Morgan Stanley decides not to tell shareholders what “priorities” are, SEC agrees to play along

March 28, 2013

Reuters reported on Friday that the Federal Reserve is taking a closer look at precisely how Wall Street CEOs get paid. This week, the SEC released correspondence between itself and Morgan Stanley that sheds some more light on the topic, and suggests that the Fed isn’t the only one questioning how bonuses are calculated. The SEC gets good marks for effort here, but the final result may leave Morgan Stanley shareholders unsatisfied.

The correspondence is pretty jargon-filled so here is a simpler version of what was said, in Unstructured Finance’s own words:

SEC: You say you don’t set any specific targets for bonuses, but then you cut CEO James Gorman’s pay 25 percent  because his performance wasn’t up to snuff. So, uh, how do you figure out that math? (June 22, 2012)

Morgan Stanley: Gorman’s pay was cut mostly because our return-on-equity didn’t reach a number we wanted it to reach. But please don’t pay too much attention to that, because we also factor in things like “culture” and “stakeholder engagement.” Have you ever tried to measure stakeholder engagement? They don’t make rulers for that kind of thing.  (July 26, 2012)

SEC: Actually, you need to tell shareholders about stuff like that. You said you’d disclose performance targets, so please go ahead and do that.  (January 18, 2013)

Morgan Stanley: No, no, no — you’ve got it all wrong. We don’t set “targets,” we set “priorities.” And anyway, markets are too crazy to plan things in advance. Instead, our compensation committee puts its finger to the wind at the end of the year and comes up with a bonus, depending on what’s going on at that time. Gorman’s pay was cut because our performance just wasn’t great any way you slice it — not just because he didn’t meet the ROE priority. If we ever change our mind and start using formulaic priorities* to set pay, we will start disclosing them.  (February 15, 2013)

There’s much more in these letters, but perhaps the most audacious thing in here is not anything Morgan Stanley said, but what the SEC did. It gave the bank permission to keep its ROE target a secret after….um… prodding the bank to disclose its ROE target. Morgan Stanley actually told the SEC what the target was in its response letter, but because the bank requested confidentiality, the SEC put a little asterisk in place of the number.

SEC spokeswoman Judith Burns directed Reuters to the SEC’s web site on confidential treatment. Morgan Stanley declined to comment.

The backstory here is that, since the financial crisis, lots of people have been up in arms about Wall Street pay. And so, Wall Street pay is now regulated, with the Federal Reserve is in charge of overhauling bonus practices.

As Reuters reported last week, the Fed has been asking banks why they use “relative” performance targets when setting executive bonuses. That allows a bank to measure its performance against rivals, rather than just comparing performance to some stable, previously set target.

Companies generally prefer that method because bonuses can be paid even when profits fall and returns are poor – as long as the company did better than the average or median competitor. Banks argue that because market conditions are outside of a CEO’s control, he shouldn’t be punished when times are tough. (The Fed doesn’t necessarily agree.)

It’s an interesting debate with smart voices on either side. But when it comes to things like ROE “priorities,” it’s a little odd that Morgan Stanley or any other bank would be granted the right to keep that information secret.

Then again, the SEC has had a long history of giving confidential treatment to things, including some trading activity that would normally be disclosed in quarterly 13-F filings. Perhaps most famously, the SEC initially granted confidential treatment to some terms of the infamous AIG bailout.

Still, requiring Morgan Stanley to fess up about its return on equity would seem important since the firm didn’t actually make money for shareholders last year.

Technically, Morgan Stanley lost $30 million. When stripping out an accounting oddity known as DVA, Morgan Stanley earned $3.3 billion, resulting in a 5.2 percent ROE. That’s still pretty weak compared with pre-crisis highs, and just half of the 10 percent threshold that analysts say is necessary merely to cover the cost of capital.


*Editor’s note: a formulaic priority is a target.

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