Reports about new regulations on compensation practices at U.S. financial institutions emerged today in the Wall Street Journal.  Evidently, the Federal Reserve is working on new rules designed to reduce excessive risk taking such as incentives for mortgage loan production that fueled the current economic crisis.  Here is what was reported.  

Among ideas being discussed are Fed rules that would curb banks’ ability to pay employees in a way that would threaten the “safety and soundness” of the bank — such as paying loan officers for the volume of business they do, not the quality. The administration is also discussing issuing “best practices” to guide firms in structuring pay.

Government officials said their effort, which is just beginning, isn’t aimed at setting pay or establishing detailed rules. “This is not going to be about capping compensation or micro-management,” said an administration official. “It will be about understanding what is the best way to align compensation with sound risk management and long-term value creation.”

Solid corporate governance practices and effective risk management programs should be enough to limit excessive risk taking through well designed compensation plans.  However, it seems the U.S. Government is not convinced that companies will navigate the proper course.  

Companies looking to strengthen their corporate governance practices typically seek legal counsel to ensure the methods used will stand up against potential challenges from plaintiff attorneys and regulators.  Terry M. Schpok, a leading corporate governance attorney, was interviewed this week about the advice he is providing boards of directors during the current financial crisis.  Here is what he had to say about risk management.

A number of surveys have recently ranked risk management as one of the top concerns of a board. The cliché “desperate times breed desperate measures” has particular relevance today. Many boards are focusing on ensuring that management does not take desperate measures that may ultimately be challenged as improper, illegal, or exceptionally risky. The board should assure itself that the company is dedicated to enterprise risk management, meaning a top-down, holistic approach to risk management, including an assessment of operational, financial, strategic, compliance, and reputational risk. This approach eschews looking at each category independently in favor of assessing the company’s overall risk.

Because the current financial crisis is generally attributed to poor risk management, boards should consider whether they have the ability to effectively monitor risk management. They should assure that the company has an education program that provides directors with a good understanding of the company’s business and the major risks it faces. Depending on the nature of the risk and, particularly, new risks, a company may need to consider changing or adding board members with expertise in particular areas of concern. There also should be an oversight structure within the board to assure that regular periodic reports from those involved in the risk management function are provided to the board.

The entire board should remain engaged in the risk management process and be kept informed by any board committee that is reviewing details of the process on an ongoing basis. Finally, directors also need to be sure that they are getting information that they need to understand the company’s risks as well as management’s assessment of those risks. They need to be sure that management is properly assessing risks. They should review current risk management practices with the company. The board should also know what the company is doing to respond to and assess counterparty risk that may be posed to the company by lenders, insurers, suppliers, customers or other parties to business relationships the company.

This is sound advice from a leading expert in the field of corporate governance.  Wheelhouse Advisors is prepared to help companies implement the practices he suggests.  To learn more, visit www.WheelhouseAdvisors.com.

This weekend, the Wall Street Journal included the opinion of John Schnatter on the current financial crisis.  For those of you who do not recognize his name, Mr. Schnatter is none other than “Papa John” of the famous pizza franchise, Papa John’s.   As Chairman of the Board at Papa John’s International, Inc., Mr. Schnatter points out that the failings of the many corporations that were involved in the carnage started in the boardroom.   With weak oversight, these companies did not possess the strong level of governance required to hold the CEO accountable as the bubble expanded.  Mr. Schnatter explains,

“As our nation works its way through this crisis, and we look for explanations as to how we reached this point and how to avoid another crisis in the future, let us keep in mind that a significant set of checks and balances — ultimately ending with the boards of directors — has failed.”

Checks and balances must be improved, beginning with the board and ending with strong controls throughout the enterprise.  As Papa John himself says, better ingredients lead to better pizza and, in the case of enterprise risk management, better governance.