United States: The Re-Proposed Rule On Incentive-Based Compensation At Financial Institutions: Overview And Observations

To date, five of the six federal regulators (the "Agencies") charged with promulgating rules under Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") have approved a joint proposed rule (the "2016 Proposal") intended to curb inappropriate risk-taking at covered financial institutions.1 Section 956 of Dodd-Frank requires the Agencies to issue jointly regulations or guidelines prohibiting at certain financial institutions incentive-based payment arrangements that the Agencies determine encourage inappropriate risks by certain financial institutions (1) through the provision of excessive compensation or (2) that could lead to material financial loss. In addition, Section 956 requires those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate Agency. The 2016 Proposal's restrictions apply to banks and a broader range of financial institutions, including investment advisers, broker-dealers and credit unions.

The 2016 Proposal will be applicable to these and other "covered institutions"2 with average total consolidated assets of over $1 billion. More prescriptive requirements will apply to those institutions with average total consolidated assets greater than or equal to $50 billion but less than $250 billion, and the most rigorous requirements will apply to those covered institutions with average total consolidated assets of $250 billion or more. The 2016 Proposal refers to these larger institutions as Level 2 and Level 1 covered institutions, respectively.

The 2016 Proposal replaces a proposed rule that had been published by the Agencies in 2011 (the "2011 Proposal") and which generated over 10,000 comments. In the interim, the Agencies have been actively reviewing the incentive-based compensation practices in the financial services industry and providing supervisory guidance on how financial institutions can ensure incentive-based compensation arrangements do not encourage imprudent or undue risk-taking.3 Resulting from this supervisory review is a proposed rule that incorporates many of the practices already implemented at large financial institutions but, in certain areas, imposes stricter requirements than what is commonplace. Other financial services institutions may find that implementation of the 2016 Proposal will require significant changes to both their incentive– based compensation programs and their risk governance processes.

Overall, the 2016 Proposal evidences the Agencies' effort to provide flexibility to the covered institutions in developing their incentive-based compensation programs while instituting certain bright-line requirements. In line with this approach, the 2016 Proposal places front line responsibility with the boards of directors and their committees, as well as with management of the covered institution, for implementation of the rule and its principles, while requiring more clearly delineated and documented procedures in each step of the decision-making process to allow Agency oversight and audit. Consistent with the trend both domestically and internationally, the 2016 Proposal imposes increased oversight and governance responsibilities on boards, their committees and management, which will require, in many cases, a rethinking of their organizational structures and procedures.

Compliance with the 2016 Proposal will be required no later than the beginning of the first calendar quarter that begins 540 days after a final rule is published in the Federal Register, but the rule, as proposed, would not apply to any incentive-based compensation plan with a performance period that began prior to that date. Comments on the 2016 Proposal must be received by the appropriate Agency by July 22, 2016.

This publication highlights significant provisions of the 2016 Proposal and some of the challenges covered institutions may face when designing an incentive-based compensation program that balances the rule's focus on safety and soundness with the desires of shareholders to see pay for performance.

Highlights and Observations

  • Requires all incentive-based compensation payable to a "senior executive officer" or "significant-risk  taker" at a Level 1 or Level 2 covered institution to be subject to a 7-year clawback requirement.
  • Requires a substantial portion of incentive-based compensation payable to a "senior executive officer" or "significant-risk taker" at a Level 1 or Level 2 covered institution to be deferred and subject to the risk of forfeiture (up to 60% for "senior executive officers" at Level 1 covered institutions and 50% at Level 2 covered institutions, and up to 50% for "significant risk-takers" at Level 1 covered institutions and 40% at Level 2 covered institutions).
  • Awards that vest solely on the basis of continued employment are not considered incentive-based compensation.
  • Expands the group of executives considered "senior executive officers" under the rule.
  • Prohibits Level 1 and Level 2 covered institutions from accelerating the incentive-based compensation that is required to be deferred, other than in the event of death or disability.
  • Although Level 1 and Level 2 covered institutions may waive continued service requirements when negotiating a separation from service, they may not shorten the deferral period.
  • Limits the amount of incentive-based compensation payable to "senior executive officers" and "significant risk-takers" at Level 1 and Level 2 covered institutions for the attainment of performance measures in excess of target measures (to 125% and 150% of target for "senior executive officers" and "significant risk-takers," respectively).
  • Requires Level 1 and Level 2 covered institutions to implement an independent risk-monitoring framework.
  • Imposes new governance requirements on boards of directors, including requiring the board of directors (or a board committee) to approve all incentive-based compensation payable to "senior executive officers" and to maintain records documenting guidelines for the utilization of discretion in implementing incentive-based compensation-related decisions.
  • Replaces the proposed annual reporting requirements of the 2011 Proposal with a 7-year recordkeeping requirement.

