Donald R. Van Deventer, Ph.D.

Don founded Kamakura Corporation in April 1990 and currently serves as Co-Chair, Center for Applied Quantitative Finance, Risk Research and Quantitative Solutions at SAS. Don’s focus at SAS is quantitative finance, credit risk, asset and liability management, and portfolio management for the most sophisticated financial services firms in the world.

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Lessons Learned from an Honest Man Who Quit AIG

03/25/2009 02:47 AM

On Tuesday, March 24, 2009, an honest man named Jake DeSantis resigned from AIG.  His resignation letter shows how typical Wall Street compensation systems and the politics of hysteria surrounding the government’s love/hate relationship with AIG can destroy value for the common shareholders of AIG, the American taxpayers.

Jake DeSantis’ letter was published by the New York Times as an Op/Ed piece and we take it at face value for the many lessons it provides.  We start by outlining the key lessons of his letter and end with the full text of the letter itself.

Confusing Performance Bonuses and “Deferred Compensation”

There are a number of reasons why Wall Street sometimes, but not always, uses low base salaries and high bonuses relative to other industries:

  • Revenues in the securities industry are very cyclical, and the bonus system in theory allows the firm to run at a lower fixed salary level when times are bad
  • Performance of an employee may be uncertain, and the bonus system allows the firm to reward the employee “ex post” after seeing how well in fact the employee did

Mervyn King, governor of the Bank of England, lamented on May 7, 2008 that “Banks have come to realize in the recent crisis that they are paying the price for having designed compensation packages which provide incentives that are not, in the long run, in the interests of the banks themselves…”  One of the reasons Mr. King is spot on is the tendency of the bonus system to dramatically overcompensate the undeserving when times are good and to undercompensate the deserving when times are bad.  Another problem created by this bonus system is that it gives both management and those that report to them an incentive to hide problems for as long as possible so that both management and their staff get paid their bonuses before shareholders are informed of the problems.

As Mr. DeSantis’ letter makes clear, none of the rationales for bonuses apply to him, nor do the problems of the bonus system.  His bonus was not “pay for performance,” it was deferred compensation.  This is a defective application of the bonus system and this problem is wide-spread.  If the true value of an employee’s annual efforts are $x or more, and the base salary is 1/2 of $x, the firm has to pay a bonus that brings total compensation back to $x or lose the employee.  That’s a misdesigned bonus system, because a component of the bonus (1/2 of $x) is deferred salary–it has to be paid anyway and neither of the reasons for paying in the form of bonus instead of salary applies here.  Both Mr. DeSantis and senior management know the reason for Mr. DeSantis’ $1 base salary, and we don’t, but in hindsight neither Mr. DeSantis nor AIG nor the American taxpayers were well served by this compensation design.

Politics versus Economics

If Mr. DeSantis’ letter describes his role at AIG correctly, he was one of the “good guys” trying to preserve shareholder value for the owners of the firm in the face of adversity. Eighty percent of the shares are held by the American taxpayers.  The $180 billion paid to save AIG didn’t go to Mr. DeSantis–only $1 did (his base salary).  His agreement to work for $1 with the promise of deferred compensation was a noble and well-intentioned mistake.  One only makes those kind of agreements if one can firmly rely on the management of the firm to keep its promises.  With all due respect to Mr. Liddy, the $1 a year CEO of AIG, he too is subject to the same kind of risk–can he rely on the Board of Directors to keep their promises to him?

What the political brouhaha over the AIG bonuses makes very clear is that the taxpayer’s effective representatives on the Board of AIG have become the members of Congress with the loudest voices, not the directors of AIG themselves.  The current shouting and yelling has created such pressure on Mr. Liddy that he is no longer allowed to distinguish between the good guys and the bad guys nor to determine the compensation of any employee of AIG, as Michael Lewis recently pointed out in a post on Bloomberg.com.  This is a double disaster for the U.S. taxpayer:

  • AIG should never have been rescued in the first place.  It would have been tens of billions of dollars cheaper for all American taxpayers to let AIG fail, with its losses instead born by the hedge funds, derivatives counterparties, and insurance policy holders of AIG as we now know.
  • AIG after the rescue seems certain to be run even less effectively as a partially nationalized firm than it would have been if it were forced into bankruptcy and the firm was administered by the courts.  Total losses are growing because AIG is now run by Congress, not by an experienced bankruptcy judge who (a) understands finance, (b) who can appoint talented management and pay them appropriately, and (c) who is not influenced by the loud voices of a mob who can’t tell the good guys from the bad guys.

Mr. DeSantis’ letter makes this perfectly clear.  Here it is, below.

Donald R. van Deventer

March 26, 2009
The following is a letter sent on Tuesday by Jake DeSantis, an executive vice president of the American International Group’s financial products unit, to Edward M. Liddy, the chief executive of A.I.G.

