The GAO Performance Management System Report


President's Perspective, June 2007: Last week, the Government Accountability Office (GAO) issued a report to Congress reviewing how several federal financial regulatory agencies have implemented key performance management practices. The agencies reviewed by the GAO included the Securities and Exchange Commission, as well as nine other agencies: the Federal Deposit Insurance Corporation (FDIC); the Commodity Futures Trading Commission (CFTC); the Office of the Comptroller of the Currency (OCC); the National Credit Union Administration (NCUA); the Farm Credit Administration (FCA); the Federal Housing Finance Board (FHFB); the Federal Reserve Board; the Office of Thrift Supervision (OTS); and the Office of Federal Housing Enterprise Oversight (OFHEO).

Among other things, the GAO’s report reviews how the ten agencies’ different performance-based pay systems, such as the SEC’s Merit Pay system, are aligned with key practices for effective performance management systems. It should come as no surprise that the SEC fared poorly in this review, despite the fact that it has had its “performance-based” Merit Pay system in place since 2002. In fact, several of the GAO’s key observations about the SEC’s performance management system closely mirror criticisms that NTEU has been consistently raising for several years now.

NTEU has long maintained that the SEC’s Merit Pay system must be built upon a solid foundation that includes not only a clear and reasonable performance management system, but also adequate and sustained funding, a prohibition against quotas in all forms, and transparency in every aspect of the program. As the GAO’s recent report makes clear, the SEC has failed to deliver.

Since the SEC is now on the cusp of yet another round of Merit Pay decisions this summer, NTEU is providing the following observations about the GAO’s report. (The full report may be reviewed by clicking here: GAO Report on Performance Management Practices). As SEC employees are aware, under the SEC’s current Merit Pay system, all employees who receive an “acceptable” performance rating may receive varying levels of Merit Pay “step increases.” These step increases purportedly are based upon the quality of each employee’s individual performance during the preceding year, as determined by agency management. The four possible categories of step increases at the SEC are: three steps for contributions of “highest quality”; two steps for contributions of “high quality”; one step for contributions of “quality”; and zero step increases for contributions that were not significant beyond an acceptable level of performance.

The SEC Appears to Rate Its Employees’ Performance at a Much Lower Level than Other Financial Regulatory Agencies Rate Theirs.

The GAO’s report provides some aggregate information about the distribution of these Merit Pay step increases at the SEC last year. According to the data, only 2.9% of SEC employees received a “highest quality” rating (3 steps), 43% received a “high quality” rating (2 steps), 47.2% received a “quality” rating (1 step), and 6.9% received a “no significant contributions” rating (0 steps). Thus, according to the SEC’s rating system, less than 3% of its employees did work of the “highest quality” last year. Furthermore, fewer than half of its employees did work of either “high quality” or “highest quality.” Almost 7% made “no significant contributions” beyond merely a minimally acceptable level of performance.

To place these ratings into a broader context, when the SEC’s aggregate data are compared to the data provided by the other financial regulatory agencies, an interesting picture emerges. For example, whereas the SEC rated only 2.9% of its employees at the highest rating category available under its Merit Pay system (“highest quality”), the overall percentage of employees at the other agencies who fell into the highest rating category varied from 10.6% to 55.5%: Federal Reserve Board economists, 10.6% “Extraordinary”; NCUA, 15.1% “Exceptional”; Federal Reserve Board non-economists, 16.6% “Extraordinary”; FCA, 23.8% “Outstanding”; FHFB, 24.8% “Outstanding”; FDIC, 25.3% “Pay Group 1” (highest level); OTS, 25.4% “Exceptional”; OCC, 26.5% “4” (highest level); CFTC, 37% “Exemplary”; and OFHEO, 55.5% “Outstanding”.

Furthermore, at each of the other agencies, the largest percentage of employees fell into the second highest rating category. At the SEC, by contrast, the largest percentage was in the second to lowest category. In addition, the percentage of employees at the other agencies reflected by the sum of the highest and second highest rating categories together far exceeded the SEC’s 45.9%. Finally, whereas the SEC rated almost 7% of its employees at the lowest rating category available to “acceptable” employees under its Merit Pay system (“no significant contributions,” earning no salary increase at all), the overall percentage of employees at the other agencies who fell into a similar rating category were generally far lower.

These comparisons could be seen as providing a revealing glimpse into how SEC management views the performance of its employees. Indeed, according to these ratings by management, the SEC would appear to have among the fewest top-performing employees, and among the most lower-performing employees, of the federal financial regulatory agencies reviewed by the GAO. These ratings, however, conflict with the general perception that the SEC is one of the best agencies in the federal government, with highly skilled professional employees.

What conclusions may be drawn from these facts? Certainly, these ratings, if they were accurate, would raise serious issues about the SEC’s ability to recruit qualified employees who are capable of performing at the highest levels. Furthermore, questions also would need to be raised regarding the abilities of SEC managers to lead their subordinates to meet the agency’s mission in the most highly effective manner. Given the number of managers at the SEC and the high degree of their involvement in nearly every phase of the SEC’s mission, surely they should share a substantial portion of the responsibility for any across-the-board failure to meet higher performance standards at the agency.

In fact, however, the primary reasons for the disparate ratings received by SEC employees as compared to those received by employees of the other agencies appear to have far less to do with the actual quality of SEC employees’ performance, and much more to do with fundamental flaws in the SEC’s pay-for-performance system, which doom it from the start – including inadequate funding, an absence of required standards in the rating process and a lack of necessary transparency. During last year’s Merit Pay process, some senior managers at the SEC sent notices to their employees indicating that they should not view the lower-than-expected step increases that they received as a reflection of the quality of the work that they had performed. Instead, they were told that their lower ratings resulted from limitations upon the overall funds made available for the Merit Pay process.

