that their peers are not and by being in that situation, that brings on a higher fiduciary duty. And I think that general principle is the right principle --

REP. FRANK: We're going to have to cut it here. And I would advise members we have to be conscious of the time. And questions with no time left are hard to get answered.

The gentleman from Delaware.

REP. MICHAEL CASTLE (R-DE): Thank you Mr. Chairman. I will tell you I have an abiding concern about what the federal government is doing in this area versus what the states are doing and in general what the federal government's been doing in terms of bailout situations and whether it's really working or not. But my first question to you is have any of you or different agencies studied who the shareholders are?

And I say that knowing that in many corporations wealthy, private individuals, private firms, mutual funds and others become the stockholders of record and sometimes very often the voting stockholders. And I'm afraid that their interests may be absolutely no different than some of the so-called greedy executives who are looking for immediate compensation. In other words, they're trying to get in and out in a relatively brief period of time. Are we really serving the public by making these changes? Or is that -- and I realize if you go through each corporation it will be different, but is there a general sense of who the shareholders are in corporations in America today that's been well analyzed?

MR. SPERLING: I will let my colleague from the SEC answer all. The only thing I would just say that goes to your point which is that we do have to be very careful in a one-size-fits-all metric for rewarding behavior. And I think some of the experts that you're going to hear in the next panel are very persuasive in making that case that simply using stock while often successful is not full proof and I think it's something we should all, us included, be studying very carefully and listening to the type of people you have coming up in the next panel, but --.

REP. CASTLE: Thank you.

MR. BREHENY: Thank you Congressman. I appreciate the question and having the opportunity to answer it. I don't know that I have a fulsome answer, a complete answer for you which I'd be happy to --

REP. CASTLE: I wouldn't expect you to but --

MR. BREHENY: Okay. And I'll be happy to work with you to get that, but the issue that you bring up is one that we absolutely have considered in most of the rule making matters that I've been involved in. You know, interest of shareholders, long term, short term percentage ownership, small companies versus large cap companies are all or many of the issues that we think about when adopting rules. It is certainly something that we seek comment on. We issue rules. And we have been thinking about economic interest and voting interest in going forward.

So I am aware of those issues, we are aware of those issues, we think about those issues, I don't again, no I have a full answer to tell you if I can give you a responses to, can I tell you the make up of the American shareholders. But those particular interests are definitely raised with the commission and it's something that we think long and hard about before we adopt rules.

REP. CASTLE: Good. I think it's important. I think we need to keep an eye on it.

My next question is sort of general and it goes back to what I said at the beginning and that is you know what should we in the federal government be doing versus what the states are doing? Most -- and corporations in this country are at the state level, states are beginning to make some changes, not dissimilar to what you're saying and as I've indicated I think that there are some concerns about some of the compensation factors.

But I'm not sure that the federal government should be stepping in and doing this. And my concern is if we do this, are we going to be expected to take whatever the next step is or whatever it may be. Are we better off discerning exactly what the problem is and then allowing the states to make whatever the decisions are that would be corrective in this case versus doing it at the federal government level?

MR. BREHENY: I'm not sure that the commission itself has weighed in on that particular issue but I think if you go back and look at the provisions that were adopted in Sarbanes-Oxley, the provisions that the -- rules that the commission have adopted, we have gone to great lengths to maintain that balance between, you know, the interest of the SEC, the authority that Congress has given to the SEC to protect investors versus the very important state law rights that all shareholders have. I think you'll see that in many of the rule making that the commission has gone through. There is a balance -- it's a policy question I'm sure that you need to answer which is why you're asking me the question -- I don't know that I can tell you. I do think it's important balance. I think the state federal rights are recognized throughout the rules that the commission has and the authority that the Congress has given to the commission.

REP. CASTLE: Well, I'd like to ask another question but I probably don't have time so let me just say this. I understand what you're saying but I think we need to be very careful about how encroaching we are being with respect to dictating in terms of corporate structures and corporate methodologies involving the federal government.

I think it can be putting the foot in the door for what could happen in the future and I think we need to be very cautious about that. If I had time Mr. Sperling I was going to ask you about the structures on the timelines you talked about at the beginning as to what those structures are but I may submit that in writing because the red light is now on and I have to yield back the balance of my time.

REP. FRANK: I thank the gentleman's sensitivity to the time, and I now recognize the gentleman from North Carolina for five minutes.

REP. MEL WATT (D-NC): Thank you Mr. Chairman and I apologize to the witnesses for not being able to be here for their testimony but I have been reviewing it. And I want to take the semantic way in which Mr. Sperling addressed these issues differently and ask a broader question.

The first three principles that you outlined in your testimony, Mr. Sperling -- compensation plans should properly measure and reward performance, compensation should be structured in line with the time horizon of risk, compensation practices should be aligned with sound risk management by all kind of general principles. But then in the fourth and fifth you may not even be aware of this, the fourth and fifth principles you shifted to a different phraseology, you say we should reexamine whether golden parachutes and supplemental retirement packages align the interest of executives and shareholders and number five, we should promote transparency and accountability in setting compensation.

My underlying question is who is the we, first of all, and the extent to which authority already exists either at the SEC or the fed to do some of this under existing statutes, or whether there are specific things that this committee and Congress must do to change the law to address these issues.

MR. SPERLING: Thank you. Perhaps in the fourth I did not use our words well because I think they are actually different. I think on the issue of golden parachutes and supplemental retirement packages, we were not coming with a particular legislative or even regulatory proposal, we really were in a sense trying to shine a spotlight on a practice that we think --

REP. WATT: That we in that case being the Treasury?

MR SPERLING: The we being the Treasury Department were trying to suggest that based on our review, that is a practice, that there are practices on the supplemental retirement accounts, excessive retirement accounts for executives, and golden parachutes that shareholders and management should reexamine.

And there may be times that they are appropriate, but there seems to be increasing evidence that they've become more prevalent, more --

(Cross talk.)

REP. WATT: Okay. Well, let me to the second question.

MR. SPERLING: So, I say, that I perhaps chose my words poorly if that implied, that we, the Treasury Department, have a specific proposal. On the fifth point, which is the one you mentioned, there we were coming to the table with a specific proposal and it was a proposal to essentially give the SEC the authority they need to do two things that the Treasury Department and the SEC both feel are in the interest of a sounder --

(Cross talk.)

REP. WATT: Those two things quickly are what?

MR. SPERLING: Are the Say and Pay legislation.

REP. WATT: Yeah.

MR. SPERLING: And which again we were given the SEC authority to do and giving the SEC clear legal authority to strengthen the independence of compensation committees in the way that after ENRON Congress gave the SEC the authority to strength audit committees.

REP. WATT: Well, I thought SEC already had this authority, Mr. Beheny, and maybe you're just not exercising it. Do you need more authority or is it just that the SEC that we've had has not exercised the authority that they already had?

MR. BREHENY: No, Congressman, I don't believe they have the authority to require companies to have a Say on Pay Proposal or strengthen compensation committee consultant. The Chairman of the SEC is on board supporting both the Say on Pay legislation --

REP. WATT: Well, if the SEC doesn't have it, do the regulators have it or are we talking about all public companies that don't have regulators? What about with banks, regulated banks? Would the regulators already have the authority to say you've got to have a more aggressive compensation committee on your board? Would they have the authority already to say you've got to give your shareholders a right to have Say on Pay?

MR. BREHENY: No, on Say on Pay. We would not have the authority to require those kinds of disclosures. That's not safety and soundness related. On strengthening compensation committees, we may be able to do some actions there, but I'm not sure we'd be able to get as far as the Treasury Department would like.

REP. WATT: Thank you, Mr. Chairman.

REP. FRANK: Well, I think, historically, safety and soundness has more often been used to invoke non-disclosure than disclosure.

The gentleman from Texas, Mr. Hensarling.

REP. HENSARLING: Thank you, Mr. Chairman.

Mr. Sperling, I tried to listen carefully to your testimony, and in listening to it I must admit I find myself in agreement with most, if not all of the principles that you lay out, compensation plans should probably measure, more performance structured in line with time horizons of risks, should be aligned with sound risk management, and the rest.

For most of my life I have signed the back of a paycheck, but there was a time I actually signed the front of a paycheck and there was a time I served on the compensation committee of a New York Stock Exchange company. And not unlike the gentleman from California in his opening statement, I thought I worked very hard to try to ensure that these principles were put into place.

I remember an unhappy CEO when I was part of a comp committee informing him he would not be getting the pay package compensation structure that he had desired. I guess my question is for you is since I have found this challenging and I was in the private sector for 12 years; I've been a member of Congress for six-and-a-half. When I came to Congress I didn't have any kind of epiphany that now I know what the perfect compensation structure is. I go back to what the gentleman from California said and, why can you do better?

MR. SPERLING: I don't think there's anything that we're proposing that suggests we could. I think what we're perhaps suggestion on the compensation committees is that when you were in that position, if you had the authority to hire your own compensation consultant if there was not an ability for the compensation consultant to have a conflict of interest because they were being paid by the CEO and some other measure that that would strengthen your hand.

You seemed to have been able to in your situation, to strike that type of independence and I compliment you on that, but I can say that many people find on a compensation committee that if the company itself is hiring both the council and the consultant that it's very difficult.

And, in fact, there's a study that shows that CEO pay does end up being higher when you use a compensation consultant that has conflicts of interest.

REP. HENSARLING: Well, I appreciate your approach in that regard and it will be an open question in my own mind whether or not there are ways to strengthen the hand or the powers commensurate with the responsibilities of the comp committees of public companies. I have an open mind about that.

I can tell you from my experience on this committee, though, that there have been many witnesses from private enterprise sitting at that table who have received strong suggestions from this committee that this is a way that you might want to do something because if you don't do something, we will do it for you. So I'm somewhat fearful that once we go down this road, we may go way beyond really strengthening the hand of compensation committees.

Also, Mr. Sperling, on Page 4 of your testimony, you state that, quote, "When workers who are losing their jobs see the top executives at the firms walking away with huge severance packages it creates the understandable impression that there is a double standard, and I agree with that impression.

Let me ask you, since the executive comp issue has first arisen in terms of TARP, I want to ask you a TARP related question. The administration put forth a reorganization plan for GM. Under that plan GM bondholders, many of them are middle income Americans, including blue collar workers, tradesmen, who invested $100, $1,000 in GM bonds for their 401k's for their retirement.

The GM bondholders apparently under the administration plan get 10 percent of the company for $27 billion in claims, warrants for addition 15 percent. The United Auto Workers get 17-and-a-half percent of the company for less in claims, 20 billion (dollars); and 10 billion (dollars) in cash; 6-and-a-half billion (dollars) in preferred stock; 2-and-a-half billion (dollars) in IOU and warrants for an additional 2-and-a-half percent of the company.

Would that not create an impression of a double standard?

MR. SPERLING: I really don't believe so. I really believe that the bondholders represented themselves very well. I think they were better off than had they allowed for a completely uncontrolled bankruptcy, and in terms of the VEBA, it is going to require very painful sacrifice from retirees, retirees who did nothing wrong, were not part of contributing to this financial crisis. I really do believe there was very careful shared sacrifice in their arrangement.

REP. WATERS: Thank you.

Mr. Sherman.

REP. BRAD SHERMAN (D-CA): Thank you. Commenting on the last gentleman's comments, I'm not sure that the bondholders were hurt. Rather a huge infusion of taxpayer money helped all the old stakeholders. I think we were more generous with the workers than we were with the bondholders, but if anybody is not being treated well in this, it's the taxpayers.

I want to recognize Kathleen Connell who is here in the audience, who was for eight years Controller (sic) of the state of California. I notice that quite a number have railed against government-controlled pay. I should point out this is companies that have taken and are holding our TARP money.

I want to join the Chairman in welcoming Republicans when they reject virtually every Bush administration economic policy of the last seven months of his administration, but I think it's now time for Democrats to reject with the same insensity (sic) virtually all of those policies.

We're told that only a few TARP recipients ever received extraordinary help and only those few should face real limits on executive compensation. I would say that TARP is an extraordinary departure from free enterprise and that even those who only got one infusion of, say, $25 billion of capital should be viewed as getting extraordinary help.

I have one question for the record because I'd like all three of you to answer it and it's way too complicated to do so orally. And that is I want you to imagine how we would design an executive compensation system for the derivatives unit of AIG or some other derivatives unit inside a big company.

If you just said we'll give them restricted stock and restrict it for a few years, they might take extraordinary risk so that the unit looked extraordinarily profitable, yet an extraordinary amount of AIG restricted stock they would have believed that AIG would have been a solid company, no matter what their unit did.

I don't think anybody in that unit or in this country realized that that unit could bring down that enormous company. Likewise, keep in mind, at least for this example, assume that this unit might show profits for accounting purposes for five or 10 years in a row before it imploded and now try to figure out what kind of executive compensation system would reward the people in that unit for taking the right kinds of risks, but would actually penalize them for taking the wrong kinds of risks.

Now, for a question for our representatives from the SEC.

There were elections in Venezuela to control the government of Venezuela. Our State Department criticized Hugo Chavez for using the resources of the government to effect the outcome of the elections, for representatives to control the government.

So, what can you do to propose to Congress, or to your own board for regulatory changes, rules that would prevent corporate management from using the resources of the country to unduly influence the outcome of the election without giving similar resources to the other side?

What would you do to, say, that certain challengers were supposed to get resources? And what has the SEC done to make sure that the challengers have equal space in the proxy statement, which is the one document you do control?

MR. BREHENY: Thank you, Congressman.

That exact issue was the point that the commission took up on May 20th. And, as you may know, this is the third attempt that the commission has made to give shareholders -- who have a state-law right to nominate directors, the ability to have those nominees included within the company's proxy materials.

So, the issue about disclosure, and the ability to provide disclosure about their nominees, is all included. And that rule proposal is up on the commission's website as of last night.

REP. SHERMAN: I would hope that you would propose legislation that would go far beyond the proxy statement. Trust me, it's a boring document.

