The largest U.S. financial companies have made progress in reforming their pay practices to limit incentives for risky behavior, but need to do more to comply with new guidelines set by bank regulators last year, a Federal Reserve report says.

The Fed released the report Wednesday on risk-taking incentives in the financial-services industry for top executives and rank-and-file workers alike.

After the financial crisis of three years ago, lawmakers and regulators in the U.S. began looking at executive and employee compensation at financial firms to try to stamp out any pay practices that could lead toward dangerous behavior, such as bets on complex financial products that threatened the financial system in 2008.

Federal regulators adopted guidance on incentive compensation in June 2010 and have been requiring large companies to develop plans to fix weaknesses in their compensation practices. While the banks have made progress, the report said, "most firms still have significant work to do" to comply with the new guidelines.

The report comes as pay practices on Wall Street have continued to be a contentious public issue. Anti-Wall Street protests in New York and other U.S. cities have put a spotlight on pay and bonuses for financial executives, while the nation struggles with a weak economy and the threat of a double-dip recession.

Before the financial meltdown, regulators allowed firms to determine pay themselves. But pay is now seen as a factor that could make a firm and the broader financial system vulnerable to collapse.

The Fed said all 25 large financial firms reviewed made progress. "All firms in the horizontal review now recognize the importance of establishing sound incentive compensation programs that do not encourage imprudent risk taking for those employees who can individually affect the risk profile of the firm," the report said.

Common changes include adjusting incentive compensation for the risk an employee's activities could pose, deferring payouts to take into account whether the employee's activities wind up producing profits or loses.

For example, senior executives, on average, now have deferred more than 60% of their incentive compensation, higher than an international guideline. More senior executives, the report said, have more than 80% deferred, the report said.

Before the financial crisis, it noted, most firms didn't pay much attention to risk-taking incentives, or only examined pay for the most-senior employees. But now the firms are "attentive to risk-taking incentives for large numbers of employees below the executive level," the report said.

The report, however, said there is still work to be done. "Some firms are still working to identify a complete set of mid- and lower-level employees, and others are working to ensure their process is sufficiently robust," the report said.

The report examined pay practices at Ally Financial Inc., American Express Co. (AXP), Bank of America Corp. (BAC), Bank of New York Mellon Corp. (BNY), Capital One Financial Corp. (COF), Citigroup Inc. (C), Discover Financial Services (DS) Goldman Sachs Group Inc. (GS) J.P. Morgan Chase & Co. (JPM) Morgan Stanley (MS) Northern Trust Corp. (NTRS), PNC Financial Services Group Inc. (PNC) State Street Corp. (STT) SunTrust Banks Inc. (STI) U.S. Bancorp (USB) and Wells Fargo & Co. (WFC).

It also examined the U.S. operations of Barclays PLC (BARC.LN, BCS), BNP Paribas SA (BNP.FR, BNPQY), Credit Suisse Group AG (CSGN.VX, CS), Deutsche Bank AG (DBK.XE, DB), HSBC Holdings PLC (HSBA.LN, 0005.HK, HBC) Royal Bank of Canada (RY.T, RY), The Royal Bank of Scotland Group PLC (RBS.LN, RBS), Societe Generale SA (GLE.FR, SCGLY), and UBS AG (UBSN.VX, UBS).

   -By Alan Zibel, Dow Jones Newswires; 202-862-9263; 
   alan.zibel@dowjones.com
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