Treasury sets pay limits for bank officials

Rules will apply to firms that receive federal funds

The US Department of the Treasury yesterday moved to curb lucrative bonuses, stock options, and golden parachute severance packages for top executives at leading financial companies, including Bank of America Corp. and State Street Corp., which have a major presence in Boston.

The limits were required for all companies participating in the government's plan to shore up the economy by injecting $250 billion into in the banking system.

While the government said only healthy financial institutions would receive cash infusions, it imposed compensation limits to protect taxpayers' investment in the companies. This month the Treasury Department was authorized to implement the restrictions by the bailout bill approved by Congress and signed by President Bush. Members of Congress said the banking industry's compensation system en couraged executives to take risks without punishing them financially if their companies lost money.

For instance, during the housing boom, the prospect of bonuses and stock options encouraged financial executives to pour more than $1 trillion into subprime loans and to trade in exotic securities, which generated enormous short-term profits. As a result of those practices, many major financial institutions have failed this year, causing the worst stock market downturn in 50 years and plunging the economy into recession.

"The unfairness of much of the economic system has become clear," said Representative Barney Frank, a Massachusetts Democrat. He called the government's intervention into private-sector compensation "historic."

Under the plan, the Treasury Department will purchase preferred shares in nine of the nation's largest financial companies, as well as in hundreds of regional banks. Chief executives at those nine companies earned a combined $289 million last year, according to the Institute for Policy Studies. The compensation pay limits would apply to the top five executives at each company for as long as the government owns shares.

Participating banks must review their compensation packages and change them to ensure they do "not encourage unnecessary and excessive risks," the government said. Frank said some executives may have to return bonuses if their firms lose money, though compensation analysts said that was not stated clearly in the legislation.

The Treasury also banned golden parachutes, multimillion-dollar severance packages chief executives often receive even when they are ousted by their boards due to poor performance. In extreme cases, the government will impose a "clawback," which is a requirement that a chief executive return some compensation if his company has to restate past earnings.

The government also reduced the size of the tax deduction companies can take for their executives' pay from $1 million per executive to $500,000.

Bank of America said it does not believe the provisions will affect compensation for chief executive Kenneth Lewis, who received a total of $24.8 million last year. Bank spokesman Robert Stickler said $4.6 million of that was in stock options that are now "far underwater," meaning they have little value because the company's share price declined. Also, he said, the bank does not offer golden parachutes.

"We feel we're in a strong position as far as executive compensation," he said.

While Bank of America was not a subprime lender, it did make money by packaging such loans and selling them to investors.

Some said the government's restrictions on companies that accept government funding may be ineffective, and that Treasury Secretary Henry Paulson will not aggressively enforce the rules.

Jack Dolmat-Connell, a Waltham pay consultant, said the clawback provision will go largely unused, because it would apply only in egregious cases of financial fraud. And a reduction in the tax deduction that offsets top executives' pay probably will not factor into a company's decision on how much to pay a chief executive, he said.

"They'll say, 'OK fine, we can't get a deduction on anything more than a half million. So what?' " Dolman-Connell said.

Richard Ferlauto, director of corporate governance for the American Federation of State, County and Municipal Employees, called the pay limits "squishy." Targeting chief executives won't necessarily stop risky behavior, for example, of traders making investments on the floor of a Wall Street firm, he said.

"My fear is that Paulson is going to interpret these guidelines quite flexibly so the kinds of real restrictions that we need will not be put in place," Ferlauto said, adding that "may be up to the next secretary of the Treasury and . . . or Congress."

Kimberly Blanton can be reached at blanton@globe.com.