What's needed is equal amounts of -- in some cases, millions of dollars to call shareholders and try to get their proxies. And that contest needs to be equal.

I guess my time is expired.

REP. WATERS: Thank you.

Mr. Garrett.

REP. GARRETT: I thank the chair.

And, before I go to my questions, let's go back to the opening of the meeting where the chairman was talking about history, and how history is relevant. Indeed, it is more the pity that revisionist history is not relevant.

Yes, there were some Republicans on this side of the aisle just now repudiating what the past administration did -- a lot of the bailouts. Unfortunately, the chairman and others were not repudiating it when it was going through the House. And you remember the chairman actually, as some said, "carried the water" for the past administration to make sure that that legislation was not only engaged in, but made sure that legislation -- the TARP legislation actually passed.

And, also, we must remember that history tells us that this new administration has basically adopted, hook, line and sinker, the past administration's of the bailout philosophy (sic). So, yes, there are a number on this side of the aisle that repudiated (it) in the past. And I look to the other side of the aisle, there's maybe one that I see over there that joined with us in that fight against the TARP bailouts, and all the string of bailouts that followed. So, let's remember what history was.

And I also see that we have the counselor to the Treasury secretary here with us today. Remember also that Mr. Geithner, at that time, was with the New York Fed; and at that time the New York Fed was the -- he was considered the "architect" of the bailout of the AIG bailout. And this administration adopted Mr. Geithner as their Treasury secretary.

So, I think there is the pity that this administration is continuing on in the mold, and continues on with the bailout, and that's what a number of us thought was wrong then, and continues to fight out against now with our legislation and what we will roll out later on.

So, with history now clarified, Mr. Alvarez, I see in your testimony you say that employees -- (inaudible) -- and expose a firm to significant risk; and importantly, and properly designed compensation programs may incite a wide range of employee behavior.

You also say, "We should adjust compensation so that employees bear some of the risk associated with their activities. An employee is less likely to take an imprudent risk if incentive payments are reduced or eliminated for activity that ends up imposing higher than expected losses."

I agree. How does that (occur ?) in the Fed right now with the activities that the employees take, that have a risk not only on themselves but the entire economy --

(Long pause.)

REP. GARRETT: -- where they can do anything they want without any risk?

MR. ALVAREZ: There is no one at the Fed that can do anything they want without taking risk. And --

REP. GARRETT: As far as their --

(Cross talk)

MR. ALVAREZ: -- we have oversight committees that --

REP. GARRETT: As far as their compensation.

MR. ALVAREZ: No, no, no, as far as their actions as well.

REP. GARRETT: Okay.

MR. ALVAREZ: So, there is a performance -- at the Federal Reserve there is a tie between performance and pay. We are all rated on our performance, and we all have adjustments to our pay based on our performance. We aren't paid with bonuses in the way that the industry is that we're talking about here today, though.

REP. GARRETT: Right.

For all the panel, looking at the proposal that's coming from this administration -- (inaudible) -- the chairman was talking about, some would suggest that the proposal would have a higher cost for businesses to operate. Most would agree with that. Some would argue that larger corporations could probably bear that cost. Others would argue that that may be the case, but smaller firms would have a difficulty dealing with those pretty significant additional expenses.

Does anyone have a comment on how smaller firms would -- may have to deal with these costs to the operation?

MR. ALVAREZ: So, I would say that smaller firms actually do a better job of aligning risk and rewards than the larger firms do. In part, because typically, in a smaller firm, the C.E.O., the C.F.O., if there is one, knows the employees; knows the risks that are coming onto the balance sheet; knows what the employees are doing, and so is able to adjust the compensation practices.

What we're talking about --

(Cross talk.)

REP. GARRETT: But, if we set up additional requirements, would that -- if we set up any additional requirement, and what have you, as far as outside -- excuse me, as far as the other requirements that have been laying out there, doesn't that add to the cost of them doing business? Will they be able to absorb that?

MR. ALVAREZ: So, I'll defer to the others on theirs, but the kind of approach the Federal Reserve is considering is outlining principles on how they --

(Cross talk.)

REP. GARRETT: Okay, then maybe I'll turn to Mr. Sperling then on that, on the administration's proposal. Thank you, Mr. Alvarez. I appreciate that.

MR. SPERLING: Well, the two proposals that Secretary Geithner put forward -- say, on pay, and the independent comp committees, I do not believe would have a significant cost. It would obviously apply to public companies.

It doesn't mandate that there is a -- you know, I mean, it does not put a mandate. It says that if you are -- if a comp committee, an independent comp committee is going to hire a consultant or counsel, that that committee needs to have the authority and funding to do their job without conflicts of interest.

So, I feel the things we've put forward right now would be affecting public companies. But, I share your view that one always has to do an analysis of what the differential impact would be on small businesses.

REP. WATERS: Thank you very much.

Mr. Moore.

REP. MOORE: Thank you, Madame Chair.

Before we learned of the $165 million in AIG bonuses in March, we also learned from New York comptroller in January that Wall Street executives were paid $18.4 billion in bonuses last year. I was troubled by this news, especially during a national emergency when the federal government is providing billions of dollars of taxpayers' funds to stabilize the financial sector.

Now, under normal circumstances I don't believe -- and I think most of the American people don't believe that we should -- Congress should be involved in any way in setting executive compensation, or compensations for board of directors and shareholders; believe the same, I think -- see shouldn't be setting those salaries.

But, we're not in normal circumstances, and that's why I filed H.R. 857, the Limit Executive Compensation Abuse Act which, for TARP recipients only, would have limited the annual executive compensation to the same level of compensation the president of the United States gets paid -- $400,000.

Starting with Mr. Sperling, I guess I want to ask you, do you believe compensation practices can pose a systemic risk or jeopardize a firm's safety and soundness? How should Congress guard against risks to the financial system without stifling reasonable compensation practices?

MR. SPERLING: I think we've learned the hard way that they can contribute, and I think it's been part of the discussion that we've had today.

And I do want to say that, you know, we often do mention, or use the examples of the extreme cases, or where people were truly bad actors. But, a lot of, I think, the danger comes from building systems then where even good people do not -- are not given the right focus.

And we talked before on the whole practice -- from the origination of subprime mortgages, to their packaging, to their sales, you almost had a chain of financial transactions where you were paid for the -- (inaudible) -- by the volume of what you did, and then you either externalized it to the firm or you kind of moved it on to the next person.

And, of course, what happens is that when you're in kind of a bubble or an asset bubble situation, the people who are being cautionary start looking they're overly risk-averse; the people who are being a bit reckless start looking they're wise, and smart and making good money.

And it's exactly why you have to really believe -- a company has to believe in risk management. And it has to be something they do throughout the system. And they have to empower that person -- as I said, you know, that even when the going's getting good, why was it, in firms throughout the financial industry, there was so little effectiveness of risk management when there were no shortage of people writing that there was a potential housing bubble?

Perhaps people didn't realize how -- the degree, the depth of what we would go through. But, there was the problem. So, I do think that companies have to believe in strong risk management, and they have to empower their risk managers to have the stature and independence to stand up, even in good times, and say, "Yes, this practice has worked the last few years, but when we look at the underlying value of what's happening, we think we are creating risk in the out-years for our company, our shareholders, and the economy as a whole."

REP. MOORE: Thank you, Mr. Sperling.

Mr. Alvarez, do you have any comments?

MR. ALVAREZ: The only thing I would add to that is that the industry recognizes that there was systemic risk, and risk to the health of the firm through the compensation practices of the past.

And if you recall, 15 or 20 years ago there was quite an effort to just get pay tied to performance, as a beginning spot. And so the methods that were used to tie pay to performance have shown, in this crisis, to have flaws to it. I think everyone is recognizing that, and so it's an opportunity -- we have an opportunity now to make some strides to improve it, to improve the health of the system and firms, individually.

REP. MOORE: Thank you, and I think my time is up and I yield back. I'm sorry, Mr. Breheny.

REP. FRANK: Thank you. The gentleman from Florida.

REP. BILL POSEY (R-FL): Thank you, Mr. Chairman. I'm still trying to figure out what would make some of the compensation boards or committees recommend the incredibly high compensation that they did when it was clear the ship was on the rocks and it was going down. How did the compensation laws that we have now, if they do -- how do they affect gifts between, say, a CEO of a company and members of the compensation board?

MR. BREHENY: Thank you, Congressman. The SEC's rules have quite a bit of requirement with regards to disclosure about conflicts between members of the compensation committee and other executives at the company. In fact, it's a -- it's a New York Stock Exchange, a listing company requirement that today compensation committee members have to be independent and those rules are quite extensive.

I think what you're hearing from my colleagues in the recommendations that were made yesterday was to increase the independence of the members of the compensation committee beyond what they currently are today to restrict all sort of connections between compensation committee members and the board. So I think we're looking at about heightened compensation. But there is an independent requirement today and there is quite a bit of disclosure already required under the SEC's rules.

REP. POSEY: Have you ever found that to be violated in the history of the SEC or the law?

MR. BREHENY: Unfortunately, I don't have that information to be able to give you a thoughtful answer on that. I'd be happy to look into that. Certainly, the commission takes this authority to enforce the rules with regards to, you know, violations of any -- either our disclosure rules or other rules very serious. But I'd be happy to get back to you with information about that.

REP. POSEY: Mr. Alvarez and Mr. Sperling, why do you think they would pay out some -- such incredibly high bonuses when they see the ship's on the rocks?

MR. ALVAREZ: I think one reason is what we call a collective action problem. No one wanted to be the first to rationalize bonuses for fear that they would lose their best talent. That's actually one of the reasons I think we as supervisors can be helpful here. By increasing the priority of the board of directors and the management to pay attention to the incentives and compensation, helping to outline best practices and good principles, we can push the whole industry to act together, and in that way there's a little bit of safety. Then there's less concern that an institution that does make the proper adjustments does, for example, take away bonuses when performance is poor won't be left as the only one doing it and that will improve the practices of everyone.

REP. POSEY: Do you think there would -- it would make any sense just to impute some culpability to stockholders in their losses if you act poorly like this -- that opening the exposure to liability could be just as effective?

MR. ALVAREZ: Shareholders already do share in -- when there's excessive bonuses paid to executives that's costs that are borne by shareholders. When there's excessive risks taken --

REP. POSEY: When was the last time -- when was the last time you're aware that that was utilized?

MR. ALVAREZ: Well, but the shareholders -- it's reflected in the decrease in the shareholding -- in the price of the --

REP. POSEY: I understand in theory but, you know, most stockholders that I know -- and they're small investors, they're not big investors -- they think that these humongous bonuses are just a necessary evil -- there's nothing that they can do about them and it's just as bad one place as at another one.

Everybody's misbehaving. They're not going to find anything better to their bottom line if everybody's misbehaving to the same extent, and nobody's done anything about it. And quite frankly, I doubt that you're going to be able to regulate people into doing the right thing like that. I think that just holding them more accountable individually and personally liable and accountable would just make a little bit more sense. Mr. Sperling, I'd like your two cents worth.

MR. SPERLING: I actually think the proposals we're talking about would be effective. I agree with -- I would agree with Mr. Alvarez that there is a bit of -- and you see this in the whole way the compensation consultants work. It is simply -- it's not -- there's less of is this fundamentally sound, fundamentally good for the shareholder, and more, how does it compare to the practices of your peers. And so you do get a bit of a collective action problem where people simply just say well, our five competitors do this and that becomes the beginning and end of the discussion.

And I think that empowering compensation committees but also the say on pay bringing this to light does have a powerful deterrent impact. And I'll just say in the U.K. even the study from the Harvard Business School that was a little more skeptical said its positive effect was on deterring high payouts to those who clearly performed poorly.

REP. FRANK: We have a vote. We're going to take Ms. McCarthy. Let me announce that we have another subcommittee hearing, but Ms. Waters has graciously agreed to use that in our subcommittee room. So we will take a break and continue. I'd ask the panel to stay. There's only two votes. We won't be gone that long. Ms. McCarthy will have a chance to get in your questioning and then we'll break for the vote.

REP. MCCARTHY: Thank you, Mr. Chairman, and I appreciate that. Many, many years ago my husband worked on Wall Street. He started off on Wall Street, I think, when he was 17, and he worked his way up and he worked for a very large financial service company. He was in compliance and he had the whole Northeast Corridor to go to all the little offices to make sure that they were complying with the SEC rules but also for the company rules, and he always found it amazing -- because he never announced when he was going to be there -- that he would go into an office, and a lot of them obviously followed all the rules and regulations, no problem.

But there were certain offices that did not follow those rules and regulations, and he would write them up and then make another surprise visit back to see if they cleaned everything up. They did not. And that's when they got in trouble with the company, and these were usually large offices that produced a lot of money for the -- that particular location. And I think when we talk about why we're here today and even talking about what we're doing, I think people have forgotten that we're here because the companies did what they did and they're trying to get their reputation back now.

The banks have to get their reputation back now. The financial services have to get their reputation back. And people do not trust them yet, and it is our responsibility as the government to try to protect our constituents. They lost trillions of dollars. People are hurting and they are still hurting. We're happy to see that things are starting to go forward, I believe, because of what the government did that the markets are starting to stabilize. We still got a long way to go on housing.

But it's because what we did do. With that being said -- and I have to say also for my colleague when she mentioned Kenneth Feinberg (sp) -- he's great. I worked with him unfortunately when an awful lot of my constituents that lost somebody on 9/11, and I think he was a great choice. But I go back to, you know, one of the articles -- and by the way, that was another thing in the article. Already, this Wall Street today -- already many on Wall Street are beginning to voluntary change their pay practices through -- though it remains to be seen how long. That's another reason on why we're doing what we're doing today and hopefully for the future. But my question to you would be could you expand on what is considered exceptional assistance? I actually don't understand that part.

MR. SPERLING: The easiest way to describe would be that in the previous administration they set up the Capital Purchase Program. This was -- and this was expanded to all banks so even smaller banks can come in -- and the idea was to try to give more banks the capital so that they were in a stronger position to lend, not because we were concerned about each of those banks but because we felt collectively if there was stronger capitalization of the banking system there would be more lending and that would be good for the economy.

