Background
In February, the Federal Deposit Insurance Corporation (FDIC) issued
proposed
rules implementing Section 956 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the Act). Section 956 of the Act prohibits covered
financial institutions – including public or privately held banks, bank holding
companies, credit unions, broker-dealers, investment advisers and certain
government-sponsored enterprises, in each case with more than $1 billion in
total assets – from entering into risky or excessive incentive compensation
arrangements with covered employees.
On March 2, the SEC
proposed its adoption of these rules. The other agencies that will adopt
similar rules for institutions under their regulatory authority are the
Comptroller of the Currency, the Federal Reserve System, the Office of Thrift
Supervision, the National Credit Union Administration, and the Federal Housing
Finance Agency.
For a discussion of all of the Act’s executive compensation-related
requirements, please click
here.
A discussion of the SEC’s rules on say-on-pay votes, say-on-frequency votes and
votes on “golden parachutes” can be found
here.
The Proposed Rules
The proposed rules contain specific requirements for larger financial
institutions (generally defined as any institution with at least $50 billion in
assets) as follows:
- Annual incentive payments to “executive officers” at larger financial
institutions must be deferred for at least 3 years and be subject to
adjustment/forfeiture during this period for actual losses or for “other
measures or aspects or performance that are realized or become better known”
during the deferral period. Deferred amounts could be “released” from this
requirement (vest) in equal annual installments (e.g. 1/3 each year). An
“executive officer” for this purpose includes the president, CEO, executive
chairman, COO, CFO, chief investment officer, chief lending officer, chief
legal officer, chief risk officer, and any head of a major business line.
- The board or compensation committee of a larger financial institution
must identify any additional persons, other than executive officers, who
individually have the ability to expose the institution to substantial
losses in relation to the institution’s size, capital or overall risk
tolerance, and must approve any incentive-based compensation arrangements
for such individuals, and maintain documentation of such approvals.
The following additional requirements are applicable to all covered
institutions (those with consolidated assets of $1 billion or more). For
broker-dealers and investment advisers, the measurement for both tests is assets
of the broker-dealer or investment adviser itself and is not their assets under
management.
- Such institutions may not maintain any incentive-based compensation
arrangements that expose the institution to inappropriate risks by providing
any “covered person” with excessive compensation. Whether compensation is
excessive is determined based on facts and circumstances, including the
value of the compensation, the compensation history of the individual, the
financial condition of the institution, comparable practices at peer
companies, any bad acts by the covered person, and any other factors the
agencies determine are relevant. A “covered person” for this purpose would
include any executive officer (as defined above) or other employee, any
director, and any 10% or more shareholder.
- The proposed rules would prohibit any covered institution from
maintaining any incentive-based compensation arrangement which encourages
any covered person to expose the institution to inappropriate risks that
could lead to a material financial loss at the institution, based on
principles that are essentially the same principles as set forth in the
“Guidance on Sound Incentive Compensation Policies” (see our
previous article), and which include the special deferral requirements
for larger financial institutions discussed above.
- The proposed rules would require each covered financial institution to
submit annual reports to the appropriate regulator, in a format specified by
the regulator, disclosing the structure of all incentive-based compensation
arrangements, including a narrative description of the components of the
arrangements, a description of the institution’s policies and procedures
with respect to such arrangements, a description (for larger institutions)
of the specific arrangements applicable to executive officers or other
identified employees, any material changes to the arrangements since the
most recent prior report, and the specific reasons the institution believes
the structure of the arrangements does not violate the prohibitions
discussed above. Some covered institutions would apparently need to submit
the same report to multiple regulators.
- Finally the proposed rules would require each covered institution to
maintain “policies and procedures,” appropriate to the size of the
institution and the complexity and extent of the incentive-based
compensation arrangements it uses, that are designed to promote compliance
with the requirements discussed above.
What is “Incentive-Based Compensation”?
The proposed rules indicate that any compensation which is variable and
serves as an incentive for performance would be considered “incentive-based.”
The form of the payment, whether cash, equity, or other property, is disregarded
when deterring whether the arrangement is subject to the proposed rules. In
contrast, compensation awarded solely for, and the payment of which is solely
tied to, continued employment (e.g., salary) would not be considered
incentive-based compensation. Additionally, payments that serve as rewards for
activities that do not involve risk-taking (e.g., a bonus for maintaining a
professional certification) are also not considered incentive-based compensation
under the proposed rules. Likewise, compensation arrangements that are
determined based solely on an employee’s level of fixed compensation and do not
vary based on one or more performance metrics (e.g., employer contributions to a
401(k) retirement plan based on a fixed percentage of an employee’s salary) are
not covered by the proposed rules.
Timing
The proposed rules would not become final until six months after publication
in final form in the federal register. Final rules would not be adopted until
all seven of the federal regulatory agencies with authority to implement Section
956 of the Act have adopted the proposed rules and the comment period with
respect to the proposed rules has lapsed.