Budgetary Restrictions Have Transformed the Merit Pay Process into Something Other than a “Performance-Based” Pay System. 

It should go without saying that a pay system that is supposed to be based upon an objective evaluation of employees’ performance can never work as intended if it is insufficiently funded. When budgetary limitations become a key determinant of any agency’s performance-based pay system, the central premise of the system is undermined. For that reason, the SEC should adequately fund the Merit Pay system each year, to ensure that it remains an effective and objective motivational tool at the agency. NTEU has repeatedly noted that the SEC’s Merit Pay system lacks essential transparency because it lacks clear performance standards. Furthermore, the criteria that managers rely upon to make decisions are not communicated to employees. Indeed, employees are not even provided a copy of the initial Merit Pay ratings that they receive from their supervisors – ratings which, in many cases, are changed by the compensation committees that ultimately make the Merit Pay decisions. Finally, aggregate Merit Pay information is not reported to employees as part of the process. In its report, the GAO makes the same criticisms.

The SEC Should Increase Transparency by Establishing and Communicating Performance Standards, the Criteria for Merit Pay Decisions, and Aggregate Performance Information to Its Employees. 

In fact, the GAO observed that the SEC was the only financial regulatory agency among the ten reviewed that has not safeguarded the transparency of its pay for performance system by establishing and communicating (1) standards for differentiating among performance rating categories and (2) the criteria for management’s performance-based pay decisions. In contrast to other agencies, “...SEC officials did not establish standards upon which to base rating decisions for nonexecutive employees, nor did they communicate criteria used to make performance-based pay decisions to these employees.” Such safeguards are essential to obtain employee confidence in a performance pay system. Since such systems are intended to motivate improved employee performance, a fundamental lack of confidence in the system can only undermine its effectiveness.

The GAO noted that currently there are no written performance standards at the SEC for appraising whether an employee’s performance is “acceptable” or “unacceptable.” Furthermore, with respect to the Merit Pay process for employees with “acceptable” performance, the GAO noted that the “SEC did not develop criteria to differentiate between the four contribution categories that the compensation committees considered when recommending merit pay step increase amounts.” In addition, it was not clear to employees how performance contribution statements and the subsequent supervisory recommendations were translated into the decisions about the four contribution categories into which employees would be placed. In short, the entire process as it relates to individual employees currently lacks transparency.

The GAO’s report also reviewed how well agencies share overall rating information with employees. The GAO noted in this regard that “the safeguard of communicating the overall results of performance appraisal and pay increase decisions while protecting individual confidentiality can improve transparency by letting employees know where they stand in the organization. An employee’s summary performance rating conveys information about how well an employee has performed against established performance standards, which is important, but not sufficient to provide a clear picture of how the employee’s performance compares with that of other employees within the organization. When the organization communicates where an employee stands, management can gain credibility by having honestly disclosed to the employee the basis for making pay, promotion, or developmental opportunity decisions that may have been based on relative performance.”

Unlike some other agencies, the SEC does not currently make the aggregate results of performance rating decisions available to all employees as part of the Merit Pay process, leading to further transparency issues. NTEU has long pushed for the agency to publish such information in connection with its Merit Pay decisions each year. NTEU is hopeful that the SEC will move expeditiously to take the steps that are required to improve the Merit Pay process and make it effective.

The Future of the Merit Pay Process. 

With respect to funding issues, NTEU has repeatedly urged the SEC to adequately fund Merit Pay each year, including for the most recent rating period that ended on April 30, 2007. This should be an attainable goal within the agency’s budget, particularly in light of staff attrition over the past year. Indeed, given the number of employees who have recently left the agency, the SEC is asking those who remain to do more and more to meet mission requirements. Fully funding the Merit Pay process should be a top priority, reflecting the value and importance of the agency’s employees to the SEC’s mission. Should the agency choose not to adequately fund Merit Pay, as it did last year, employee cynicism regarding the purportedly “performance-based” process will continue to increase and morale will decrease – precisely the opposite of the intended motivational effect of such a system.

On the performance standards front, a joint labor-management committee has been established for the purpose of working on establishing objective standards and improving the performance management process. It is clear that this important work will take time. It also will require a significant commitment by SEC managers, as well as fundamental changes in the agency’s views regarding standards, transparency, and funding, if it is to be fully successful. As SEC employees’ representative, NTEU is fully committed to achieving the goals of this committee, and the union looks forward to continuing to work with management representatives to ensure the committee's ultimate success.

Other transparency issues with the Merit Pay process can and should be addressed much more quickly by the SEC. For example, in its report, the GAO noted that the SEC now intends to share with its employees information about their supervisors’ preliminary recommendations on ratings that are provided to the compensation committees, so they can see what they were recommended to receive, as well as the rationale for any changes by the committees. NTEU applauds this decision, and looks forward to an improved process this year, in which employees should be afforded a better understanding of the Merit Pay rating that they receive.

The GAO also urged the SEC to “work with the union to communicate the overall results of the performance appraisal and pay increase decisions to all employees agencywide while protecting individual confidentiality.” NTEU believes that the SEC should take this advice with respect to this year’s Merit Pay process, to ensure that employees will understand what their ratings mean in a larger context at the agency.

NTEU continues to stand ready to work with SEC management to make changes to the Merit Pay system that will improve its fairness, transparency and effectiveness.

by Chapter 293 President Greg Gilman