An individual bank might say, you know what, we're just going to weather this storm by not lending -- we're not going to make much money but we'll get through it. But for us, we know that if 5,000 banks all do that at the same time that means there's going to be less small business lending and there's going to be less growth and this recession will last longer. So that's a generally accessible program and the people who come to it don't necessarily come because they're weak -- they come because we have a policy goal of wanting banks to have more capital.

Compare that to perhaps CitiGroup, where they required government assistance for their fundamental financial stability, and because of their importance to the overall financial stability, the economy, because of our desire to not let something like Lehman Brothers again happen, we make an exceptional effort -- we make an exceptional assistance that they get that is not available to their peers and it's not based on a general goal. It is based on an exceptional intervention to assist them essentially in their fundamental financial stability. That is a very different situation, and while I could give you -- and I think that principle is one people understand.

I mean, I think people understand that there is something different about AIG and CitiGroup and GM than their community bank that takes more capital in the Capital Purchase Program. And I want to make clear -- the law of the land that was passed in the Recovery Act applies to everyone, so the restrictions on bonuses. We added provisions on luxury expenditure, on say on pay, on having to write in a narrative way what your risk analysis is.

But we were not as intrusive in those situations because many of those banks are the community banks in your district where you are giving taxpayer dollars to a company that would have gone into bankruptcy if they were not systemically significant. We feel a higher obligation, and that really is the -- in many ways the fundamental test.

(Cross talk.)

REP. MCCARTHY: My husband actually believed nobody should get bonuses, just get a good paycheck.

REP. FRANK: We are going to return with this panel and I am going to call on the Democratic side only those members who were here and did not get to ask a question. New members will get to question the second panel. So the five members here who didn't get to ask will be called on to finish this panel and we will then get to the next panel. If one or two Republicans show up we'll do that. We should be gone for not more than 25 minutes. There are only two votes. Most of the time is gone on one of them. We will be back as soon as we can. I thank the panel for waiting.

(Recess.)

REP. FRANK: Mr. Scott of Georgia is recognized for five minutes.

REP. DAVID SCOTT (D-GA): Thank you, Mr. Chairman.

I want to say two things at first, because I think that from our various conversations during the first part of the hearing, just to make clear, we're all capitalists here. We believe strongly in the capitalistic system. And the reason this committee is moving and exploring this issue is because we care about the capitalistic system.

And the capitalistic system is not manifested just with CEOs. It's not structured to take care of them first. The capitalistic system is geared with public interests, it's geared with shareholder's interests.

What we are concerned with here, particularly in a financial sector, is the health of our economy. At the heart of the health of our economy, the heart of this, is basically our financial service industry. And so what we have here in dealing with this issue of compensation and the role it plays in systemic risk is that there is some valve clogging going on. And we need to examine this so that this heart, the heart of our system, the financial system, does not endanger itself with a heart attack. Clogged arteries bring that, and we do have a clogged artery here.

It's clear that excessive compensation has played some degree and some contributing factor to our financial situation. And I think what we're trying to do here is on two levels. One, we have to respond to companies like AIG and others that come and ask for the taxpayer's money to help them. We've got to make sure we're good stewards of that taxpayer dollar, to make sure that compensation is in line.

And it's clear, anybody with any ounce of caring about the capitalist system realizes that giving of $168 million in bonuses and compensation of taxpayer's money to a failing company asking for a bailout was excessive.

But what it did, it opened us up to a realization of perhaps this compensation issue. This heavily unbalanced structure between bonuses and salaries certainly had some risks involved. Excessive compensation packages were indeed a contributing factor because incentives for short-term gains overwhelmed the checks and balances that were meant to mitigate against the risks of excessive leverage.

So the question is, how can we better align our compensation packages with sound management risks that properly measure reward performance. Sort of like Scott Burroughs here with some of these CEOs, where they've gone and cut deals regardless of performance. We're paying some of these CEOs as if they were 350-point hitters hitting 50 home runs when they're 220 hitters, no performance.

So I think that what is wrong with having shareholders to be able to have a say in these packages. Now, we have an excellently run company in my state of Georgia, Aflac, that has done this with great success. Shareholders want to see that their leaders, the people who are running the companies, they have the best talent, but they certainly want to make sure they perform. So we have excellent examples here of shareholders who are taking part in that.

But I just wanted to make sure that was said.

But my question, Mr. Chairman, before my time is out is just a comment from each of you. How can we better align our compensation packages with sound management so that they properly measure pay for performance? And what is wrong with having shareholders have a say -- not the government, not us, but the people who own that company? But the people who own that company, they ought to have a say in what these people are being paid, particularly hired guns with contracts.

REP. FRANK: We have time for one answer.

MR. BREHENY: I truly think the Say on Pay is a situation of all upside, no downside. We are empowering the shareholders with the ability to have stronger oversight. You are forcing the company to think more seriously about what they do, how it will be perceived and not just to go on automatic pilot doing practices that are not defensible simply because their peer group is doing it.

All I'd say kind of quickly, knowing we have time issues, is that I think that you need some type of long-term compensation or something that at least makes you internalize some of the risks that you are creating so you do not get entire industries or entire sets employed who are all being paid by volume based on fees, and nobody in the process is looking at the underlying value or the long-term risk.

And then I think a hard part for all of us is that we don't simply create a world where everybody is out saying, yes, pay for performance, and we haven't really looked carefully whether the performance we're now blessing is subject to manipulation itself. And I think that's going to be more complex, more careful mixes of metrics.

(Gavel sounds.)

Sorry, Mr. Chairman.

REP. FRANK: The gentleman from Texas.

REP. AL GREEN (D-TX): Thank you, Mr. Chairman. Mr. Chairman, I thank you for your leadership.

It's been said that managers want to do things right, and leaders want to do the right thing. I think we're doing the right thing. And I'd like to have just a moment of soliloquy, because I'd like to speak for many persons who are not here to speak for themselves.

I want to speak for the autoworkers. I speak for them because today there seems to be some debate as to whether or not we should endeavor to make some adjustments with reference to executive compensation in terms of how it can promote excessive risk taking. And the autoworkers have had their salaries maligned, they have been castigated for making too much money.

And it's unfortunate that there are those who would want to limit the salaries of autoworkers but would take a firm stand against making any endeavor to look into whether or not excessive risk by way of salary has driven some of these adverse market conditions that we have.

I have before me evidence of a bill, H.R. 7321, which proposed requiring the employees of Ford, GM and Chrysler to receive the same compensation, or nearly the same, as Nissan and Volkswagen. It just seems to me that those who would sponsor this kind of legislation would find it in their hearts to see that we can look into the type of legislation that we are considering today.

I have evidence of H.R. 5, which passed the House in 2005, which would have placed a cap on the percentage of damages that lawyers can receive. It would have capped them at the 15 percent of any fee over $600,000. A lot of money, not nearly as much as what some others are making.

And it just seems to me that if we can cap or try to cap and cap the fees of lawyers who represent consumers, we can also look at lawyers who represent corporations.

Those who are not here today, I just believe they'd want this said, because there are people who are suffering, who have had their salaries cut, who work in the auto industry. And these are people who are not getting bonuses that they'd use to buy second and third homes or to buy additional cars. What they lost was money for education, money to pay house notes, money to sustain themselves.

And I find it quite frankly disenchanting to know that there are those who would want them to receive cuts and not want us to look at the compensation that these executives are receiving, that can create excessive risk in the marketplace.

So I thank you, Mr. Chairman, for giving me this moment to voice the concerns of those who are not here, the blue-collar workers and the lawyers who represent the consumers, who have gone to battle for them and made a difference in their lives and in the lives of people in this country by causing us to have products that are safe by virtue of knowing that there are these -- these lawyers who will take on these challenges and make sure that the consumer is protected.

Consumer protection is important. We have one of the best consumer protection systems in the world, and it did not cost the government one penny because we had lawyers who were willing to stand up for those who could not stand up and speak up for themselves, and it's very unfortunate that we choose to regulate these lawyers, but we don't regulate our -- these -- don't see the need to regulate lawyers who are creating excessive risk who work for corporations.

I -- I don't want to see anybody's salary cut, I don't want to see anybody's salary regulated, but the American people understand that something wrong has happened, and they want to see us do something about it. And that takes leadership. We can't just manage this problem, we've got to show some leadership and make the necessary changes to eliminate this excessive risk-taking that created much of the systemic problems that we've had to contend with.

I yield back. Thank you, Mr. Chairman.

REP. FRANK: The gentleman from Colorado and then the gentleman from Missouri.

REP. ED PERLMUTTER (D-CO): Thanks, Mr. Chair.

And just a couple questions and comments. My friends on this side of the aisle have expressed a lot of what I'm feeling, and even my friends on the other side of the aisle who could be the greatest laissez-faire capitalists in the world have got to question when there is such a serious divide between management and ownership, and -- you know, I'll take Qwest, which is a big company in Colorado.

Qwest -- one of our CEOs -- he's now gotten himself in trouble -- got $148 million, all right. Now this is -- this is comparing apples and oranges, but the governor of the state of Colorado gets $90,000, and most people make 50 (thousand dollars) to $200,000 in Colorado. How is it that a -- an executive gets $148 million? I mean, how does that pay come about?

Mr. Sperling, can you -- I mean, how does -- how does -- how does anybody approve that kind of salary for anybody?

MR. SPERLING: Well, I am -- I don't know your specific case -- the specific case, but I will say one thing -- and, again, you have some excellent experts coming on -- which is one of the things that -- you know, one of the things that disturbs me is whether or not retirement, golden parachute type of payments are somewhat promoted because they are less transparent. People do not know the walk-away value of what a corporation -- a CEO may have until that moment.

REP. PERLMUTTER: Well, let me -- let me give you one that maybe you are familiar with, or maybe the other panelists, because I appreciate, you know, giving some more teeth to the compensation committee, but, I mean, there still is a divide between the owners of the company and the management, and maybe the owners reign it in. That is laissez-faire capitalism.

Let's take Angelo Mozilo, Countrywide Financial, who has been involved in a lot of the troubles potentially that we have today. His salary was $102 million -- $102 million. Are the owners of Countrywide actually having a say in what he's making? I mean, if I'm the owner of the company, I'm going to want that in my pocket as a dividend! Do you think your compensation committee approach really gives those owners the strength that they need to say, "No, that's too much."

MR. SPERLING: Well, I -- I think that -- I think the case you just mentioned goes to the heart of the pay for performance. I think there's been nothing that so promotes the sense of double standard that I mentioned -- and I believe you are mentioning -- than the extraordinary cases of huge sums for CEOs who have failed. And the juxtaposition between workers losing their jobs, seeing pensions cut, with the failed CEO receiving an enormous amount of -- of sums as they leave, having failed, I think is very destructive to the kind of public trust in our financial system. And so I think it really -- I think that goes to almost the heart of everything we're talking about.

How do you ensure that there actually is pay for performance, and I think part of that is shining a spotlight on whether people are just doing compensation based on what their peer group is, whether it's acceptable to have these kind of compensation packages that allow this when there's been no performance. And, you know, I'm heartened a little bit to see that -- you know, I saw that a couple of the companies who were just paying back their TARP, without any push from the government, but I think because of this focus, put out statements saying they're just going to do pay for performance, they're going to give most of the compensation in stock to be held for a long time, and they weren't having any golden parachutes. So I think this goes to the heart of almost everything we're talking about.

REP. PERLMUTTER: All right. Just one more question. If -- when we say pay for performance, is that going to be tied to -- to like the stock market because that -- that's a problem in and of itself.

MR. SPERLING: Well, you know, I mean, you're absolutely right. I mean, former Chief of Staff Erskine Bowles was the first person who told me that when he was at Wall Street, his boss used to always tell him, "Never confuse brains for a bull market," and --

REP. PERLMUTTER: Exactly.

MR. SPERLING: -- so, yes, I mean, the idea that -- the idea that performance is simply stock price -- I think it works bad both ways. It rewards -- amazing awards for people that has nothing to do with their performance, just the overall economy's getting better. On the other hand, I don't have a problem with rewarding an executive who's doing an exceptional job in a terrible economic time.

But -- but you don't see that symmetry. You -- the sense is that -- that people get paid a lot when they fail. They get paid when they succeed. Chairman Frank was in the paper the other day saying, "Heads, you win, tails, at least you don't lose," on -- on these packages.

But I do -- I do think one of the key points is just tying to stock does have its risk, and, you know, some -- I know some of the experts we've talked to have said, you know, "Be careful. Don't make that a one-size-fits-all," because if I accumulate all of my funds and I'm -- in stock, I have huge stock holdings, and am allowed to take it as soon as I retire, well, that could create, again, a -- for a corporate CEO a strategy to do -- strategies that are about raising their stock price as they leave. So it's helpful, but it's not one- size-fits-all.

REP. PERLMUTTER: All right. Thank you.

REP. FRANK: Gentleman from Missouri.

REP. EMANUEL CLEAVER (D-MO): Mr. Chairman, I associate myself with the comments of Mr. Perlmutter, and I will forego any questioning and wait until the second panel, or I will yield to one of my colleagues on the other side.

REP. FRANK: All right. That concludes this panel, and we will call the next panel.

Thank you all very much.

As the next panel comes forward, I -- they do so with my apology. I -- we have a terrible problem with the size of this committee. I'm going to experiment with new rules. This is a very important panel, and I appreciate and look forward to learning from them. We may have to do two-day hearings or only have one major panel on a day. We will be monitoring this, and I -- I -- this is a panel that deserves some attention. You will get it. I apologize for the fact that some of it's going to have to be in absentia.

Let's move quickly here, people.

All right. Let's get everybody seated. You can all make small talk outside, if you feel the need for it.

Thank you. We'll send out the word for our missing witness, and we will begin -- we've already made our opening statements -- with a return witness who we have appreciated having before us, Nell Minow.

MS. MINOW: Thank you very much, Mr. Chairman.

