, which took effective Aug. 15, allows the FDIC, as the receiver of a financial company, to "recover from senior executives and directors who were substantially responsible for the failed condition of the covered financial company any compensation they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or for an unlimited period in the case of fraud."
As most executives know, their compensation -- particularly if they work at a financial firm that accepted monetary help from taxpayers -- has become a flashpoint among the public. Between 2006 and 2008, the top five executives at the 20 banks that accepted the most federal bailout dollars, at that point in the financial crisis, averaged $32 million each in personal compensation, , which bills itself as a progressive think-tank.
Perhaps more than the level of executive compensation, its structure, particularly within the financial industry, has become a concern. "Is executive compensation, as it's established within the financial industry, conducive to increasing moral hazard and risk taking?" asks Gerald Hanweck, professor of finance at George Mason University, and previously a visiting scholar with the FDIC.
"It certainly is," he answers his own question.
While it might be a stretch to accuse top financial-institution executives of ignoring risk, some certainly fail to factor in the full cost of that risk, Hanweck says. Consider the packages of mortgage-backed securities that some financial institutions created, ostensibly using credit default swaps to hedge against the risk of the loans going sour. Many of the swaps that were created, however, failed to reflect what was underlying them: "a cruddy bunch of mortgages," as Hanweck phrases it.
Even some who support revamping executive compensation, particularly within the financial sector, question whether handing the FDIC authority to recoup money from negligent executives shown to be negligent in their leadership is the most effective way to go about this.
Some insist that it is, of course. A letter from the Council of Institutional Investors submitted to the FDIC in May reads, in part: "We encourage the FDIC to exercise its authority to the fullest extent possible by establishing broad criteria for recouping compensation from executives responsible for the failure of a covered financial institution."
But on the other side, the Financial Services Roundtable, which represents large financial services companies, that Section 380.7 "is unwarranted both as a matter of statutory language and as a matter of sound policy." For one thing, the regulation could provide an incentive for the management team with an institution in distress to wind it down, rather than attempt to turn it around -- likely a riskier proposition.
The potential risk to possible chief executive candidates might make it difficult to entice individuals who have the skills and experience needed to turn around a failing institution to come on boards, says Edward Hauder, senior advisor with Exequity, a compensation consulting firm. "It may not give the board enough tools to get someone to come in, take a huge risk and try to turn around a sinking ship."
Rebel Cole, professor of finance with DePaul University in Chicago, however, points out that executives can account for this risk when negotiating their compensation package. "It's a specious argument," he says of the claim that board could find themselves hobbled.
Still, having the FDIC start regulating executive pay does pose problems, Hanweck says.
The setting pay should be a management decision; directly regulating it could drive away candidates at all levels. Such pay regulation also could stifle innovation, which requires taking risks. "I'm in favor of regulatory oversight, but there are certain things where you run into serious problems," says Hanweck.
A more effective option for recouping funds is through shareholder lawsuits, he argues. Any funds recouped would go directly to shareholders, rather than some fund established by regulators.
In addition, the courts, rather than the regulators, have more experience overseeing large, complicated liquidations.
"The courts know how to liquidate assets," he says. "It's what they're established and set up to do."