U.S Senator Robert Menendez
528 Senate Hart Office Building
Washington, DC 20515
April 22, 2010
Dear Senator Menendez:
The over 250 consumer, employee, investor, community and civil rights groups who are members of the Americans for Financial Reform (AFR) write to express our strong support for your amendment to ban the widespread use of hedging contracts by company executives to bet against their own firms’ success. This practice is just one way that Wall Street insiders have enriched themselves at the expense of their own companies and shareholders – despite existing rules meant to link executive pay with company performance.
Your amendment focuses attention on a practice that many employees and investors might be surprised to learn about: CEOs’ purchase of hedging contracts to ensure they will be richly rewarded, no matter what their actions cost their company, workers, investors, or, ultimately, the broader economy. The practices alleged in the current SEC civil suit against Goldman Sachs – creating an investment vehicle for clients and then betting against its success – are one thing.[1] Betting against your colleagues, partners, and shareholders – and, actually, against your own performance – is another. It creates perverse incentives and undermines confidence in our markets.
If the performance-based compensation that firms trumpet in shareholder reports (and use to take advantage of the special tax treatment afforded to pay that is linked to performance) is to be believed, then fairness requires that the incentive isn’t undermined by complex hedging investments disclosed on rare occasion in fine print but generally undetectable.
A recent report by Gradient Analytics, analyzing research on 2,010 hedging transactions by 911 separate firms over more than a decade, makes clear that CEOs are increasingly taking hedging positions to ensure that they get huge rewards from their firm’s failure. In fact, the research also reveals that “on average, executives appear to use hedging instruments `opportunistically‟ by entering into these transactions ahead of poor share-price performance and „bad news‟ corporate events.” Existing law is insufficient to stop this practice. Many calls for this reform can be found in law review articles, press reports and individual investor commentary.
Without your amendment, Wall Street insiders will be able to go on rewarding themselves spectacularly even when they fail spectacularly. Your amendment is vital to the integrity of executive compensation practices. It should no longer be possible for CEOs – and other employees making more than $1 million a year –to claim to be champions of performance-based compensation while hedging against risk in the fine print.
The underlying financial reform bill aims to restore stability to and confidence in the financial sector through the principles of fairness, transparency, and accountability. Your amendment helps the bill increase stability and confidence by ensuring that the highly-paid executives of financial companies play fair, disclose their incentives, and are held accountable for their failures. Fundamental market improvements such as say on pay, enhanced governance and disclosure requirements, and others, are more meaningful if this executive compensation loophole is closed. For these reasons, we support your efforts and look forward to working with you on this.
If you have any questions, please do not hesitate to contact Heather McGhee, Washington Office Director, Demos, at hmcghee@demos.org or (202) 559-1543.
Sincerely,
Americans for Financial Reform
[1] To address this practice, AFR supports exchange-trading and clearing of derivatives and the Merkley-Levin PROP Trading Act amendment to address “Goldman-style” conflicts of interest in securitization.
Click here to see the members of Americans for Financial Reform.