This is, I think, my fifth or sixth time being before the committee, but the first time you spelled my name wrong. So I'd appreciate it if we could correct that in the record. There's one N in Minow.

REP. FRANK: Yes, we will -- we will do that. We just wanted to differentiate you from the big fish you'll be discussing.

(Laughter.)

MS. MINOW: Okay. I appreciate that. Thank you very much.

Mr. Chairman and members of the committee, I'm in the enviable and, in my experience, unprecedented position of agreeing with both sides and with most of the comments that have been made here today. But I think there -- it's a mistake to say that -- that we object to the government getting involved in compensation. The government is already deeply involved in compensation, often inadvertently, and one of the things that I want to talk about today is removing some of the inadvertent obstacles that we have to having optimal pay.

The markets and the government have both failed here. The primary role of the government is to get out of the way of the market and remove obstacles to the kind of oversight that capitalism requires. Bad pay is a risk factor, and I was very pleased to hear the earlier panel talk about that and that the Fed will now look at it. But where are the other people who are supposed to be looking at risk in the markets -- the rating agencies, the securities analysts, the liability insurers, and the journalists? And it's also important to stop saying that the company pays the CEO this amount of money or that amount of money. It's actually the boards of directors, and we need to put the focus on there.

And, in theory, as we talked about with the last panel, it's the shareholders who elect the boards, but if you're going to give them stay-on pay and some of these other rights that you're talking about, proxy access, you have to make sure that -- to remove the obstacles that they're carrying it out. And our reports show that shareholders fail tremendously most of the time and that independence is as important on the shareholder side as it is on the board side.

As I prepared my testimony, which I'm not going to summarize because it's in the record, I felt a little bit like Dickens. I was talking about the ghosts of compensation past, present, and future. And I want to really focus on what's going on now because I -- I did disagree with the statement made by Mr. Alvarez about the fact that they've gotten the message. In fact, what we see is that we have particular concerns about efforts to circumvent even the preliminary constraints already imposed. Executives will always be more motivated and agile than regulators and legislators.

With regard to pay structures, I support indexed options, clawbacks, banking of bonuses. With regard to boards of directors, it's very important that they have the vulnerability to remind them who they represent, that they can be removed if they don't represent shareholders. And with shareholders, I really want to focus on the collective choice problem, what's called by economists rational apathy, and suggest possibly the appointment of independent voting fiduciaries.

Finally, the billions lost in the financial market meltdown are dwarfed by the loss of reputations and the brand of American financial markets. I'm a passionate capitalist myself and I hope that this committee will work to restore the credibility of our system of capitalism by removing obstacles to the role of the market in establishing optimal compensation. Thank you very much and I look forward to your questions.

REP. FRANK: Thank you. I apologize, but our administration at the last minute has raised some issues with me about some other things that they should have raised before, and I have finally told them to forget about it and show a little more consideration, and I apologize that it spilled over onto you.

Another returning witness, Mr. Lucian Bebchuk.

MR. BEBCHUK: Mr. Chairman and distinguished members of the committee, one major factor that has induced excessive risk taking is that firms reward executives for short-term gain. Although the financial sector has lost more than half of its stock market value during the last five years, executives were still able during this period to cash, prior to the implosion, large amounts of both equity compensation and bonus compensation. Jesse Fried and I warned about this short-term distortion in the book titled "Pay Without Performance" that we published five years ago.

And following the crisis this problem has now become widely recognized. To tie compensation to long-term performance executives shouldn't be allowed to cash out options and shares for several years after vesting, and similarly, bonuses should not be cashed right away but should first be placed in an account for several years and adjusted downward if the company learns that the reasons for the bonus no longer hold up.

In addition to the short-term problem, bank executives had a second and important source of incentive to take excessive risk that thus far has received little attention. The payoffs of bank executives were tied to highly-leveraged banks on the value of banks' capital. Compensation arrangements tied the interests of executives to the value of common shares in the bank holding company or even to the value of options from such shares, and as a result, executives were not exposed to the potential negative consequences that very large losses could have for preferred shareholders, bond holders and the government.

This gave executives incentive to give insufficient weight to the possibility of large losses and therefore gave them incentives to take excessive risks. To address this distortion, the payoffs of bank executives could be tied not to the long-term value of banks' common shares but to the long-term value of a broader basket of securities which should include at least the bank's preferred shares and bonds.

Now, let me turn to what role the government should play. For non-financial firms, the government should avoid intervening in the substantive choices that firms make but the government should see to it that shareholders have adequate rights. And as I testified before this committee three years ago, the right of shareholders in U.S. public companies are much weaker than in other common law countries. We need to introduce Say on Pay votes to strengthen shareholder power to replace directors, and shareholders should also have the power to amend the corporate charter and to change the company's state of incorporation.

Finally, in the case of executive pay in banks, or more generally, any financial firm that pose systemic risk, here the government should have a broader role. It is necessary for the very same moral hazard reasons that provide the basis for the traditional regulation of bank activities. The interest of common shareholders of banks are served by having investment, lending, and capital decisions that are riskier than is desirable for the government as a guarantor of deposit.

That's why traditional bank regulation monitors and regulates this decision by banks. By the same token, the interest of common shareholders in banks may be served by giving executives incentives to take risks that are somewhat was excessive. Therefore, even if and when internal governance problems in banks are fixed, regulators should monitor and regulate executive pay in all banks regardless of whether they get public funding. The regulators should focus on the structure of pay arrangement, not the amount, and they should seek to limit the use of the type of incentives that have contributed to bringing about the current financial crisis. Thank you.

REP. FRANK: Next, Mr. Lynn Turner, who's the former chief accountant of the Securities and Exchange Commission.

MR. TURNER: Thank you, Chairman Frank, and thank you for the opportunity to be here today, and I applaud the leadership you exhibited in the past when the House did pass Say on Pay, and it's unfortunate that your colleagues in the Senate didn't share the same wisdom. And so as they say --

REP. FRANK: There's a lot of that going around.

MR. TURNER: -- they're -- we're back. And the views I express today, I might add, are based upon not only my time as a regulator, but perhaps more importantly, I've been an executive setting compensation in a large international semiconductor company as well as a small venture start-up, and served on the board of a Fortune 500 company as well as a small technology software company where entrepreneurship is very important -- perhaps one of the few if not the only person at the table today with that type of experience and perspective.

And there's no doubt in my mind that when it comes to influencing people's behavior in a company at the top level at the low level there's nothing like pay that drives what people do. And when you give people pay that drives short-term performance, as we did on Wall Street where there was very low base and huge bonuses paid out on an annual basis, you're going to get the type of short-term thinking and short-term behavior all up and down the ladder that you turned around and got. You can't avoid it. If you want long-term thinking and long-term shareholder value you've got to change that compensation scheme significantly, and that's up to the compensation committees to do.

Unfortunately, today the compensation committees are all too comfy with the CEO. I've seen that on the boards that I sat on, and they're very reluctant if not absolutely against really reining in the compensation. So we've got to really put together a package that includes greater transparency, greater accountability, and some enforcement at the end of the day. So for the sake of time, let me jump into some of the recommendations. I'd just ask the chairman to include the whole written testimony for the record.

REP. FRANK: Yes. Without objection, all of the submissions will be included in their entirety.

MR. TURNER: In the area of transparency, I think we've got to start with the SEC enhancing its disclosure of compensation arrangements. In particular, today they don't require disclosure of the key performance metrics -- the things that really drive how you get that package. So we don't get the details on how (Queft ?) got to 148 million (dollars). We don't get the factors and we need to see those factors and require those factors be disclosed by the SEC.

They made a voluntary a couple years ago. About half the companies give it -- half the companies don't. We need it from all the companies on an appropriate level of detail. That includes we need to get back and figure out what the value of the real equity grants are when they're given. We've lost that. We need to have disclosure about the compensation consultants and whether or not they're truly independent -- are they being hired directly by the comp committee -- are they doing a lot of other work for members of management.

I think we need to see transparency with how the investors are actually voting. We've still got a lot of public pension funds, corporate plans, hedge funds that aren't disclosing how they're voting on this stuff and we need to bring transparency to it. At a public pension fund I sit on that has about 30 billion (dollars) of assets in our state, we recently went to disclosing our votes just so all of our members and people can see how we vote, and we think that -- (inaudible) -- some accountability. If we don't do it right we're going to have to explain why we do it the way we do it.

There needs to be something done with the way shareholders vote. We can put in Say on Pay, and I certainly support that -- strongly support that -- and by the way, I don't see that as government intervention in any way, shape, or form, and to the question of whether or not that would drive people offshore I absolutely don't believe it'll drive people offshore. Many of the other countries around the world -- Australia, Netherlands, many of the European, the U.K. countries -- many of the countries where there's the largest market cap already have that. So what are they going to do, leave here to go to a other country with the same regime?

I just think that's a myth -- nonsensical. But we do need to get the shareholders in mutual funds voting in the best interests of investors. As I say in my testimony, almost 90 percent of the time the mutual funds -- the Fidelities, the Barclays, Alliances of the world -- are voting with management, and there's no requirement that they vote for their investors, whose money they're managing, as opposed to voting their own interest. And Fidelity, Barclays, and these all manage a tremendous amount of money for these large companies with tremendous fees that comes -- that's not disclosed, and it's shown time and time again they vote that way.

So I'd certainly encourage Say on Pay, do something about the mutual fund voting, elimination of broker votes, as the SEC has said they're going to do. I think we need to get to majority voting and the right for shareholders to also remove directors when they haven't got the job done. Thank you, Mr. Chairman.

REP. FRANK: Thank you. Next, Professor Kevin Murphy from the University of Southern California.

MR. MURPHY: Thank you, Chairman. Thank you, Chairman Frank. We're here today in large part because we are all angry that Merrill Lynch and AIG paid huge bonuses to its employees after receiving federal bailout funds. Our anger coupled with our suspicions that the Wall Street bonus culture is the root cause of the ongoing financial crisis has led to an effective prohibition on cash bonuses for TARP recipients and is leading us today towards more sweeping regulation of compensation in financial services firms.

I agree that there is problems with compensation structures in financial firms than in most other sectors, but it is my opinion that the constraints already currently on TARP recipients will likely destroy those organizations unless they can quickly repay their -- the government and avoid the constraints. Moreover, it is my opinion that regulation -- regulating compensation in financial services more broadly will cripple one of our nation's most important and historically most productive industries.

The heavy reliance on bonuses has long been a defining feature of Wall Street compensation, going back to the days when they were privately-held partnerships. Such firms kept fixed costs under control by paying low base salaries and paying most of the compensation in the form of bonuses tied to profit. This basic structure remained intact when the investment banks went public but the cash bonuses were replaced with a combination of cash, restricted stock, and options.

The primary way that such structures can encourage excessive risk taking is through asymmetric awards and penalties -- that is, high rewards for superior performance and essentially no penalties for failure. Financial firms provide significant penalties for failure in their cash bonus plans by keeping salaries below competitive market levels so that earning a zero bonus is actually a penalty, and bonuses do fall in bad years. Average bonuses for executives in the TARP- recipient firms were 82 percent lower in 2008 than in 2007.

Take away bonus opportunities and the banks will have to raise salaries or find other ways to pay, or they will lose their top talent. In addition to cash bonuses, executives in financial firms receive much of their compensation in the form of restricted stock and options, and these instruments also provide penalties for failure. The average intrinsic value of options held by executives in TARP- recipient firms fell by -- fell 94 percent from 2007 to 2008, and the value of their restricted stock holdings fell by 72 percent, and these statistics only include firms that continued to operate at the end of 2008, thus ignoring the losses incurred by executives at Bear Stearns, Lehman, Washington Mutual, Wachovia, and the other casualties of the crisis.

Given the existing penalties for failure, there's nothing inherent in the current structure that leads to obvious incentives to take excessive risks. To the extent that the firms indeed took such risks, we need to look beyond the pay structure to explain it. In particular, the role of bonuses is likely dwarfed by the role of loose monetary policies, social policies on homeownership, and poorly- implemented financial innovations such as exotic mortgages, securitization, and collateralized debt obligations.

Looking forward, I'm especially concerned about offering too-big- to-fail guarantees that provide enormous incentives to take risks, but this isn't a compensation problem. Another way the compensation can lead to risk taking is through inappropriate performance measures. For example, consider mortgage brokers paid for writing loans rather than writing loans that actual -- that borrowers will actually pay back. We saw this happen at Washington Mutual, Countrywide, Wachovia, and scores of smaller lenders who weren't overly concerned about the default risk as long as home prices kept rising and as long as they could keep packaging and selling their loans to Wall Street.

A solution to this performance measurement problem is to pay people to write good loans and penalize them for writing bad loans. The challenge is identifying a good loan without waiting up to 30 years to see whether the loan is repaid. The answer -- (inaudible) -- bonus based -- involves basing bonuses on subjective assessments of loan quality. Unfortunately, most current and projected regulations go in the opposite direction and require that bonuses be based solely on objective measures of performance such as the quantity of loans. The regulatory demands effectively substitute the judgment of government for the business judgment of directors, and this is a dangerous path to go down.

In conclusion, it is not my opinion that current compensation practices are optimal. For example, bonus plans could be improved by introducing and enforcing (bonus banks and call-back provisions ?) and making sure we reward long-term value creation rather than short-term results, and performance measurement can be improved by allowing more rather than less subjectivity and discretion.

However, I believe that regulation will systematically and predictably make things worse rather than better. Indeed, Washington has a long history of attempts to regulate pay including caps on golden parachutes in the 1980s, the million dollar pay cap in the 90s, more recent restrictions on deferred compensation, and the most recent constraints on TARP recipients. Each of these attempts has created unanticipated side effects that have generally led to higher levels of pay and less efficient pay deliveries. I strongly recommend that the committee consider carefully this history before inevitably repeating the mistakes of the past. Thank you.

REP. FRANK: Thank you. Professor Verret?