Key Terms

Incentive-based Compensation4

"Incentive-based compensation" is any variable compensation, fees or benefits that serves as an incentive or reward for performance. Compensation, fees or benefits that are awarded solely for, and the payment of which is solely tied to, continued employment would not be incentive-based compensation.5

Level 1 and Level 2 Covered Institutions

As stated above, each covered institution will be placed into one of three categories—or Levels—based on its average total consolidated assets:6 

  • Level 1 covered institutions are those with average total assets of $250 billion or more;
  • Level 2 covered institutions are those with average total assets of at least $50 billion and less than $250 billion;7 and
  • Level 3 covered institutions are those with average total assets of at least $1 billion but less than $50 billion.

The 2016 Proposal includes more prescriptive requirements for Level 1 covered institutions and Level 2 covered institutions.8 These additional requirements are discussed throughout this publication.

Further, to the extent a subsidiary of a covered institution is also a covered institution (including the requirement to have $1 billion in assets), the subsidiary will be defined to be at the same level as the parent, regardless of the size of the subsidiary.9 These subsidiaries, however, would be in compliance with the rule if the parent organization complies in such a way that causes the subsidiary to comply with the requirements.

Senior Executive Officers and Significant Risk-Takers

A number of the additional requirements apply to two subgroups of covered persons,10 "senior executive officers" and "significant risk-takers."

  • Senior Executive Officer. A senior executive officer is a covered person who holds the title or, without regards to title, salary or compensation, performs the function of one or more of the following positions for any period of time during the relevant performance period: (1) president, (2) chief executive officer, (3) executive chairman, (4) chief operating officer, (5) chief financial officer, (6) chief investment officer, (7) chief legal officer, (8) chief lending officer, (9) chief risk officer, (10) chief compliance officer, (11) chief audit executive, (12) chief credit officer, (13) chief accounting officer or (14) head of a major business line or control function.
  • Significant Risk-Taker. A significant risk-taker is any covered person at a Level 1 or Level 2 covered institution who (1) received incentive-based compensation equal to at least 1/3 of the annual base salary and incentive- based compensation received and (2) satisfies either the "relative compensation test" or the "exposure test." For purposes of the 1/3 test, compensation is taken into account if it was received during the calendar year that ended 180 days before the beginning of the performance period for which the significant risk-takers are being identified.11
  • Relative Compensation Test. For Level 1 covered institutions, a covered employee is a significant risk- taker if the individual is among the highest five-percent of all covered persons (excluding senior executive officers) in annual base salary actually paid and incentive-based compensation of the Level 1 covered institution.12 For Level 2 covered institutions, the covered person must be among the highest two-percent.13 As is the case with the 1/3 test, this determination is made on the basis of the compensation that was paid during the calendar year that ended 180 days before the beginning of the performance period for which the significant risk-takers are being identified.
  • Exposure Test. A covered person would be a significant risk-taker with regard to a Level 1 or Level 2 covered institution if the individual was able to commit or expose 0.5% or more of the capital of the covered institution, or in the case of the OCC, the Board, the FDIC and the SEC, any "Section 956" affiliate of the covered institution (regardless of whether the individual is employed by that affiliate), during the same calendar year used to determine whether the covered person meets the 1/3 test. An individual is considered to be in the position to commit or expose capital if the individual has the right to put the capital at risk of loss due to market or credit risk.

To continue reading this article, please click here

Footnotes

1 The Agencies that have approved the 2016 Proposal are the (1) National Credit Union Administration ("NCUA"), (2) Office of the Comptroller of the Currency ("OCC"), (3) Federal Deposit Insurance Corporation ("FDIC"), (4) Federal Housing Financing Agency ("FHFA") and (5) the Board of Governors of the Federal Reserve System ("Board"). The remaining Agency is the Securities and Exchange Commission ("SEC"). The 2016 Proposal will be published in the Federal Register once all the Agencies have formally granted their approval. The NCUA's draft of the 2016 Proposal can be found at: https://www.ncua.gov/About/Documents/Agenda%20Items/AG20160421Item2b.pdf.

