The Wall Street bonus in retreat

As Washington steps up its attacks, bankers are already getting used to a whole new pay scale.

By William D. Cohan, contributor

NEW YORK (Fortune) -- While Washington's attacks on Wall Street bonuses have reached a fever pitch - "outrageous," declared President Obama's economic advisor Larry Summers on Sunday about AIG's bonuses - this latest round of firepower is being leveled at forces already in retreat.

In the wake of one of the most heavily scrutinized bonus seasons on what is left of Wall Street, a review of how bankers and traders got paid this year reveals not only a few unexpected surprises but also a sense that market forces - with two notable exceptions - are doing as much to set compensation now as are the lawmakers in Washington.

The outrageous exceptions, of course, occurred at both AIG (AIG, Fortune 500), the large international insurer that is now nearly 80%-owned by U.S. taxpayers, and at Merrill Lynch, where "Let them eat cake"-style massive bonuses were paid last December to a plethora of top traders and bankers before the firm completed its sale to Bank of America, even though Merrill lost $27.6 billion in 2008, took $10 billion in TARP funds and was days away from a likely bankruptcy filing.

With complete disregard for reality, Merrill's board of directors authorized the payment of $3.6 billion in bonuses, including $209 million for 10 of Merrill's bankers and traders alone - notably $33.8 million to European investment banker Andrea Orcel - while another 149 bankers were paid $3 million each and some 700 in total were paid at least $1 million each. This tone-deaf behavior has prompted a full-blown investigation by Andrew Cuomo, the New York State attorney general, into how and why this happened.

AIG has also been operating in a fantasyland where it was somehow acceptable to pay out $450 million in bonuses to the very employees in the financial products unit, in London, that caused so many of AIG's problems - and now ours too.

Aside from Merrill and AIG, however, most other Wall Street firms seemed to get the message that 2008 was not the year for lavish bonuses. Top executives at Goldman Sachs (GS, Fortune 500), Morgan Stanley (MS, Fortune 500), JPMorgan Chase (JPM, Fortune 500), Bank of America (BAC, Fortune 500) and Citigroup (C, Fortune 500) took no bonuses. (Several top executives at Merrill Lynch, including Greg Fleming, Robert McCann and Rosemary Berkery also received no bonuses when they left the firm in January 2008; after requesting a $10 million bonus, former Merrill CEO John Thain quickly backtracked and got nothing, too.) The rank-and-file at Citi received cash equal to about 50% of vastly reduced bonuses, half of which was deferred for three years in case it needs to be clawed back, and half was paid in stock.

At Goldman, many bonuses were reduced by 80% from 2007 and the cash component was capped at $400,000. At UBS, the bonus pool was also cut by 80%. Cleverly, at Credit Suisse (CS), bankers and traders were paid, in large part, from a $5 billion pool stocked with some of the very same mortgage-backed securities and leveraged loans that have played such a vital role in causing the financial crisis and of which the bank had a surfeit. Any payoff from these assets will be received in around seven years. Talk about a dog's breakfast.

John Mack, the CEO of Morgan Stanley, testified before Congress in February that not only had he received a zero bonus for the second year in a row but also that since he became the firm's CEO in 2005 he has never received a cash bonus. (His salary, meanwhile, was $800,000 in 2007 and his total compensation was around $1.5 million, including $400,000 in perks for use of the company's jet.) He also said his firm would take the lead in tying compensation more explicitly to the longer-term performance of bankers and traders.

Morgan Stanley, in fact, was the first U.S. bank to institute a "clawback" mechanism that allows it to reclaim pay from anyone who causes detrimental harm to the firm or "significant" financial losses. "I know the American people are outraged about some compensation practices on Wall Street," Mack said. "I can understand why. I couldn't agree more that compensation should be closely tied to performance." Bankers at the firm refer crankily to their 2008 compensation as forms of scrip.

Meanwhile, at Lazard, the 160-year-old M&A advisory and asset-management firm, some managing directors were surprised to discover recently that they received no cash bonuses for 2008. The bonuses they did get were about half of what they had been the year before - although others were paid better - and consisted only of Lazard's restricted stock units that vest in 2013 (the firm's stock closed Friday at $28.30, 13% above its IPO price).

The ironies of that decision abound: First, until Lazard (LAZ) went public in 2005, the firm prided itself on paying its partners and employees large bonuses consisting solely of cash, as its stock was closely held by a lucky few individuals, most of whom were either Michel David-Weill, the firm's longtime patriarch, or his relatives. Second, the firm remained profitable during 2008 - earning $206 million, excluding one-time charges - and has not taken a penny of TARP money or in any other way been a burden to anyone.

While it is true that Lazard's earnings in 2008 were about 37% below the firm's earnings in 2007, the firm's decision did raise the question among many managing directors about what a banker had to do to get a cash bonus in 2008. (The answer apparently was to be at Merrill Lynch or AIG.)

Lazard trumpeted in a press release that its CEO, Bruce Wasserstein, who wrested control of the firm from David-Weill soon after he came to Lazard at the end of 2001, requested "no additional bonus" for 2008 - cash, stock or otherwise. He does get a $900,000 annual salary and 2.7 million restricted stock units that vest in 2012, which he was given a year ago as part of a five-year employment agreement. As of last Friday, Wasserstein's 2008 stock grant was worth $76.4 million. Lazard spokeswoman Judi Mackey said the firm does not comment on compensation matters and so would not share Wasserstein's thinking with regard to not paying cash bonuses to everybody despite being profitable.

In the end, the bonuses paid in 2008 - whether outrageous or tempered - elicited a rare moment of public passion from Tim Geithner, the Treasury secretary and the man who will have a lot to say about how bonuses on Wall Street are doled out in the future.

The leaders of the financial community "made some exceptionally bad judgments," he told Charlie Rose the other night, "not just in compensation practices, and how they ran their firms and how much risk they took but as the crisis intensified and as they got themselves in the position of needing exceptional assistance from the government, many of these boards of directors made things dramatically worse by continuing to pay out unjustifiable bonuses to their senior executives as they were losing tens of billions of dollars. That made this basic crisis of confidence much worse because people understandably looked at that and said, 'How could that be tenable?' And that leaves a deeper loss of basic faith [in the] quality of leadership in our institutions. We're not going to let that happen again."

William Cohan is the author of House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, published this month by Doubleday Books, a division of Random House, Inc. To top of page

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