MR. VERRET: Chairman Frank, Ranking Member Bachus, and distinguished members of the committee, it's a privilege to testify in this forum today. My name is J. W. Verret. I'm an assistant professor at George Mason Law School and also a senior scholar at the Mercada (ph) Center's Financial Markets Working Group.

I also direct the Corporate Federalism Initiative, a network of scholars dedicated to studying the intersection from state and federal authorities in corporate governance. Before I begin, I also want to say that it's a particular honor to testify on a panel with Professor Bebchuk, who was my mentor, and without his guidance I wouldn't be a law professor today. So that's a particular honor.

Today, I want to discuss executive compensation proposals currently under consideration. I will also highlight a Wall Street norm of issuing and feeling pressure to meet quarterly earnings (guidance ?) which is a central cause of short-term tunnel vision for Wall Street executives. The role executive compensation plays in the current crisis is, in fact, unclear. There is little difference -- and this is key -- there is little difference between the executive compensation approaches of banks healthy enough to repay their TARP funds and those of banks likely to need additional injections of capital.

If executive compensation were the culprit, the differences between executive compensation at healthy banks and executive compensation at bad banks would be much more apparent. What is apparent is that executive pay packages are of necessity complex. Compensation packages are designed to link pay to an executive's performance running the company without rewarding or punishing executives for factors outside of their control.

Regulatory restrictions and Say on Pay requirements may limit a compensation committee's flexibility to achieve this important goal. There are no less than seven executive compensation initiatives either proposed or recently underway. Such a wide array of ideas from disparate corners offers to repeat the lack of coordination that contributed to the present crisis. The multitude of proposals also threatens to override two important SEC-driven disclosure initiatives that offer some significant promise in this area. Former SEC Chairman Cox completed an extensive overhaul of executive compensation disclosure in 2006, and Chairman Shapiro is promising further changes.

Congress should study the effect of these disclosure rules before instituting prescriptive regulation. I would also add that they should think about studying disclosure rules and the SEC should consider disclosure rules for proxy advisory firms, which is notably missing from the chairman's current proposal.

I would warn -- I would echo Professor Murphy's warning about the effect of unintended consequences, and we've seen them before. In 1993, lawmakers sought to limit the disparity in pay between executives and the average worker. The result was that -- was quite the opposite, in fact. Executive compensation increased exponentially, widening the gap between executives and the average worker.

(To offer ?) an unintended consequence already apparent for the current reform effort, pay restrictions have made it harder for American banks to retain talented executives. Immediately following the announcement of compensation restrictions by the Obama administration, Deutsche Bank poached 12 of Bank of America's highest performing executives, and UBS used compensation increases as high as 200 percent -- this is a Swiss bank -- to hire away financial advisors from TARP firms.

The greatest risk to the safety and soundness of the nation's banking system is not compensation but short-term thinking. Compensation is how companies may motivate executives to look short term, but the real question is why do companies pursue short-term goals in the first instance. The widely accepted convention of predicting quarterly earnings drives the short-term approach.

Pension funds, mutual funds, and company (issuers ?) all express dissatisfaction with the pressure to predict quarterly earnings but companies feel that voluntarily opting out will be taken as a negative signal. Pressured to make quarterly predictions about their earnings, companies frequently feel pressure to cut corners to meet those predictions. I would recommend that the Treasury Department list executive compensation restrictions for those companies and banks that adopt a bylaw to prohibit quarterly guidance. If this committee wants to limit systemic risk it should not dramatically overhaul executive compensation structures. Instead, focus on the destructive pressures caused by the prediction of quarterly earnings, and give the SEC's disclosure reforms time to work. I thank you again for the opportunity to testify and I look forward to answering your questions.

REP. FRANK: I'll just begin by -- (inaudible) -- one historic inaccuracy. You said we're here because of Merrill Lynch, et cetera. The fact -- the Democrats on this committee raised the Say on Pay issue in 2006 and, in fact, the House passed Say on Pay in 2007 back when I thought TARP was what you used to cover the infield when it rained. So just historically because -- (inaudible) -- is not as you suggested.

Ms. Minnow, let me ask -- your general sense is that you've simply got to make it less difficult to replace board members -- that that's the -- that that's the central piece and that other things aren't going to work out if you don't have a board that's more sensitive?

MS. MINNOW: Yeah. I do think that's right and you -- but you also have to have shareholders who are capable of exercising that authority -- (inaudible) --

REP. FRANK: Well, that's what I mean. You have to --

MS. MINNOW: -- as well. But -- but yeah --

REP. FRANK: -- that the key is not Say on Pay but Say on Board?

MS. MINNOW: It kind of a forest-tree thing, you know. I think when we -- when we focus on compensation and we get down to the real fine details of whether options should be indexed or not or, you know, whether they should be tied to quarterly earnings or not, I think we're sort of missing the big picture here which is how it got out of whack -- (inaudible).

REP. FRANK: (Inaudible) -- nothing that we're proposing would get to that level of -- (inaudible). Say on Pay will do that. So you -- you think Say on Pay is a step forward but in the absence of the kind of -- (inaudible) -- well, let me ask, the proposed -- because we will get to corporate governance later on, maybe something earlier. The current SEC proposal they just talked about -- will that -- that meet your --

MS. MINNOW: (Inaudible.) I think -- I think that it's my opinion -- I know the SEC doesn't agree with me on this but they're going to need some legislative clarity on that --

REP. FRANK: We'd do that.

MS. MINNOW: -- on that point. But yes, I think -- I think proxy access would be very meaningful but I also support majority vote. I --

REP. FRANK: Now, let me ask all of you -- your compensation experts. (Inaudible) -- there's something that puzzles me, and that is we have the CEOs and other top decision makers telling us that part of the problem is that we have to align their interests with those of the company. Is there something about their characters that's lacking that says that we have to take extra steps to align their interests with those of the company?

In the normal course of economic life we kind of assume that your interests will be aligned with the people who are paying your salary and for the job you're doing. What is it about the financial sector that says the most highly paid members who have taken on these jobs, who have in fact fought hard to get these jobs, that somehow they will not align their interests to those of the company unless we design special incentives? Couldn't we expect them to have their interests aligned with the company even if there weren't these incentive bonuses? Let me start, Mr. Verret -- (inaudible).

MR. VERRET: Mr. Chairman, I think the -- it's not about aligning the interest.

REP. FRANK: No. Excuse me. My question is the world may not be -- a lot of things aren't. The score of the Red Sox game is not about that. But my question is -- because one of the justifications we're getting for these forms of compensation is it is necessary to align the interests of these top decision makers with the interests of the company, and I don't understand why they need that special set of circumstances when most of us don't.

MR. VERRET: Well, Mr. Chairman, I appreciate your Red Sox reference. I'm a Red Sox fan as well. I think the issue is risk. The essence is risk, and I think the question is do we want them to swing for the fences or do we want them to only swing for the (easy pitch ?) --

REP. FRANK: No, I want them to --

MR. VERRET: -- and wait to get walked? And sometimes I think we want CEOs to swing to the fences.

REP. FRANK: But if that's the right thing to do why shouldn't they be able to -- why shouldn't they do that because that's the right thing? By the way, I think you take the analogy -- the answer is whether you swing to the fences or not will depend on the pitch -- it would depend on the score -- it would depend on the inning.

If the bases are loaded and nobody's out in the last of the ninth, no, I don't want you to swing for the fences. There are probably more effective, less risky ways to advance your goals. But the point --

MR. VERRET: Absolutely. I would trust the coach to make that decision.

(Cross talk.)

REP. FRANK: -- you're evading the question, which is however you decide what the interests are, what is it that makes us have to give them some special incentive to take the -- to put the company's interests first?

MR. VERRET: Well, because, as you know, some players like to take the easy way out, and some players can take the risk for the good of the team.

REP. FRANK: But is that -- so you think that we have a -- but we don't usually do that with our employment system and with compensation.

Let me ask others. Does anybody know what it is about chief executives of financial companies that means that they have to get special bonuses to align their interests?

Mr. Murphy?

MR. MURPHY: Yeah, well, what -- and I will try to answer that question, but remember --

REP. FRANK: Well, if you're not going to try to answer that question, then I'll ask --

(Cross talk.)

REP. FRANK: Excuse me, Mr. Murphy. I asked you a question. If you don't want to answer it -- you haven't been subpoenaed, you can pass.

MR. MURPHY: (Inaudible.)

REP. FRANK: Does anybody else want to answer the question? Mr. Murphy said he didn't want to answer it.

MR. VERRET: Precisely, the question is -- do they want to --

REP. FRANK: Do you want --

MR. VERRET: They say they want to align their incentives because it's a human capital-driven organization where they can go start their own company --

REP. FRANK: Okay, but the answer is --

MR. VERRET: -- build private equity and leave those firms.

REP. FRANK: Well, I -- first of all, when we do uniform things, the leaving the firm thing I think is greatly exaggerated, particularly since American companies pay much more than most other companies. I haven't seen all that reverse brain drain.

But is that something then, Mr. Turner, would you want to try to answer that?

MR. TURNER: Yeah, Chairman Frank. We all wish everyone acted in the same way.

But my experience -- and I've worked with many executives, including executives of financial companies -- and some do put the shareholders and the company first, and other executives put their own interests first. And that's just people being people.

And because of that, we have to put a system in. And in this country (e put in corporate governance. We know what we've put in to date hasn't worked. The compensation committees haven't worked.

So in light of that, it's very reasonable to put in --

(Cross talk.)

REP. FRANK: Oh, I agree. But I think --

MR. TURNER: But not everyone's the same way, and not every -- (inaudible) -- does it right.

REP. FRANK: No, I agree, except I think what we -- the lesson we have is that we have overdone this so-called alignment of interests, that we have overcompensated them to do what they should have been willing to do in the first place.

And I think if you called their bluff, they'd probably still keep doing it.

The gentleman from Delaware.

REP. CASTLE: Thank you, Mr. Chairman.

Mr. Verret, I was interested and intrigued by your testimony, until you admitted you're a Red Sox fan. (Laughter.) And -- I have no hope for the chairman, but you should know the Philadelphia Phillies are the world champions. You want to think about who you're cheering for out there.

MR. VERRET: I understand, Representative Castle.

REP. CASTLE: One of the things that you state in your writing, but you also mentioned in your testimony, the part that I heard, is the whole quarterly earnings pressure.

We talk about the compensation issues, and I want to talk about that in a minute. But the quarterly earnings business concerns me.

And I don't know if you have any ideas about how to change that. Do we ask them not to publish anything, or do it once a year or something to make it longer range? Because I'm of a belief that that's probably a greater driving force in the managing of a corporation than even the salaries are. And I'm not sure how we should approach that. I'm not sure we should approach it, or the states should be approaching it.

But the question I have is do you have any thoughts about any solutions to what a lot of us view as a problem?

MR. VERRET: Well, I appreciate your question, Representative Castle, and I think the unique thing about this issue is this is something that everybody agrees on.

The U.S. Chamber of Commerce, the pension funds, the mutual funds all say we hate quarterly earnings guidance. And companies, when you ask them privately, they say we don't like to do it either, but we feel pressured to do it.

And we feel they -- if one of us was the first one to stop doing it, then everybody would say, oh, well, this is because obviously you have bad news about your quarterly earnings. That's why you're stopping.

Before this crisis hit, things were beginning to change. About 10 percent of companies stopped providing quarterly guidance. Intel stopped, and I think that Unocal stopped. I know Berkshire Hathaway stopped.

It's like Warren Buffett said, it's both deceptive and dangerous for CEOs to predict growth rates for their companies. I think that very clearly gives us his view.

So it's already going in that direction, and I think that perhaps -- that the focus on executive compensation is kind of stealing attention away from that important issue.

And in terms of the specific policy prescriptions, I would say I think that to the extent we want to lift the restrictions in TARP on executive compensation, I think it could be tagged.

We could say if you're a TARP company, but you adopt a bylaw that's in accordance with and legal under your state corporate law obligations, a legal corporate bylaw that says we will no longer provide quarterly earnings guidance -- and boards can do that -- then perhaps we could give them some sort of a reward, a carrot, rather than the stick under TARP, because they've taken steps to limit systemic risk at their company.

I think that might be one way worth at least talking about.

REP. CASTLE: Let me shift back to the subject of the hearing today, which is the executive compensation question and just ask you about the governance of all that.

I am concerned that the federal government is getting more and more involved in the running of corporations and the fact that we own corporations now, which we don't really want to do and, hopefully, we'll work away from that.

But that's where we are, and we seem to be even going further in that direction with various things that I'm hearing.

And the states, for years, have handled matters of corporate interest, incorporation, et cetera. And my concern is that all of a sudden we're asking the federal government to come in and override what the states may or may not do.

And I'm not saying they shouldn't do anything. I think there are some executive compensation issues that should be addressed. But I would hope that the states would be the ones to address that.

I would be interested in your parsing that issue in terms of what we as a federal government, the executive branch and congressional branch -- legislative branch -- should do, versus what should be done at the state levels, if anything, in the area of executive compensation.

MR. VERRET: Sure. Well, to the extent that this discussion is going towards proxy access and say-on-pay as imprudent aspects of the executive compensation discussion, I think state law does play a very important role.

With respect to proxy access, the SEC's current proposal is very clear in that it says the federal government should say how proxy access should work, how state law nomination rights should work.

And it specifically says if you want to exercise your state law rights, you've got to make sure that they don't conflict in any way with what SEC says is the one single approach to proxy access that we think should work for all of the over-4,000 publicly traded companies in the United States. I think it's about 4,000, is my guess.

So I think that's an issue worth thinking about.

And with respect to say-on-pay, I think this is basically a sort of an attempt to make a change that companies -- that a small subset of shareholders haven't been able to achieve through proposals.

Just last year, 70 proposals for say-on-pay were introduced at companies, 2008. Ten of them were successful. The average vote was a 60 percent vote against say-on-pay by the shareholders.

At financial companies, it's even higher -- 70 percent was the average vote against say-on-pay at financial companies.

