All Things FinReg


Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) instructed six federal financial regulatory agencies—the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), the Federal Deposit Insurance Corporation (FDIC), the US Securities and Exchange Commission (SEC), the Federal Housing Finance Authority (FHFA), and the National Credit Union Administration (NCUA) (collectively, the Agencies)—to jointly issue rules or guidelines limiting incentive-based executive compensation for certain financial institution senior officers and employees. Such guidelines must (1) prohibit incentive-based payment arrangements that the Agencies determine encourage inappropriate risks by providing excessive compensation or that could lead to a material financial loss and (2) require “covered financial institutions” (in general, financial institutions with $1 billion or more in total assets) to disclose information regarding the structure of their incentive-based compensation arrangements to their federal regulator.

So far, four of the Agencies (OCC, FDIC, SEC, and NCUA) have approved the proposed rule (Proposed Rule), and the Board and the FHFA are expected to approve the Proposed Rule shortly. The Proposed Rule is actually a reproposal of an April 2011 proposed rule that was never issued in final form, and according to the draft release, reflects the numerous comments on the 2011 proposal as well as experience that the Agencies have gained in applying prior guidance on incentive-based compensation. The Proposed Rule has an effective date of at least 18 months after the final rule is published, and as proposed, would not apply to any incentive-based compensation plan with a performance period that begins before the effective date.

The Proposed Rule would subject incentive pay to deferral, forfeiture, downward adjustment, and clawback requirements and would require senior executive officers of the largest financial institutions to have 60% of their incentive pay at risk for 11 years. Options and stock appreciation rights, although permitted, could only count toward deferral of 15% of incentive compensation. We are in the process of conducting an in-depth analysis of the Proposed Rule and will publish more detailed commentary on it and its impact and implications for covered financial institutions in the near future. Overall, the Proposed Rule contains more detail regarding obligations of financial institutions, and generally expands the scope of applicability of the incentive-based compensation rules. However, some of the detail helps clarify and limit the scope of its applicability. From our initial review, here are some noteworthy items in the Proposed Rule:

  • It expands the definition of “covered financial institution” beyond the statutory definition to include Federal Home Loan Banks, state-licensed uninsured branches and agencies of foreign banks and other US operations of foreign banking organizations, and state-chartered nondepository trust companies.
  • It creates three levels of financial institutions based on the total consolidated assets of the institutions, with the largest institutions ($250 billion or more in total consolidated assets) being subject to the most stringent requirements.
  • It applies the incentive-based compensation limitation to “significant risk-takers” as well as senior executive officers. Significant risk-takers are individuals who are not senior executive officers but are in a position to put a Level 1 or Level 2 covered institution at risk of material financial loss.
  • It clarifies that “incentive-based compensation” does not include compensation, fees, or benefits that are awarded solely for (and the payment of which is solely tied to) continued employment. Therefore, base salary, retention awards, signing, or hiring bonuses would not be incentive-based compensation because they are generally not conditioned on performance achievement.
  • It adds a requirement that any incentive-based compensation arrangements would need to include nonfinancial measures of performance to be considered to appropriately balance risk and reward.

Until the Proposed Rule is approved by all the Agencies, it may be subject to change before it is finalized for publication in the Federal Register. Once it is published, the comment period will likely extend for around 90 days.