On February 7, 2011, federal financial regulatory agencies including the Federal Deposit Insurance Corporation, U.S. Securities and Exchange Commission, Office of the Comptroller of the Currency and the Office of Thrift Supervision, issued joint proposed rulemaking implementing Section 956 of the Dodd-Frank Wall-Street Reform and Consumer Protection Act.
The proposed rule would prohibit covered financial institutions from offering any type of incentive-based compensation that (1) exposes the institution to inappropriate risk by providing excessive compensation or (2) could lead to material financial loss. The proposed rule was posted in the Federal Register in April 2011, with a 45-day comment period extending to May 31, 2011.
Covered Entities
Within the act, the term “covered financial institution” primarily includes any of the following types of entities with $1 billion or more in total assets: national or state-chartered depository institutions, holding companies of depository institutions, credit unions, investment advisors and registered broker-dealers. Each regulatory agency has its own methodology for determining asset size. For most depository institutions and holding companies, this will generally be based upon an average of the four most recently filed call or thrift financial reports.
Summary of Proposed Rule
The proposed rule aims to better align the risks and financial rewards from incentive compensation plans with the complexity and risk profile of the institution’s operations. The proposed rule:
- Prohibits covered financial institutions from offering incentive-based compensation arrangements encouraging individuals to expose the institution to inappropriate risks by providing “excessive” compensation
- Prohibits covered financial institutions from establishing or maintaining incentive-based compensation arrangements encouraging activity that could lead to material financial loss
- Requires larger covered financial institutions (those exceeding $50 billion in assets) to defer at least 50 percent of incentive-based payments to executive officers for at least three years
- Requires covered financial institutions to provide annual reports to federal regulators describing incentive compensation arrangement structures
- Requires covered financial institutions to maintain policies and procedures to help ensure compliance with these requirements and prohibitions
Determining “Excessive” Compensation
The proposed rule does not provide tangible benchmarks to determine when compensation is excessive. Amounts can be deemed excessive if they are unreasonable or disproportionate to the amount, nature, quality and scope of services performed. In making such a determination, the agencies will consider:
- The combined value of all cash and noncash benefits provided
- The compensation history of the individual and others within the organization with comparable expertise and responsibilities
- The institution’s financial condition
- Compensation practices at institutions of comparable asset size, geographic location, etc.
Reporting Requirements & Implementation
The proposed rules would require each covered financial institution to file an annual report with their federal regulator, detailing:
- The structure of any incentive-based compensation plans
- Key components of these arrangements
- Policies and procedures governing incentive compensation arrangements, along with any changes in policies or procedures since latest filing
- Specific reasons why the institution believes the plans do not provide excessive compensation or incentive to engage in behavior that could result in material financial loss
The proposed rule does not require institutions to report the actual compensation received by individuals within these plans. Reports would remain confidential to the maximum extent permitted by the Freedom of Information Act.
Per the April 14, 2011, publication in the Federal Register, the estimated burden (in hours) of implementing the proposed rule was reported as follows:
Conclusion
The proposed rule on incentive compensation could have a significant impact on the establishment or continuance of incentive compensation plans for financial institutions exceeding $1 billion in total assets. In the coming months, management at these institutions should evaluate any existing incentive arrangements that could be affected by this legislation. Further, steps should be taken to build documentation that compensation from such arrangements is reasonable and does not undermine the institution’s risk management. For more information regarding this proposed rule, please contact your BKD advisor.
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