So shareholders have -- at least the shareholders at the majority of companies, in a very strong majority way, have expressed dissatisfaction with say-on-pay proposals.

REP. CASTLE: Thank you.

My time is up. I yield back.

REP. RUBEN HINOJOSA (D-TX): Recognize the gentlelady from California, Ms. Waters.

REP. WATERS: Thank you very much. I think part of what I was interested in has been answered.

I basically take the position that government perhaps should not be involved in deciding the compensation for executives of these companies.

But I do believe that when you have your banks and financial institutions coming to the government and accepting TARP money, accepting investments by the government, that they have to accept some of the rules of government to go along with it. And a part of that may be a say-on-pay.

But I'm really interested in the shareholders. And you just gave us some information that is surprising to me, basically that the majority -- more than a majority of shareholders do not support say- on-pay. Is that what you just said?

MR. VERRET: Well, I just said that last year there were 70 proposals at companies to adopt say-on-pay at those companies.

Now, of those 70, 10 of them were successful. And the average vote at those 70 different elections on whether we should do say-on- pay at our company, the average vote was a 60 percent vote against.

And among the financial companies, a subset of this -- this is from a paper by Jeff Gordon at Columbia Law School -- the average vote at financial companies was a 70 percent vote against say-on-pay.

REP. WATERS: Well, I need to ask all of you -- and you may have stated this already -- whether or not you believe that the government has a right to say-on-pay and other demands on companies that receive taxpayer money, either in loans -- well, in the form of loans.

MS. MINNOW: Yes.

REP. WATERS: Everybody yes?

MR. TURNER: Congressman Waters, absolutely. When you take money -- and I've run a business. When you take money from a government, you understand it's a whole new rule of games. And if you don't want to play by the government rules, you don't need to take the government's money. It's a simple as that.

Back to the point, though, about investors' votes on say-on-pay, there's a couple other key facts that you need to consider in those votes.

In some of those companies, the compensation -- the investors might have, in fact, decided the compensation was satisfactory. And in that case, they tend not to vote for say-on-pay proposals.

I sit on two large institutional funds, one being the public pension fund for Colorado, the equivalent of your CalPERS and CalSTRS, as well as a mutual fund for AARP.

If compensation is fine and, we think, within limits, one may not vote for say-on-pay, although typically we still do.

The second thing is that the large mutual fund institutions -- Fidelity, Barclays, et cetera -- vote with management close to 90 percent of the time.

The reason they do is because they get assets from management from the corporate pension funds to manage, and they get tremendous fees for that. And as a result of that, they aren't going to vote against management, they aren't going to vote for say on pay, because the management team will go take those funds away from them and place them with another asset manager. And so those votes become very problematic.

What we need is legislation that says when the pension -- or when the mutual funds vote on behalf of the investors in that fund, they have to make that vote based on the best interest of those investors, not their best interest as a mutual fund. A prime example is a few years ago, when there were phenomenal -- almost 200 million (dollars) in payouts to an executive leaving at Pfizer, and there was a question about their board and all. The Pfizer management team two senior top people -- who are, quite frankly, close personal friends -- flew to California, met with Barclays, reminded Barclays that they were getting 14 million (dollars) in fees to manage Pfizer assets and the next day they voted straight down the line for Pfizer. And I think that's a classic example of what goes on and the problem that has to be corrected.

REP. WATERS: Well, I really do appreciate that advice and that information. And I'm looking to play a role in some of this reform. And those are precisely the kinds of issues that I want to deal with. So you'll hear more from me.

Thank you very much. I yield back.

REP. HINOJOSA: Thank you. I will yield time now to the gentleman from North Carolina.

REP. PATRICK MCHENRY (R-NC): Thank you, Mr. Chairman.

I've got a question that one of my colleagues asked the previous panel that I thought was an interesting one. Mr. Neugebauer from Texas asked a question. He said, if I presented you with $1,000 and in two weeks you brought back a $1 million on that investment, that in essence you made me -- you know, took $1,000 and turned it into $1 million for me, would it be appropriate for me to pay you $10,000? Would that be fair compensation for the return you've given me?

Mr. Bebchuk, if we could just go quickly down the line and answer this question yes or no.

MR. BEBCHUK: I wouldn't be able to answer it without knowing more about the circumstances. But none of the proposals that even -- that anyone here supports and none of the proposals that the government has put forward involves this kind of judgment. They all involve, at most, either changing the governance rules --

REP. MCHENRY: Okay.

MR. BEBCHUCK: -- vetting people who make decisions or involve judgment about structure. If you ask me about structure, I will have clear answers to you.

REP. MCHENRY: Well, the structure's just as I said. If we could just do quickly -- I only have five minutes -- but Ms. Minow?

MS. MINOW: I think you'd be getting a very good deal for that amount of money.

REP. MCHENRY: So it's fair compensation.

MS. MINOW: Yeah. Even a higher amount, I think, could be fair under your --

REP. MCHENRY: Okay. It might not be fair to the -- to the agent --

MS. MINOW: Right.

REP. MCHENRY: -- who should be getting a higher percentage of the deal. Interesting.

Mr. Turner?

MR. TURNER: The question may be whether I should actually pay them more than 10,000 (dollars) or not, because they were able to get you 1 million (dollars). Our problem is, though, that isn't the facts that we're dealing with. The fact is, instead of paying 1,000 (dollars), we paid hundred of thousands or millions of dollars, and instead of getting back the $1 million in profit, we ended up with billions of dollars in write-off that, in fact, today have -- are in excess of 1.2 trillion (dollars) and requiring government bailout of the companies who failed.

REP. MCHENRY: Sure. Much longer answer than I was looking for.

(Cross talk.)

MR. TURNER: So -- (inaudible) -- $10,000 bonus.

REP. MCHENRY: Mr. Verret?

MR. TURNER: The real question is, should I get my $1,000 back because they lost so much?

MR. VERRET: Well, Representative McHenry, I have a lot of confidence in my investment skills. I'd be happy to put you in touch with my agent. But I think 10,000 (dollars) would be way too low.

But I would just offer, this hearing's about systemic risk and executive comp. I would just rest on my testimony, that if that were really such a strong link, healthy TARP banks that are about to get out of TARP and bad TARP banks, we could look at them and we could see some differences in their executive comp. I've read through the disclosures of every single one of them over the last two days. Haven't done much else besides that. Not my difference between those two comp policies, so --

REP. MCHENRY: Would it be fair to perhaps up the base compensation and have fewer incentives? Is that best aligned with shareholder interests, Mr. Verret?

MR. VERRET: I mean, in some cases, yes. In some cases, no. I would -- I would defer to negotiations between the shareholders and the board on that issue.

REP. MCHENRY: So how can the government prescribe corporate governance effectively? Mr. Verret -- I'm actually continuing with his line.

MR. VERRET: Well, I think that it's about a combination of corporate governance issued at the state level -- that's been, I think, very effective in a lot of areas -- some corporate governance disclosures issued at the SEC -- that, by the way, is the -- is the -- has become the essential mission of the SEC. And I think some of the things the SEC's been trying to do, especially with respect to the current proxy access proposal as it's currently designed, exceed its authority under the 33 and the 34 act. And we've seen the SEC about oh for three in challenges before the D.C. circuit. I think it's going to be oh for four after this proxy access rule. So I think it's about disclosure and I think it's about state corporate law and the protections afforded shareholders at that level.

REP. MCHENRY: Is the shareholder proxy, though, on executive compensation the way to go?

MR. VERRET: I think say-on-pay can be particularly dangerous. And I also think comparisons to the U.K. are deceptive for a lot of reasons. The structure of shareholders in the U.K. is very different, dominated by insurance companies and private pensions, much more -- where the U.S. is more retail investors with a lower voting grade and also substantially more union pension ownerships. So I would say it's not the right way to go.

REP. MCHENRY: Okay. Now, in the previous panel, Mr. Sperling testified that the corporate community is setting best practices in regard to executive compensation. Do you think that's the way to go, Mr. Verret?

MR. VERRET: I think best practices generally are great. I think we've seen some great best practices promulgated by RiskMetrics, great best practices promulgated by the Council of Institutional Investors, some great risk -- best practices promulgated by the U.S. Chamber of Commerce and the Business Roundtable. When the government does it, I wouldn't call it a best practice anymore. We've seen the government use its moral authority and the threat of regulation to -- when best practices are effectively a demand. I mean --

REP. MCHENRY: How effectively do you think the 2006 executive compensation laws have been?

MR. VERRET: The 2006 disclosures? I think it's too early to tell, because we've only had about two years of history there. And I think part of the issue is just there's not enough working history to really work from. And I think part of what Chairman Schapiro's committed to do in refining the disclosures I would also, frankly, support, so --

REP. MCHENRY: Thank you.

REP. HINOJOSA: The gentleman from Minnesota is recognized.

REP. KEITH ELLISON (R-MN): Professor Verret, you just made an interesting point about there not being enough history to make a decision. And I think that that might even apply to your analysis with regard to banks that paid back their TARP funds and banks that did not having similar compensation systems. I mean -- I mean -- I mean, TARP hasn't been around that long. I mean, how can you be so sure, based on the limited history that we have? And why is that metric one that we should rely when we determine whether or not compensation systems have a causal effect on risk-taking?

MR. VERRET: Well, Congressman, that's exactly the point. I'm not sure. I'm not sure that executive compensation led to systemic risk issues. And I -- the reason that I'm not sure --

REP. ELLISON: Okay. So given that --

MR. VERRET: -- is because of the evidence that I've suggested.

REP. ELLISON: So given that -- I mean, when you're not sure, that means maybe it is, maybe it ain't, right? I mean, it almost tell -- I mean, the point you're making, I come away with thinking, well, so what, you know, that there's not enough body of information to use that metric to decide whether or not it is or it isn't? Can you tell me why I'm wrong about that, Mr. Bebchuk? I mean --

MR. BEBCHUK: (Off mike) -- now widely shared consensus that executive compensation incentive did contribute to the crisis. We can rely on the CEO of Goldman Sachs, who, in an editorial in the Financial Times just two months ago, stated very strongly his view that those compensation arrangements were flawed and we need to reform them. Indeed, financial firms across the board now take the view that they were wrong. They might not like government intervention, but I think that at this point there is widely-shared consensus that executive compensation arrangements need to be reformed. And the only room for disagreement is what role the government should have in bringing about the changes that everybody agrees are necessary.

REP. ELLISON: Professor Bebchuk -- or actually, I want to open this up to anyone. One of the things that I keep hearing is, well, we have to let American corporations get all the money they want under whatever compensation system that they want, because if we don't, then these really smart, talented people are going to go elsewhere. Well, what I'm -- and I -- and I know they're -- I know that I'm not doing exact justice to this point of view, but I think you all know what I -- you've heard this line of argument.

Ms. Minow, could you comment on this issue? I mean, if we reform the entire American system --

MS. MINOW: Yeah. I agree with you, Congressman. I think that's a bogus argument. For the first point is, where would they go? They would go into private equity. And the people -- shareholders can invest in the private equity, so that's just fine. And second, these guys didn't do that good a job. So let them go. You know, let them go abroad. Let them wreck their economy.

REP. ELLISON: Well, let me ask you this question: Do European firms compensate the way we do? And in line with that, I mean, is there another way to conceive of executive compensation, or is the way we've been doing it the only way to see it? And from what I understand -- and I could well be wrong -- European and Asian firms don't pay their executives this way, so --

MS. MINOW: Unfortunately, one area where the United States is way ahead of everybody else is in the area of disclosure. And we don't have good comparable data. So there are a lot of off-the-book -- or off-of-the-disclosure-book --

REP. ELLISON: Okay.

MS. MINOW: -- kinds of payments that we don't know about.

MR. MURPHY: But we have increased disclosure across -- across the world. I've just completed a study of 27 countries. And one of the things we find is that the rest of the world slowly is catching up to the U.S. The U.S. has higher compensation after you control for size in industry, but stock options, for example, which used to be nonexistent in all but a couple countries 20 years ago are now prevalent in almost all countries.

REP. ELLISON: I'd like you to send me that study. Would you?

MR. MURPHY: I absolutely will.

REP. ELLISON: Thank you.

Mr. Bebchuk?

MR. BEBCHUK: Yeah. The argument that people will go and work elsewhere is also unwarranted, because everybody here is focusing on changing the structure. So there is really no reason whatsoever to provide compensation that produces perverse incentives and destroys value. At most, this argument would be, give them the same amount but use it to give the incentives to work for the company, not against it.

REP. ELLISON: You all familiar with a book called "In Search of Excess" that was written in 1991?

MS. MINOW: By Crystal, Graef Crystal wrote that. Yes.

REP. ELLISON: Yeah, so we -- this conversation about excessive executive pay, whether or not you buy it or not, it's not a new argument, is it?

MS. MINOW: No. The book that I would recommend to you even more than that, because it's more up to date, is Rakesh Khurana's book "In Search of a Corporate Savior," which -- and the thing I like about that book, which influenced my own thinking, is that he says that payments and executive compensation need to be looked at in terms of return on investment, like any other asset allocation.

REP. ELLISON: I think I'm out of time. Thank you very much.

REP. HINOJOSA: The gentlewoman from Minnesota's recognized.

REP. MICHELE BACHMANN (R-MN): Thank you, Mr. Chair.

My first question would be for Mr. Bebchuk. And my question would be this: Publicly traded companies also pay high salaries to entertainers, to news anchors, to athletes. And so what I'm wondering is, should these decisions also be subject to shareholder approval?

MR. BEBCHUK: No, I think not. What we are concerned about about top executive is not so much the amount but the concern that we don't have arm's-length contracting, because we don't have the market at work. When you have the market at work, we can let privately reached decisions stay, but what we are trying to do with respect to top executives is to make sure that we have a well functioning system, rather than the one that we've had thus far.

REP. BACHMANN: Thank you. And next would be, I guess, Ms. Minow, I have a question for you.

You mentioned in your testimony that although disclosure is important, that people have to be able to act based on the information that's disclosed. Isn't the right to sell stock the ultimate way that shareholders can act? What's your opinion on that?

