Financial Institutions Face New Regulation of Incentive Compensation

March 8, 2011


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.


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.