Analysis: U.S. financial reform seen pressuring bonuses

By Dan Wilchins

NEW YORK (BestGrowthStock) – Wall Street bonuses could face pressure from an unexpected source this year: the new U.S. financial reform law.

The wide-ranging Dodd-Frank law has little to say directly about most bank employees’ compensation, but it is expected to squeeze revenue in some banking businesses.

For example, banks have grown used to making billions of dollars annually from trading derivatives. With the law pushing much of that activity onto exchanges in coming years, those trading businesses are widely expected to be less profitable.

JPMorgan Chase & Co estimated in September that the law could depress its revenue by about $1 billion a year, which amounts to less than 1 percent of its annual revenue in a typical year.

But for other banks, the impact could be dire — Sanford C. Bernstein estimated in April that Goldman Sachs Group Inc could lose more than 40 percent of its earnings in a typical year from the law.

“Compensation is set at the highest level of the company, and it’s based on two things: what you did this year, and what the prospects are for your business in the future,” said a former treasurer for a major bank.

If those prospects are poor, he said, “there’s not a compelling reason to incent you with pay.”

Lower income for these operations across Wall Street means lower pay packages for the traders, salespeople and bankers involved, recruiters, business heads and analysts said.

“Greater regulation gives banks more flexibility to pay people less this year than they did last year,” said Paul Sorbera, a recruiter for Alliance Consulting in New York.

Increased oversight is one more pressure on big banks’ end-of-year bonuses, which according to Wall Street compensation consultant Alan Johnson, could broadly fall by 5 to 10 percent from last year.

Dodd-Frank did nothing to explicitly limit pay, but regulators would likely welcome it as an unintended consequence.

Many analysts believe that bad incentives linked to compensation encouraged traders and others to take outsized risk before the financial crisis. A 2008 study found that up to 50 percent of the extra pay that sector employees received from the mid 1990s to 2006 had no economic justification.

Federal Reserve Chairman Ben Bernanke said in June that many banks have not done enough to change their compensation practices.

Dodd-Frank may be doing some of that work by tamping down revenue in what used to be the most lucrative businesses on Wall Street, including derivatives trading and trading for the firm’s own account, experts said.

Even when managers are not thinking about future revenue, they are considering regulatory pressure to reduce outsized bonuses, analysts said. Press reports have said that Morgan Stanley has told executives to budget 10 percent to 25 percent less for bonuses this year.

The Wall Street Journal reported that Morgan Stanley Chief Executive James Gorman has publicly said that Wall Street pay was too high, and the industry needs to stress teamwork over the perception that “the individual is… the hero.”

Said Charlie Peabody, a veteran independent banking analyst, “The star player is not going to be excessively rewarded because the government and regulators don’t want you to go there.”

“You can still pay people well without going to extremes,” Peabody added.


Generally, banks try to pay employees just enough to prevent them from leaving the company. If employees are less likely to quit because competitors are less likely to hire them, lower pay makes sense. And if employees are expected to earn less for the firm in the future, that also can translate into lower pay.

“It’s standard on Wall Street to look at future potential revenue from an employee in addition to this year’s performance when deciding how much to pay people,” said David Wise, a compensation consultant at Hay Group in New York.

Said one head of equities for a major bank, “If you have a big over-the-counter derivatives trading business and you’re thinking about what to pay those people, you won’t go out of your way to give them big bonuses. What’s the threat — that they’ll leave? The business is leaving anyway.”

Some business heads played down the extent to which Dodd-Frank will affect this year’s compensation.

“I think I’m going to get paid based on the revenue I made the firm, not their guess about how much I’ll make in the future,” said one managing director at a major bank. “You won’t risk ruining your franchise based on forward assumptions.”

Another said, “If I’m worried about the outlook for my group, the last thing I’m going to do is signal that to my boss and pay lower bonuses.”

But the former Treasurer for a major bank said that was wishful thinking.

“If the CFO doesn’t know that your business’ prospects are bad, your bank has bigger problems than your compensation,” he said.

Areas like retail brokerages, where revenue is less likely to be affected in the near term by financial regulation and executives are often loathe to mess with compensation, are unlikely to experience much downward pressure on bonuses.

The businesses that could get hit hardest include sales and trading, where many groups, from equity derivatives to government debt trading, had rough years. The potential for lower future profits only makes things worse for traders, sales staff, and others in these businesses, experts said.

Pay consultant Johnson sees Dodd-Frank as a small but real factor in 2010 bonuses, and noted that as its rules come closer to being enacted, it will loom larger and larger.

“It will be a bigger and bigger factor as time goes on. It’s definitely in the back of peoples’ minds now,” Johnson said.

(Reporting by Dan Wilchins. Editing by Robert MacMillan)

Analysis: U.S. financial reform seen pressuring bonuses