July 28 (Bloomberg) -- The U.S. House Financial Services Committee approved legislation that would let regulators ban incentive pay at banks and give shareholders a vote on bonuses in response to public outrage over Wall Street pay.

The bill, adopted 40-28 today, would allow banking agencies and the Securities and Exchange Commission to bar compensation practices that push financial companies to take “inappropriate risks.” The House and Senate must pass the bill before the president signs it into law. The House may vote by July 31.

“There is a risk to the system when the incentive structure is huge,” Committee Chairman Barney Frank, a Massachusetts Democrat, said as the committee debated the legislation during a meeting in Washington.

Members of Congress have faulted Wall Street banks for basing employee compensation on revenue generated in a given year without adequate regard to whether those transactions succeed over time. The legislation, which goes further than the Obama administration’s proposals to regulate compensation, also is aimed at quelling a political uproar over bonuses paid to executives whose companies took aid from U.S. rescue programs.

Republicans opposed the measure, arguing that giving regulators power to ban compensation practices would be tantamount to the government determining pay.

“The government should not be in a position of setting executive compensation,” said U.S. Representative Spencer Bachus, an Alabama Republican. No Republicans back the bill.

Shareholder Votes

The measure gives shareholders an annual vote on salary and bonuses for top executives at all public U.S. companies. The votes are non-binding, meaning companies can ignore them. The committee rejected an effort by U.S. Representative Scott Garrett, a New Jersey Republican, to conduct votes every three years.

The committee approved an amendment from Frank that authorizes the SEC to exempt some companies from the shareholder votes. He said the amendment gives the SEC flexibility to weigh the effect of so-called say-on-pay on “small” companies.

The measure also requires that each member of a corporate board’s compensation committee be independent, meaning they can’t be an executive or employee of the company.

The legislation drew an immediate rebuke from the U.S. Chamber of Commerce, which said it would “restrict economic growth and job creation.”

“This legislation would create a command and control regulatory scheme,” Tom Quaadman, an executive director at the nation’s biggest business lobby, said in a statement. “Employee compensation should be a decision made by appropriate levels of management or the board of directors and based on a variety of factors, including merit and promotion.”

Bank Compensation

Goldman Sachs Group Inc. set aside a record $11.4 billion, or 49 percent of revenue, for employees’ compensation in the first half of this year. Morgan Stanley allocated $5.91 billion and JPMorgan Chase & Co.’s investment banks put aside $6.01 billion.

The three firms paid back government funds they received through the Troubled Asset Relief Program, escaping pay restrictions imposed on recipients of U.S. aid.

President Barack Obama’s Treasury Department this month urged Congress to let shareholders weigh in on top executives’ salaries, bonuses and severance packages. Treasury’s proposals didn’t call for giving regulators power to ban incentive-pay practices.

Changing executive pay practices is part of an initiative by Congress and Obama to overhaul U.S. financial rules in the aftermath of a crisis that has cost banks, insurers and securities firms more than $1.52 trillion in writedowns and credit losses.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

Last Updated: July 28, 2009 17:36 EDT