DEAR Mr. Liddy,

It is with deep regret that I submit my notice of resignation from A.I.G. Financial Products. I hope you take the time to read this entire letter. Before describing the details of my decision, I want to offer some context:

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

You and I have never met or spoken to each other, so I’d like to tell you about myself. I was raised by schoolteachers working multiple jobs in a world of closing steel mills. My hard work earned me acceptance to M.I.T., and the institute’s generous financial aid enabled me to attend. I had fulfilled my American dream.

I started at this company in 1998 as an equity trader, became the head of equity and commodity trading and, a couple of years before A.I.G.’s meltdown last September, was named the head of business development for commodities. Over this period the equity and commodity units were consistently profitable — in most years generating net profits of well over $100 million. Most recently, during the dismantling of A.I.G.-F.P., I was an integral player in the pending sale of its well-regarded commodity index business to UBS. As you know, business unit sales like this are crucial to A.I.G.’s effort to repay the American taxpayer.

The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity — directly as well as indirectly with the rest of the taxpayers.

I have the utmost respect for the civic duty that you are now performing at A.I.G. You are as blameless for these credit default swap losses as I am. You answered your country’s call and you are taking a tremendous beating for it.

But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn’t defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut.

My guess is that in October, when you learned of these retention contracts, you realized that the employees of the financial products unit needed some incentive to stay and that the contracts, being both ethical and useful, should be left to stand. That’s probably why A.I.G. management assured us on three occasions during that month that the company would “live up to its commitment” to honor the contract guarantees.

That may be why you decided to accelerate by three months more than a quarter of the amounts due under the contracts. That action signified to us your support, and was hardly something that one would do if he truly found the contracts “distasteful.”

That may also be why you authorized the balance of the payments on March 13.

At no time during the past six months that you have been leading A.I.G. did you ask us to revise, renegotiate or break these contracts — until several hours before your appearance last week before Congress.

I think your initial decision to honor the contracts was both ethical and financially astute, but it seems to have been politically unwise. It’s now apparent that you either misunderstood the agreements that you had made — tacit or otherwise — with the Federal Reserve, the Treasury, various members of Congress and Attorney General Andrew Cuomo of New York, or were not strong enough to withstand the shifting political winds.

You’ve now asked the current employees of A.I.G.-F.P. to repay these earnings. As you can imagine, there has been a tremendous amount of serious thought and heated discussion about how we should respond to this breach of trust.

As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.

Many of the employees have, in the past six months, turned down job offers from more stable employers, based on A.I.G.’s assurances that the contracts would be honored. They are now angry about having been misled by A.I.G.’s promises and are not inclined to return the money as a favor to you.

The only real motivation that anyone at A.I.G.-F.P. now has is fear. Mr. Cuomo has threatened to “name and shame,” and his counterpart in Connecticut, Richard Blumenthal, has made similar threats — even though attorneys general are supposed to stand for due process, to conduct trials in courts and not the press.

So what am I to do? There’s no easy answer. I know that because of hard work I have benefited more than most during the economic boom and have saved enough that my family is unlikely to suffer devastating losses during the current bust. Some might argue that members of my profession have been overpaid, and I wouldn’t disagree.

That is why I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn. This is not a tax-deduction gimmick; I simply believe that I at least deserve to dictate how my earnings are spent, and do not want to see them disappear back into the obscurity of A.I.G.’s or the federal government’s budget. Our earnings have caused such a distraction for so many from the more pressing issues our country faces, and I would like to see my share of it benefit those truly in need.

On March 16 I received a payment from A.I.G. amounting to $742,006.40, after taxes. In light of the uncertainty over the ultimate taxation and legal status of this payment, the actual amount I donate may be less — in fact, it may end up being far less if the recent House bill raising the tax on the retention payments to 90 percent stands. Once all the money is donated, you will immediately receive a list of all recipients.

This choice is right for me. I wish others at A.I.G.-F.P. luck finding peace with their difficult decision, and only hope their judgment is not clouded by fear.

Mr. Liddy, I wish you success in your commitment to return the money extended by the American government, and luck with the continued unwinding of the company’s diverse businesses — especially those remaining credit default swaps. I’ll continue over the short term to help make sure no balls are dropped, but after what’s happened this past week I can’t remain much longer — there is too much bad blood. I’m not sure how you will greet my resignation, but at least Attorney General Blumenthal should be relieved that I’ll leave under my own power and will not need to be “shoved out the door.”


Jake DeSantis



Donald R. Van Deventer, Ph.D.

Don founded Kamakura Corporation in April 1990 and currently serves as Co-Chair, Center for Applied Quantitative Finance, Risk Research and Quantitative Solutions at SAS. Don’s focus at SAS is quantitative finance, credit risk, asset and liability management, and portfolio management for the most sophisticated financial services firms in the world.

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