MS. MINOW: Not really. I mean, the one thing you know about stock is you want to buy low and sell high. If the stock has been depressed by bad decisions on the part of management, it can be cost effective for you, in fact, to send a message back to that management rather than to sell out.

Furthermore, many of the investors, including the large institutional investors, are so large and diverse that they're either index de facto or index de jure. They've got nowhere else to go. And these pay plans are so pervasive they have nowhere else to go, at least within the United States. So they do not have the opportunity for what is called the "Wall Street walk."

REP. BACHMANN: Okay. My next question for you would be, given the shareholders' ultimate ability just to be able to sell and -- their shares, shouldn't we be concentrating our efforts on compensation disclosure, in your opinion?

MS. MINOW: Compensation disclosure's absolutely essential and I hope we can improve it. As Professor Verret said, we made some improvements in 2006, but it doesn't really cover a lot of the kinds of issues that have been revealed by the financial meltdown.

REP. BACHMANN: And you had talked before about preventing bad compensation practices that really little can be done before the structure of the board is fixed. I think that's an excellent point that you're making. And could you talk about what your proposal would be?

MS. MINOW: Certainly. Right now -- I know it's always hard to understand if you're an elected official -- but right now boards are elected; no one runs against them; management counts the votes; and they can -- they can serve even if they only get one vote. I think it's very important that directors not be allowed to serve unless they get majority support from the shareholders. And I think that way shareholders will be able to remove bad directors.

MR. VERRET: Although I would add that contested elections intended by the -- that would be part of the commission's current proxy access proposal -- would also be, I believe, plurality votes. So the same standard would apply. It wouldn't be majority voting for a contested election.

REP. BACHMANN: And I would open the questioning up to any of the panel members on my previous question regarding athletes and news anchors and entertainers, and then also on transparency and on disclosure if anyone else would like to comment.

MS. MINOW: Lucien was a hundred percent right. Those transactions are, believe me, very closely negotiated at arm's length. It's the coziness of the transactions between the top executives and the board that leads to this problem.

REP. BACHMANN: And why is it that the board can't be changed? Why is that?

MS. MINOW: Because the CEO picks the board.

REP. BACHMANN: And so you've got -- you've got the -- (inaudible) -- you've got the circle. They're chasing each other.

MS. MINOW: Yes, right.

REP. BACHMANN: Yes, Dr. Bebchuk?

MR. BEBCHUK: Yes. I would add that disclosure is helpful only if investors can then, you know, make decisions that would have an impact on directors using the information that they are given. And right now, their hands are tied in a number of ways. In addition to the difficulty of replacing the board, there are staggered boards, which are a unique American institution which means a large fraction of public-traded companies prevent the shareholders from replacing the full board in any given election. And there is also the inability of the shareholders to amend the corporate charter. So the shareholders cannot change the rules of the game if they could.

Some of the work that, you know, you guys are called on to do could be left to the market, but right now the market cannot put in place corporate governance reforms that are viewed as important.

MR. VERRET: Although --

REP. BACHMANN: And I guess -- I don't know how much time I -- oh, yes.

MR. VERRET: I would counter that about half of the S&P 1500 is declassified, so shareholders have made -- it's difficult, but shareholders have made some progress in declassifying boards.

And I would also just highlight a bit of a market failure, I think, in proxy advisory services. We saw the problems with market concentration in the credit rating agencies. It's much, much worse with proxy advisory services. RiskMetrics rules the roost, and there's no required disclosure in these -- in the -- these independence of compensation committee rules, there's no required disclosure for proxy advisory firms, and I think there should be. We're not likely to see it, of course, because the chief -- the former chief administrative officer of RiskMetrics is now a special advisor to the chairman. So I think we're unlikely to see it at this point, but I think it's worth considering.

REP. BACHMANN: I yield back.

REP. HINOJOSA: We recognize the gentlewoman from Florida -- from California. Both warm climates.

REP. JACKIE SPEIER (D-CA): Thank you, Mr. Chairman.

And I want to thank the panelists for the very lively discussion. And I think you underscore for all of us what a sticky wicket this issue area is.

I would first like to point out, though, that Paul Volcker said it very succinctly very recently when he said, "The financial demise that we have just witnessed is the result of executive compensation that has been linked to riskier and riskier activity." And I think a number of you have pointed at that in your testimony.

I think that we have no role as a Congress to affect executive compensation if we don't have an investment, so to speak. So when it comes to TARP recipients, you bet I think we have a role to play.

Now, what we do have a role to play in other circumstances is empowering the shareholders. That's what our focus should be. And I think right now the game is fixed. And based on what you've just said, if you get one vote, you are reelected -- wouldn't we all like to have that kind of experience, being elected to Congress? It sounds fundamentally undemocratic that you don't have someone independently counting the ballots and that a majority is not required.

So I think -- I keep coming back to Mr. Sullivan, who was then the CEO of AIG, who had performance requirements for bonuses. He went to his board of directors and said, "We want you to waive the requirement for performance in this situation, even though we've just lost $6 billion, and give the bonuses anyway." And guess what the board did?

MS. WILLOW: They said yes.

REP. SPEIER: They said yes. And those bonuses were offered and Mr. Cassano received a million dollars a month after he was fired. It's extraordinary and it's wrong and the American public is onto it.

So my question to all of you is -- since you can always manipulate the system, as Mr. Sullivan did, where he actually had performance requirements in place for purposes of giving bonuses -- why not just require of all of the members of the board of directors a fiduciary duty to the shareholders?

MR. BEBCHUK: They do have a fiduciary duty, but the problem is that enforcing fiduciary duty is difficult, because there is a business judgment rule, and courts are not going to second-guess the judgment of the director. So that's why the main remedy is to make directors accountable to the judgment of the shareholder.

And you mentioned AIG. We have never had in the history of the U.S. public market a control contest for a company the size of AIG, because the impediments to a proxy fight in a company that large are just practically insurmountable. And many of the arrangements that people are discussing are arrangements that try to, you know, expose the incumbent directors more to the discipline of an electoral challenge.

MR. MURPHY: I might note that there -- Congresswoman, there is almost never any actions brought against board of directors. The SEC, to the best of my knowledge, never brought an action against any of the directors of Enron, never brought an action against any of the directors of WorldCom, only brought one action against the directors of Tyco, and that's because the guy had taken a bribe.

So for the most part, given the way state laws operate -- which aren't very good, and quite frankly, the staff of this committee has been urged to take up a proposal to allow shareholders to ask for reincorporation in a more shareholder-friendly state, which is an excellent proposal, by the way -- but for the most part, until you can hold directors accountable -- and in this way, it's the proposal just to be able to throw them out -- you're never going to get any action, because the law enforcement agencies literally will not touch them, have not touched them, even in the most egregious cases to date.

REP. SPEIERS: Many of the directors of the failed companies are continuing to serve on boards. It's flabbergasting to me, but they are still there.

MR. VERRET: I would specifically counter the observations about state law. Delaware is the corporate state law that I've spent the most time studying. Delaware's very responsive to shareholders, particularly responsive. They instituted majority voting; they made majority voting easier. As a result, now we have majority voting, I think, 60 to 70 percent of companies -- this is the withhold vote, kick the bums out sort of rule. Delaware -- people wanted proxy access. Delaware instituted proxy access, although the SEC wasn't able to do it. So that was very responsive to shareholders, I would say.

REP. SPEIER: When's the last time a director has been held liable by a Delaware court for any personal payment out of his own pocket, absent personal corruption?

MR. VERRET: After approving the Ovitz -- and the court held Ovitz could get paid $160 million, in the most egregious situation, and said it's A-OK. The courts in Delaware said it. It's not an investor-friendly --

MR. TURNER: Well, the Ovitz litigation is one specific case. That was six, seven years, and --

REP. SPEIER: Thank you. My time is expired.

MR. TURNER: -- the case.

REP. HINOJOSA: The gentleman, the ranking member from Alabama is recognized.

REP. BACHUS: Thank you.

How many of you all were at the first panel -- have heard the testimony?

Mr. Sperling, I have a great respect for him. He talked about some of the executive compensation decisions that actually led companies -- you know, they were, they actually increased risk.

And I think when we hear that we think of AIG, and we think of maybe some of the subprime lenders, where people -- mortgage originators were paid by the volume of work without regard to whether the borrower could repay.

But, how many -- and I'd ask each one of you, maybe, whether you were here or not, give me a percentage of companies that you think engaged in this sort of risky, dangerous behavior.

I'll start -- Professor.

MR. BEBCHUK: I think that the widely-shared view -- that I alluded to before, that incentive structures were flawed, applies to companies in the financial sector across the board, most of the companies in the financial sector. This is what made this financial crisis so difficult.

Most of them made decisions that -- at least, in retrospect, seemed to have involved excessive risk-taking. And they all, generally, had those incentive structures that had the short-term flow that they now generally recognize.

REP. BACHUS: Well, so you -- of just the corporate America, how many have -- how many corporations do you think engaged in dangerous, risky behavior that endangered the economy?

MR. BEBCHUK: I think that the problem --

REP. BACHUS: Would you say --

MR. BEBCHUK: -- the problem of short-termism -- the proxy that is now widely recognized as being problematic, namely, that executives can cash out shares and options immediately upon vesting; and that bonuses are often short-term. This practice is general across corporate America.

Now, I would say the financial sector, the opportunities for risk-taking are not as large as they are in the financial sector (sic ?), and, therefore, the fact that we have had flawed incentives (has ?) manifested itself. But, it is now generally accepted that also firms outside the financial sector should fix this very problem of tying compensation to the long-term, and not to short-term --

REP. BACHUS: All right, anybody else?

MR. TURNER: Yeah, I'd like to be careful not to define excessive risk-taking as just those risks that generate losses --

REP. BACHUS: Right.

MR. TURNER: -- as opposed to gains.

And, actually, through most of our history, our problem in corporations has been to encourage individual risk-averse individuals to actually take risks. The individuals inside corporations tend to be more risk-averse than the shareholders are. Our problem -- the entrepreneurial spirit is all about risk-taking.

REP. BACHUS: Okay, I like -- I agree.

Mr. Verret?

MR. VERRETT: Just to answer your question specifically, I think it's a small number of corporations, in terms of number; very large in terms of the assets that they manage. I think this goes to a related issue of 'did we let them get too big?'

And I would applaud the Federal Reserve's current initiative to think about changing capital requirements based on size. I think that's a useful thing to talk about.

And I would also offer -- just to highlight again my testimony, that quarterly earnings guidance is a dangerous thing that affects a lot of companies. And I think it's -- it's something the companies want to get out of talking about.

REP. BACHUS: Let me ask you this: Do you believe that the CEO or the board of directors, or people inside the corporation are -- aren't one of the jobs of the CEO to look at performance and pay, and set executive compensation, as opposed to some independent board?

MS. MINOW: Yes.

REP. BACHUS: Okay.

MS. MINOW: And it's the job of the board to set the CEO's compensation and to evaluate his performance, including his performance in setting incentive compensation --

REP. BACHUS: All right. So, both the CEO and the board of directors, you all would all agree that they primarily should be responsible for setting compensation?

MS. MINOW: Yes, --

MR. VERRET: Absolutely.

REP. BACHUS: Okay.

Professor Verret, as I understand it, Professor -- Bebchuk? --

MR. BEBCHUK: Mm hmm.

REP. BACHUS: -- compensation proposal envisions linking executive compensation to performance of bank debt and preferred shares. What's your view of that proposal?

MR. VERRET: Well, I would offer just -- with respect to the idea of using debt to link -- linking debt to pay, I think three things are worth thinking about: First, an executive's ability to (do a good job ?) -- be rewarded on the upside, would be limited the more you include debt in the mix.

I also think that he makes an assumption -- at least in the paper, that I think is absolutely correct, that the fact that there's a -- the moral hazard of government bailouts means that debt tends to not be affected too much when a bank's health is affected.

I think that's an absolutely safe assumption. It's part of the reason why the debt-holders don't police executives as much as they should. But, it also means that if you were to link debt to executive's pay, it means that, you know, if the debt doesn't go down, then the pay doesn't go down. So, you limit the upside and you also limit the downside.

So, with respect, that's sort of the -- the amplitude you get is very flat, rather than upward and downward incentives as you add pay into the mix.

REP. BACHUS: Okay.

REP. HINOJOSA: The gentleman from Texas is recognized.

REP. GREEN: Thank you, Mr. Chairman.

And thank you, members of the panel. If I interrupt, please forgive me. I don't mean to be rude, crude and unrefined, but I'm trying to make a point.

Let me start by asking about the executives in the U.K. Do they, in the main, make more than executives in the United States?

MR. TURNER: No.

REP. GREEN: Executives in Germany, do they, in the main, make more than executives in the United States?

MR. BEBCHUK: No.

REP. GREEN: Executives in France, do they, in the main, make more than executives in the United States?

MR. TURNER: No.

REP. GREEN: The question becomes this, then -- to those who contend that if we do anything to encroach upon the current system people will flee to other places, and make inordinate amounts of money in other places, leaving us with a brain-drain -- the question becomes where do they go?

MR. TURNER: They go to private equity and hedge funds --

REP. GREEN: Private equity and hedge funds -- in the United States?

MR. TURNER: Within the United States, and --

REP. GREEN: And, and --

MR. TURNER: -- (inaudible) --

REP. GREEN: -- wait, hold on. Just a minute.

The percentage of private equity and hedge funds cannot accommodate the number of executives that we are talking about. So, some may go. But, the truth be told, the argument is that we are going to lose them to other countries. That's the argument that's being made.

And there is no other country that they are going to go to and fare as well as they're faring in the United States of America.

MR. TURNER: Except that could change, Congressman, if we --

REP. GREEN: Well, that could change, if we --

(Cross talk)

REP. GREEN: -- excuse me, it could change if the U.K. will change its laws. It could. It could change if Germany would change its laws. If France will change its laws. That doesn't seem to be the case because they seem to be leaning even more toward executive regulations.

