United States: Regulators Propose Restricting Incentive-Based Compensation Arrangements At Covered Institutions

Last Updated: April 27 2016
Article by Steven D. Lofchie

Most Read Contributor in United States, September 2017

Six regulatory agencies requested comment on a jointly proposed rule to limit incentive-based compensation arrangements at covered institutions as required by Section 956 of the Dodd-Frank Act.

The proposing agencies are the OCC, the Board of Governors of the Federal Reserve System, the FDIC, the Federal Housing Finance Agency ("FHFA"), the National Credit Union Administration and the SEC. The proposal includes the following:

  • Incentive Compensation Arrangements: The regulations would include any arrangement where there was some benefit tied to performance.
  • Regulated Institutions: The regulations would apply to covered institutions having $1 billion or more in assets. The term "covered institution" would include: (i) depository institutions and depository institution holding companies (which includes their various subsidiaries); (ii) SEC-registered broker-dealers; (iii) investment advisers, regardless of whether registered; (iv) credit unions; (v) Fannie Mae and Freddie Mac; (vi) U.S. operations of foreign banking organizations that are treated as bank holding companies pursuant to Section 8(a) of the International Banking Act; and (vii) any other institution the federal regulators determine appropriate. 

Among such institutions, the severity of the rule would vary with the institution's size as follows:

  • Level 1 (greater than or equal to $250 billion);

  • Level 2 (greater than or equal to $50 billion and less than $250 billion);  and

  • Level 3 (greater than or equal to $1 billion and less than $50 billion).

  • Investment Advisers:  In the case of investment advisers, the relevant measure is proprietary assets, not assets under management. (See footnote 72, page 60.) Thus, standalone investment advisers should not be subject to the rule if adopted.
  • Regulated Individuals:  The individuals whose compensation would be subject to the proposed rule includes "executive officers" (a term that is itself defined to include "senior executive officers"), "significant risk takers," directors and principal shareholders. The term "executive officer" includes a whole laundry list of senior individuals, including not merely business people but also chief legal officer, chief compliance officer and chief risk officer. A "significant risk taker" is: (i) someone who may be among the top 5% percent compensated individuals at a Level 1 institution or top 2% at a Level 2 institution or (ii) someone who has authority to commit or expose 0.5% of the institution's capital to loss. 
  • Contractual Requirements Applicable to Compensation Arrangements: An incentive-based compensation arrangement must:
    • include financial and non-financial measures of performance;
    • be designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and
    • be subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies or other measures or aspects of financial and non-financial performance. 
  • Payment Requirements Applicable to Incentive Compensation Arrangements:  Compensation arrangements would be subject to significant deferral periods (that would begin after a performance period had been completed) and, even after payment, to clawback risk that could run up to seven years from the time a payment was awarded. 
  • Disclosure and Recordkeeping Requirements: The proposed rule would require all Level 1 and Level 2 covered institutions to create annually and maintain for at least seven years records that document: (i) the covered institution's senior executive officers and significant risk-takers and their respective incentive-based compensation arrangements, including information on the percentage of incentive-based compensation deferred and form of award; (ii) any forfeiture and downward adjustment or clawback reviews and decisions for senior executive officers and significant risk-takers; and (iii) any material changes to the covered institution's incentive-based compensation arrangements and policies.
  • Additional Prohibitions: The proposal contains prohibitions for Level 1 and Level 2 covered institutions that apply to: (i) hedging; (ii) maximum incentive-based compensation opportunity (also referred to as leverage); (iii) relative performance measures; and (iv) volume-driven incentive-based compensation.
  • Risk Management and Controls: The proposed rule would require all Level 1 and Level 2 covered institutions to have a risk management framework for their incentive-based compensation programs that: (i) is independent of any lines of business; (ii) includes an independent compliance program that provides for internal controls, testing, monitoring, and training with written policies and procedures; and (iii) is commensurate with the size and complexity of the covered institution's operations.
  • Governance: The proposed rule would require each Level 1 or Level 2 covered institution to establish a compensation committee composed solely of directors who are not senior executive officers to assist the board of directors in carrying out its responsibilities under the proposed rule. 
  • Policy and Procedures: The proposed rule would require all Level 1 and Level 2 covered institutions to have policies and procedures that:
    • are consistent with the requirements and prohibitions of the proposed rule;
    • specify the substantive and procedural criteria for forfeiture and clawback;
    • document final forfeiture, downward adjustment and clawback decisions;
    • specify the substantive and procedural criteria for the acceleration of payments of deferred incentive-based compensation to a covered person;
    • identify and describe the role of any employees, committees or groups authorized to make incentive-based compensation decisions, including when discretion is authorized;
    • describe how discretion is exercised to achieve balance;
    • require that the covered institution maintain documentation of its processes for the establishment, implementation, modification and monitoring of incentive-based compensation arrangements;
    • describe how incentive-based compensation arrangements will be monitored;
    • specify the substantive and procedural requirements of the independent compliance program; and
    • ensure appropriate roles for risk management, risk oversight, and other control personnel in the covered institution's processes for designing incentive-based compensation arrangements and determining awards, deferral amounts, deferral periods, forfeiture, downward adjustment, clawback, and vesting and accessing the effectiveness of incentive-based compensation arrangements in restraining risk-taking.
  • Indirect Actions: The proposed rule would prohibit covered institutions from doing indirectly, or through or by any other person, anything that would be unlawful for the covered institution to do directly under the proposed rule.
  • Start Date: The compliance date of the proposed rule would be no later than the beginning of the first calendar quarter that begins at least 540 days after a final rule is published in the Federal Register. The proposed rule would not apply to any incentive-based compensation plan with a performance period that begins before the compliance date.
  • Enforcement: The proposed rule would be enforced under: (i) subtitle C of the Safety and Soundness Act for the Federal Housing Finance Agency; and (ii) Section 505 of the Gramm-Leach-Bliley Act, as specified by Dodd-Frank Act Section 956 for the other five agencies. 

Comments on the joint proposal must be submitted by July 22, 2016.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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