The Managed Funds Association ("MFA"), the Alternative Investment Management Association ("AIMA") and SIFMA told the SEC that its proposal concerning incentive-based compensation arrangements imposed restraints that exceeded the intent of Section 956 of the Dodd-Frank Act. Section 956 requires U.S. financial regulators to issue rules prohibiting excessive compensation arrangements that encourage inappropriate risk taking at Covered Financial institutions.

In their comments, MFA and AIMA recommended that the proposal should:

  • explicitly exclude non-proprietary assets in the final rule;
  • exclude (i) certain assets that may appear on an adviser's balance sheet from the calculation of that adviser's assets for purposes of the asset thresholds, (ii) assets that are invested or otherwise remain in a fund managed by an adviser, and (iii) assets that are held in or set aside for deferred compensation arrangements from the adviser's assets, in order to determine whether the adviser exceeds one of the thresholds set out in the rules;
  • clarify that only assets from an adviser's investment advisory business should be included in the calculation of the adviser's assets for purposes of the asset thresholds in the proposed rules;
  • exclude advisers that rely on the foreign private adviser exemption;
  • exclude investment advisers that are charitable organizations or advisers to church plans or, at the very least, minimize the rules' effect on them;
  • permit a registered commodity trading advisor ("CTA") to count only the pro rata portion of its assets in a ratio that is based on the portion of its investment adviser business, as compared to its CTA business, for purposes of the asset thresholds in the rules; or, alternatively, provide a limited exclusion from the definition of "investment adviser" solely for purposes of the incentive-based compensation rules for advisers that are exempt from SEC registration;
  • provide a clear provision in the final rules specifying that payments tied to ownership interests will not be deemed incentive-based compensation under the rules;
  • permit an investment adviser to determine its assets based on an average of multiple dates in a calendar year;
  • require the asset threshold to be adjusted periodically for inflation and the growth of capital markets; and
  • involve coordination between the SEC and the Internal Revenue Service regarding the relationship between the proposed rules and the tax consequences of those rules for covered institutions and covered persons, which would permit covered financial institutions to consider (i) a covered person's tax situation in setting their incentive-based compensation, and (ii) the after-tax resources of the financial institution in implementing the deferred compensation arrangement.

In a separate comment letter, SIFMA suggested that the SEC proposal should:

  • balance principles-based guidance and prescriptive rules in order to advance the tenets of the Dodd-Frank Act, Section 956;
  • limit the definition of "covered persons" to apply only to those who expose institutions to risk;
  • limit the coverage of incentive-based compensation programs only to those that could encourage inappropriate risk-taking by carving out broad-based arrangements and de minimis compensation; and
  • reflect business structure, risk and governance factors in its approach to consolidation.

SIFMA emphasized that greater flexibility is necessary:

[T]he Reproposed Rule includes a comprehensive framework of often inflexible requirements. Because it will be promulgated and enforced by six independent agencies, once finalized it will be unusually difficult to adjust. It may significantly impact the financial services industry for a long time, through many business cycles and evolutions in the financial markets.

Commentary / Steven Lofchie

A disproportionate number of individuals who are paid less because of rules like the ones in this proposal happen to work and pay taxes in the New York metropolitan area. New York politicians should consider the negative effect that targeting the financial industry can have on the local economy. Perhaps the localized impact would not matter if such rules made for good public policy. Unfortunately, government-imposed pay rules are a purely political calculation and not based on economic rationality.

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