By the way, I'm not a proponent of trying to stifle the free market. I want to see people make as much as they can. But I don't want to see people at AIG drive a company into the ground and then walk away with huge bonuses.

There's something wrong with this, and the American people know there's something wrong with it. And they're going to chastise us if we don't do something about it. They really are. Now, this is -- I appreciate the notion that there are other places for people to go, but they won't find the coffer in these other places that they find in the United States of America.

And those who want the autoworkers at Ford, Chrysler and GM to get salaries comparable to Nissan and Toyota, they don't look at what the salaries of those CEOs at Nissan and Toyota are making. Their salaries are not in line with the salaries of the American auto industry executives in this country. They're not.

And nobody that I have heard -- there maybe a voice that I haven't heard, I confess that I don't hear everything that's said -- but nobody that I have heard has indicated, in any way, that we need to make sure that the salaries of the auto executives in this country are in line with the salaries of the auto executives in other countries. It's just not being made.

Now, at some point we've just got to fess up and say, we've got some business to take care of, and take care of the business that we must take care of. If we don't do this -- this our hour, this our moment, this is our time to do what's right. Not to try to manage this, not to try to make sure we do this thing right, but do the right thing. That's what we've got to try to do here.

So I am not for taking control of a company. I don't want to see stockholders micromanage a company. I'm not interested in that. But I contend that the chairman is right when he talks about how we have promoted excessive risk without consequences for the failure -- not serious personal consequences for the failure.

So we've got people who are trying to do all that they can to make as much as they can, understanding that, "If I don't, I'll just take my bonus, my golden parachute, and I'll fly out." That kind of behavior is what we're talking about, as I see it. And I think -- I think that there is room for us to do something to try -- and I would like to see it done in a bipartisan way, by the way. I -- I'm amenable to working with folk on the other side to try to come to some sensible center on this so that we can have bipartisan legislation.

But I -- I still contend that those workers who took that cut at GM and who are taking cut, they didn't get bonuses cut. They -- they got bread and butter cut, and there's a difference. And there's not a big to-do about what's happening to them.

Thank you, Mr. Chairman. I yield back the balance of my time, after having the opportunity to -- to speak for those who are not here to speak for themselves.

Thank you.

REP. CLEAVER: Let the church say amen. (Laughter.)

We want to thank the panel for the extraordinary time you've -- you've given. And unless something -- unless additional members come in, the gentleman from Florida will be the last questioner, or Mr. Sherman, if he should return.

The gentleman from Florida is recognized.

REP. ALAN GRAYSON (D-FL): Thank you, Mr. Chairman.

We are trying to make policy on the basis of recent memory. For the past few months, we've seen banks that have brought themselves to the brink of ruin, brought the whole U.S. economy to the brink of ruin, and what people see, which is so frustrating to them, is that they see that nobody's being held accountable for that. Nobody's been punished for that. Maybe the gravy train has slowed down for them a little bit, but it's still rolling. And I think that people find that frustrating, and rightfully so.

What I'm worried about is that proposals like this don't go far enough because what they do is they say, "You don't get paid extra if you destroy your company. You don't get paid extra if you handed the taxpayers a $100 billion bill." So I want to hear is I want to hear your best ideas about how we should hold accountable the people who have already screwed up, the people who have already caused the destruction of their own bank and caused the taxpayers to have to give out billions upon billions of dollars. And I want to know what we should do in the future about people like that.

Let's start with Ms. Minow.

MS. MINOW: Well, there is a limitation on ex post facto laws. There's not much you can do about what has already happened. But I would certainly strongly urge Congress to make sure that anyone involved can never serve on the board of a public company or as an officer of a public company ever again. It's unthinkable to me that these people continue to be involved.

REP. GRAYSON: Let's be specific about this. When you say, "everybody involved," who would you include in that?

MS. MINOW: I would include the executives and the boards of directors of all of the main TARP companies, the ones that -- that are still participating in the program.

REP. GRAYSON: So you would apply the same sort of punishment that the SEC actually frequently applies to people who are engaged in illegal trading?

MS. MINOW: Yes, I would.

REP. GRAYSON: Okay. What about you, Mr. Turner? Your best ideas.

MR. TURNER: I -- I totally agree with you about the frustration and that there needs to be accountability. I think the SEC in their announcement just in the last week about Countrywide and going after them is exactly what we're looking for. I think there's also been cases filed with respect to fraudulent reporting by companies, such as Citicorp, and I think that DOJ and SEC needs to work those through the courts in the most diligent way, and I would say some of the same question applies to Fannie and Freddie as well with some of their practices.

And just as Nell has said, with those where after due process people are found not to do the job -- due process is important in this country and we don't want to run into cowboy justice, but where due prices is, these people ought to be barred, and the SEC has the authority to bar those people from ever being an officer and director again. And they haven't had a good track record of doing that in the past, and they need to do it. And if they don't do it, then you guys ought to haul SEC up here and ask them why.

REP. GRAYSON: All right. Mr. Turner, you're talking about cases of fraud. I'm talking about something a little bit different. I'm talking about cases of gross, gross mismanagement that literally led to the destruction of a multibillion-dollar institution. How should we treat people like that, not people who file false statements with the government, with the SEC, but people who destroy their companies and, right now, maintain control of those companies only at the benefit -- only through the largesse of the taxpayers? What should we do with those people?

MR. TURNER: Would you -- when you passed the Sarbanes-Oxley Act, you gave the SEC the authority to find that when they look at directors or officers and find that they're substantially unfit to fill those roles, they can bar them forever from serving in those roles at a public company, and I think, in some of the instances of these companies, we're going to find that some of these directors are, in fact, substantially unfit to fulfill that role, haven't demonstrated the fitness ability, and the SEC should forever bar them from being officer or director of another public company.

REP. GRAYSON: Mr. Bebchuk, what do you think we should do in a situation where somebody who heads a bank or a group of people who head a bank have run that bank into ruins and handed the taxpayers a $100 billion bill? What should we do with those people?

MR. BEBCHUK: I very much understand your frustration, but I think that -- I am concerned about retroactively changing the rules of the game. So to the extent that -- and this is hypothetical. If you have someone who acted completely according to the law, I would try to --

REP. GRAYSON: Mr. Bebchuk, I'm asking you what should the law be. That's what we do around here.

MR. BEBCHUK: But the law --

REP. GRAYSON: We determine that.

MR. BEBCHUK: -- the law that we had on the books after this point was a law that did not make it criminal as well as limited private actions when somebody had --

REP. GRAYSON: Right.

(Cross talk.)

REP. GRAYSON: Mr. Bebchuk, it's legal to destroy your company and hand the taxpayer a $100 billion bill. We understand that. We want to change that. What should we do?

MR. BEBCHUK: About people going forward?

REP. GRAYSON: If you wish.

MR. BEBCHUK: Going forward, you can reconsider the legal rule that, right now, completely insulates someone from legal liability when they engage in gross negligence. So we could reconsider those legal rules and open them to legal liability subsequently (ph).

REP. GRAYSON: Okay. My time is up. Thank you, Mr. Chairman.

If any of the other members of the panel want to comment on this, please feel free to write to me and let me know.

Thank you.

REP. CLEAVER: We -- the chair recognizes the gentleman from California.

REP: SHERMAN: Or better yet, you could furnish your answer for the record, and we could all know.

REP. GRAYSON: Thank you.

REP. SHERMAN: I would point out that criminal law can't be ex post facto, but, as I believe Mr. Turner pointed out, we can ban some of these people from ever serving on the board of a publicly traded corporation again. We might also look at the civil law to see whether those whose actions have cost us perhaps $700 billion, perhaps less, would be liable to the federal government. Ex post facto criminal laws are much more constrained by the Constitution.

I would think that Wall Street itself would keep some of these people off the boards, except I could see some of them saying, "Well, these folks didn't show remarkably bad financial judgment. They showed tremendous political skill. They separated the taxpayers from $700 billion of assets."

Now, Mr. Verret, you've been talking about how we need to keep talent motivated as -- but I think it's been pretty well illustrated by the gentleman from Texas nobody's moving to London, let alone Tokyo, to make more money, or very few are.

Is there any economic theory that would say that if 10 percent of the executives who work for publicly traded banks then found themselves at the hedge funds that that would mean a diminution in the quality of financial management in this country? Is -- would a slight change in talent moving from the publicly traded sector to the not publicly traded sector -- has anybody proven that that would hurt us?

MR. VERRET: Well, I'm not an economist specifically.

REP. SHERMAN: Are you aware of any such study?

MR. VERRET: I'm not aware --

REP. SHERMAN: Okay. Thank you.

(Cross talk.)

MR. VERRET: -- question.

REP. SHERMAN: Thank you.

Professor -- I'm going to mispronounce your name.

MR. BEBCHUK: Bebchuk.

REP. SHERMAN: Bebchuk. I don't believe that we're going to control or should control compensation for a company that -- except if it's publicly traded in which case we want to make sure the shareholders are empowered. Systemically, it puts the country at risk or is government -- governmentally subsidized, assured, insured, et cetera.

And this leaves the hedge funds whereas my understanding that -- for the most part you do have an incentive to take enormous risks. That is to say -- I mean, there's a lot of talk about, "Well, if the investment does well, the management should do well. If the investment does poorly, the management should do poorly." I know of no hedge fund that's structured that if they lose money, the management writes a check out of their own pocket to the -- are -- is the typical structure of a hedge fund one that encourages excess risk?

By typical structure, I mean one where the management puts in none of its own money, shares only in the profits, has no real compensation except for the profits, and in some cases doesn't share until a 5 (percent) or a 10 percent rate of return is achieved, and, if so, are some of these hedge funds a systemic risk to the country?

MR. BEBCHUK: I agree with you that the government should not constrain the specific choices that are made in the fee arrangement between hedge fund managers and their investors. But I also agree with you that as part of this general reconsideration that is going -- that is now taking place, investors in hedge funds should take a serious look at those arrangements because I do share your sentiment that the same short-term focused program that we have now weakness with publicly traded companies exists in the hedge fund area.

So what we have is -- there are many hedge funds where -- usually, the arrangement is we don't give back money, but there are those high watermarks and, therefore, right now, there's a situation in which we might not be able to get extra funds which creates a lot of distortion because either they fold the fund or they work without high-powered incentives. So I think it would be a good idea for investors to reconsider --

REP. SHERMAN: Are investors given enough information about management compensation at hedge funds?

MR. BEBCHUK: Yeah. Those are arrangements that --

REP. SHERMAN: Okay.

MR. BEBCHUCK: -- you know, are negotiated with a small number of investors and are fully disclosed. But --

REP. SHERMAN: My -- my next question is: Is a fight between management and insurgent shareholders a fair fight, or is it more like an election in Venezuela? Do the minority shareholders have any access to corporate funds, and is management allowed to use corporate funds as they will to call and propagandize?

I see Ms. Minow may have an answer.

MS. MINOW: Yeah. I think I'm the only one on the panel who's actually tried to do this, and so I can tell you that management will spend all -- every last dime of your money against you. And it is -- you know, I'm not saying it needs to be a level playing field, but, right now, it's pretty perpendicular.

REP. SHERMAN: So much for shareholder democracy.

I yield back.

REP. CLEAVER: Thank you. I have one -- just one question. Morgan Stanley, I guess, through this clawback provision -- are you familiar with it -- where they -- it's after the fact where they -- if a CEO has jeopardized the country -- the company, they -- they will then repossess any bonuses or special compensation. Is that something that would be -- you think would be applicable for legislation that this committee will consider?

MR. TURNER: Morgan Stanley -- it's not even just the CEO. It's -- it's any executive that they determine has --

REP. CLEAVER: Yes, yes.

MR. TURNER: -- caused harm. I would have gone further and say, "Even if you didn't cause harm, if you got money that you shouldn't have gotten, you should give it back." But -- but that's -- that's the role of good corporate governance and good compensation policy, not the role of government regulation.

MS. MINOW: On the other hand, the executives have raised their base pay to make up for some of the additional risk that they're taking on. So I don't approve of that.

REP. CLEAVER: Of course, it would be government business if we put it into legislation.

MR. TURNER: I understand that, yes.

REP. CLEAVER: Yes. Thank you.

MR. TURNER: I do support and noted in my testimony the right of investors -- when someone has operated in a reckless or fraudulent way, I do support giving investors the right to go for that clawback, and, in that manner, either the board can ask for the clawback and get it back or, if they don't, the board -- or the shareholders can because someone ought to go get that money back.

MR. VERRET: I think this goes to the disclosure issue and the SEC's work in 2006 and Chairman Shapiro's current work in this area, and I think the right issue is -- the right question is: Did the board go for a clawback? If not, it should have to explain why to its shareholders.

REP. CLEAVER: Thank you. I appreciate all of the time you've spent with us today, and I have -- and the ranking member has a question.

REP. BACHUS: Professor Verret, Treasury yesterday released a statement on executive compensation that supported the passage of say- on pay. Will say on pay be effective, in your opinion?

MR. VERRET: Well, I think one of the problems that I hope I get across is that I think -- what we've seen in Britain is that concentration of the proxy advisory firms has caused a -- sort of a one-size-fits-all solution to take hold in pay. And I think it's better to have a flexible approach. The compensation committee should have the flexibility to design compensation proposals appropriate for their own businesses.

I also worry about the possibility that say on pay could minimize the board's ability to change compensation, as required by big major changes in markets and events, in midstream between the annual advisory votes on say on pay.

I also worry about the effects of say on pay on severance packages and the ability to negotiate a so-called golden handshake to facilitate an efficient merger acquisition. Even if you do the -- even if you do a vote, sometimes negotiations happen overnight with respect to negotiating mergers and acquisitions, and I think those sorts of agreements are very important. Sometimes they have to be approved very, very quickly, not in time to do a shareholder advisory vote.

REP. BACHUS: Thank you.

REP. CLEAVER: The chair notes that some members may have additional questions for this panel which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their response in the record.

This is the end of this hearing. We thank you for participating. (Sounds gavel.)

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