The Council of Institutional Investors (CII) released a new report today that concludes that Wall Street’s executive compensation practices have improved somewhat since the global financial crisis, but warns that major banks still are not tying pay to long-term gains in performance.

 “While many banks have strengthened their pay practices, there’s still a long way to go,” Ann Yerger, CII’s executive director, said in a press release. “The report suggests they need to do more to make sure that executive compensation rewards performance over the long term.”

The report was written by Paul Hodgson, a senior research associate at the Corporate Library.

The report’s findings include:

• Total CEO compensation at major Wall Street institutions in 2003-2007 was two to three times the level of pay at other Fortune 50 companies during the same period. The differential was driven mainly by big dollops of time-restricted stock in Wall Street pay packages. 
• Pay at these banks was structured to incentivize executives to deliver strong performance--over the short-term. But lavish cash bonuses, high absolute levels of pay, and excessive focus on short-term annual growth measures had damaging consequences for shareowners over the long-term.

Compensation structures on Wall Street has improved since 2008, but the banks still are not tying compensation to long-term performance metrics.

The report details a series of best practices and urges investors to identify those firms that do not follow those standards. Those best practices include:

• Multiyear performance metrics that measure sustained and sustainable long-term shareowner value growth, not simply short-term stock price gains. Economic profit metrics that require the return on capital to exceed the cost of employing capital should be considered alongside more commonly used operational metrics, such as net income, revenue, and return on equity. Such metrics, also known as shareholder value added, including the widely used "economic value added," are a far more reliable indicator of long-term growth than, for example, total stockholder return.
• The majority of incentives are delivered as equity.
• The majority of vested and realized equity is deferred into retirement.
• Incentive compensation is subject to "clawback" in the event of financial restatement or major loss is incurred, regardless of whether an executive has committed fraud.
• Base salaries do not exceed the $1 million deductibility cap set by the Internal Revenue Service on pay that is not performance-based.

While the report encourages investors to use "say on pay" votes to signal their displeasure with a company's compensation practices, the paper observes that a significant "against" vote is a "blunt" instrument. "Shareowners should ensure that if they do vote against compensation, they explain their objections in a letter to the company," the report said. "A letter to the compensation committee chair with copies to the board chair and corporate secretary is typically the first step in the engagement process, followed by in-person meetings. If change is not forthcoming, owners can let the company know that they will vote against the reelection of compensation committee members." 

New York City’s pension funds have filed a new shareholder proposal at Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo & Co. that ask each bank’s audit committee to conduct an independent review of mortgage servicing practices. The proposal calls for a report to investors by Sept. 30, 2011, that addresses each bank’s internal controls related to loan modifications, foreclosures, and securitizations.

The new resolution was inspired by reports of faulty documentation and other irregularities in the mortgage servicing operations at large banks. State and federal regulators have launched investigations into how lenders verified foreclosure documents. As the city funds point out, the four banks may be forced to repurchase troubled loans that had been bundled and sold. Goldman Sachs estimates the four banks could face potential losses of $26 billion, according to the city funds. 

“We raised concerns with the banks in July that misaligned incentives, inferior customer service, and repeated requests for paperwork were undermining the loan modification process and leading to unnecessary foreclosures for homeowners,” Comptroller John C. Liu said in a press release today.  “The magnitude of these problems suggests a larger systemic failure with consequences that have not only adversely affected homeowners and become a drain on regional economies, but also left shareholders vulnerable to substantial liabilities.”

“The banks are under intensive legal and regulatory scrutiny and the independent directors are ultimately responsible for compliance. It’s time they step forward and reassure shareholders that the banks’ internal controls are robust,” Liu said.   

The city funds are comprised of the New York City Employees’ Retirement System, the Teachers’ Retirement System, the New York City Police Pension Fund, the New York City Fire Department Pension Fund, and the Board of Education Retirement System. The funds collectively own $1.76 billion in stock in the four banks. 

It appears likely that some of the banks will file no-action requests with the Securities and Exchange Commission to exclude this new proposal. The banks presumably would argue that the resolution relates to “ordinary business operations” or has been “substantially implemented” through existing disclosures. 
 

ESG investors have renewed their efforts to persuade the U.S. Labor Department to revisit two Bush administration interpretative bulletins that the shareholders say are inconsistent with mainstream investing principles.

The two 2008 bulletins have been cited by corporate advocates to argue that pension plan administrators may not consider ESG factors, to question the legality of labor fund activism, and to oppose governance legislation. The ESG investors met with Labor Department officials in December 2009 to express their concerns about the bulletins and sent a follow-up letter in February.

In a Nov. 8 letter to Phyllis C. Borzi, the Labor Department's assistant secretary for employee benefits, the ESG investors noted that the recent accidents involving BP and Massey Energy "are two telling examples of the financial relevance of environmental, social and governance factors, such as worker health and safety practices," and are "case studies for why institutional investors need to engage companies on their ESG performance."

The investors also point out that the New York Stock Exchange's Commission on Corporate Governance, the United Kingdom's Financial Reporting Council, and the International Corporate Governance Network all have recognized the importance of ESG considerations.

The ESG investors signing the letter included Jonas Kron, vice president and deputy director of ESG research and shareholder advocacy at Trillium Asset Management; Adam Kanzer, managing director and general counsel at Domini Social Investments; Tim Smith, director of socially responsive investing at Walden Asset Management; and Meg Voorhes, deputy director and research director at the Social Investment Forum.

While the Republican Party captured the U.S. House of Representatives this week, governance observers don't expect to see a significant change in corporate governance. 

The Democrats still control the White House and the U.S. Senate, so it's unlikely that any legislation to significantly roll back the Dodd-Frank Act would become law. The SEC still will have a majority of commissioners selected by Democrats, but the agency likely will receive fewer resources but more scrutiny from House Republicans.