The OCC's draft of the 2016 Proposal can be found at: http://www.occ.gov/news-issuances/news-releases/2016/nr-occ-2016-49a.pdf.

The FDIC's draft of the 2016 Proposal can be found at: https://www.fdic.gov/news/board/2016/2016-04-26_notice_dis_a_fr.pdf.

The FHFA draft of the 2016 Proposal can be found at: https://www.fhfa.gov/SupervisionRegulation/Rules/RuleDocuments/Incentive

Based%20Compensation%20NPR_4-26-16.pdf.

The Board's draft of the 2016 Proposal can be found at: http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160502a2.pdf.

 The Agencies have stated that published versions of the 2016 Proposal might differ from the approved drafts.

2 Each Agency will have its own definition of "covered institution" that describes the covered financial institutions that the Agency regulates. A list of covered institutions categorized by applicable Agency is attached as Appendix A.

3 For example, beginning in 2009, the Board, OCC and FDIC participated in "horizontal reviews" of incentive-based compensation arrangements at large banking organizations and, in 2010, promulgated "Guidance on Sound Incentive Compensation Policies" (the "2010 Guidance").

4 The 2016 Proposal also contains certain related definitions. An incentive-based compensation plan is a document setting forth the terms and conditions governing the opportunity for and the payment of incentive-based compensation payments to one or more covered persons. An incentive-based compensation arrangement is an agreement between a covered institution and a covered person, under which the covered institution provides incentive-based compensation to the covered person, including incentive-based compensation delivered through one or more incentive-based compensation plans. An incentive-based compensation program is a covered institution's framework for incentive-based compensation that governs incentive-based compensation practices and establishes related controls. A covered institution's incentive-based compensation program would include all of the covered institution's incentive-based compensation arrangements and incentive-based compensation plans.

5 Examples of this type of compensation, fees or benefits would include so-called "time-based" restricted stock or restricted stock units which vest solely on the basis of continued employment.

6 Average total consolidated assets means, for institutions other than investment advisors, the average of a regulated institution's total consolidated assets, as reported on the regulated institution's regulatory reports, for the four most recent consecutive quarters. For investment advisors, average total consolidated assets would be determined by the investment advisor's total assets (exclusive of non-proprietary assets) shown on the balance sheet for the advisor's most recent fiscal year end.

7 Under the FHFA's draft of the 2016 Proposal, a Federal Home Loan Bank would always be a Level 2 covered institution (so long as it had assets of at least $1 billion).

8 Each Agency may require a Level 3 covered institution with an average total consolidated assets of at least $10 billion to adhere to some or all of the provisions applicable to Level 1 and Level 2 covered institutions depending on the activities, complexity of operations, risk profile and compensation practices of the Level 3 covered institution (or any other relevant factors).

9 This provision would not apply to covered institutions regulated by the SEC unless the parent is a depository institution holding company. In addition, for the US operations of a foreign banking organization, the level would be determined by the total consolidated US assets of the foreign banking organization (including any of its branches and agencies, as well as its subsidiaries or operations held pursuant to Section 2(h)(2) of the Bank Holding Company Act). The level of an OCC-regulated federal branch or agency of a foreign bank would be determined with reference to the assets of the federal branch or agency.

10 A "covered person" is broadly defined to include any executive officer, employee, director or principal shareholder that receives incentive-based compensation.

11 For purposes of the 1/3 test and the relative compensation test, incentive-based compensation will be counted to the extent it was awarded for a performance period that ended during that calendar year, regardless of when the performance period began.

12 The OCC, Board, FDIC and SEC would also include any "Section 956 affiliates" of the covered institution that are also covered institutions. Each Agency will have its own definition of "Section 956 affiliate."

13 With respect to Level 1 covered institutions, each Agency may substitute 2% for 5% if it determines that the covered institution's activities, complexity of operations, risk profile and compensation practices are similar to a Level 2 covered institution.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Akin Gump Strauss Hauer & Feld LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Akin Gump Strauss Hauer & Feld LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions