On March 2, 2011, the United States Securities and Exchange Commission, on a split vote, proposed a new rule (the “Proposed Rule”) requiring the disclosure of incentive-based compensation arrangements at certain financial institutions with total assets of $1 billion or more, including broker-dealers and investment advisers registered with the SEC.
The Proposed Rule is being implemented pursuant to Section 956 of the Dodd-Frank Act which requires the SEC to develop regulations or guidelines, jointly with “appropriate federal regulators,”1 on incentive-based compensation arrangements at “covered financial institutions.”2 Although the Proposed Rule will only apply to financial institutions with total assets of $1 billion or more, it is not yet clear how assets will be calculated for purposes of determining this $1 billion threshold. Last November, the SEC proposed revisions to Part IA of Form ADV that would require investment advisers to indicate whether they had $1 billion or more in assets.3 The proposed amendments specified that “the amount of assets would be the adviser’s total assets determined in the same manner as the amount of ‘total assets’ is determined on the adviser’s balance sheet for its most recent fiscal year end.” The SEC has yet to take further action on these proposed amendments.
In her opening remarks to the Commission, SEC Chairman Schapiro remarked that she was “interested in commenters’ views on how assets would be calculated for purposes of determining whether institutions fall within either component of the proposal…and how the proposal might affect the broad array of financial firms covered by Section 956, including broker-dealers and advisers — most particularly private fund advisers, given how they often structure their compensation.”
The Proposed Rule is substantially similar to the rules proposed by other federal regulators having jurisdiction over “covered financial institutions” and will be published in the Federal Register once all of the federal agencies involved in the rulemaking process approve their final proposed incentive-based compensation rules. Following such publication, the public will then be given 45 days to submit comments to the SEC on the Proposed Rule.
The Proposed Rule:
A brief summary of each of the material elements of the Proposed Rule, as set forth in the SEC Press Release relating to the Proposed Rule, is set forth below:Disclosures Relating to Incentive-Based Compensation Arrangements
Under the Proposed Rule, broker-dealers and investment advisers registered with the SEC that have total assets of $1 billion or more will be required to file an annual report with the SEC relating to the firm’s incentive-based compensation arrangements, including:
Prohibitions on Encouraging Inappropriate Risks in General
The Proposed Rule will prohibit broker-dealers and investment advisers registered with the SEC that have total assets of $1 billion or more “from establishing or maintaining any incentive-based compensation arrangements that encourage inappropriate risks by providing excessive compensation, fees or benefits to ‘covered persons,’ or that could lead to material financial loss.” Accordingly, incentive-based compensation arrangements will be measured against certain standards set forth in previously enacted legislation and crafted, in part, by bank regulators in 2010.5
Prohibitions for Larger Financial Institutions
The Proposed Rule would also create more specific requirements for financial institutions with more than $50 billion or more in total consolidated assets. Financial institutions that meet this threshold will be required to:
The board of directors, or a committee thereof, will be responsible for (i) identifying additional “covered persons” and certain other designated personnel “that individually have the ability to expose the firm to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance” and (ii) approving the incentive-based compensation arrangement for each such person.
Establishing Policies and Procedures Addressing Incentive-Based Compensation Arrangements
Under the Proposed Rule, a firm would not be permitted to establish or implement an incentive-based compensation arrangement unless such arrangement is adopted pursuant to policies and procedures developed and maintained to ensure and monitor compliance with the rule and is approved by the firm’s board of directors. The Proposed Rule notes the policies and procedures should be tailored to the size and complexity of the firm as well as the nature and scope of its incentive-based compensation arrangements.
We will continue to monitor this proposal as it develops.
Please direct any questions to any of the listed lawyers or to any other Bingham lawyer with whom you ordinarily work on related matters.
1The term ‘‘appropriate federal regulator’’ means the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Board of Directors of the Federal Deposit Insurance Corporation, the Director of the Office of Thrift Supervision, the National Credit Union Administration Board, the Securities and Exchange Commission, and the Federal Housing Finance Agency.
2 The term “covered financial institution” means (a) a depository institution or depository institution holding company, as such terms are defined in section 3 of the Federal Deposit Insurance Act; (b) a broker-dealer registered under section 15 of the Securities Exchange Act of 1934; (c) a credit union, as described in section 19(b)(1)(A)(iv) of the Federal Reserve Act; (d) an investment adviser, as such term is defined in section 202(a)(11) of the Investment Advisers Act of 1940; (e) the Federal National Mortgage Association; (f) the Federal Home Loan Mortgage Corporation; and (g) any other financial institution that the appropriate federal regulators, jointly, by rule, determine should be treated as a covered financial institution for purposes of Section 956.
3 See “Rules Implementing Amendments to the Investment Advisers Act of 1940,” available at http://www.sec.gov/rules/proposed/2010/ia-3110.pdf.
4Section 956 of the Dodd-Frank Act defines “covered persons” to include a covered financial institution’s executive officers, employees, directors and principal shareholders.
5The Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation jointly issued “Guidance on Sound Incentive Compensation Policies,” available at http://www.federalreserve.gov/newsevents/default.htm.
This article was originally published by Bingham McCutchen LLP.