Coming Soon: New Incentive Comp Limits for Financial Institutions


Coming Soon: New Incentive Comp Limits for Financial Institutions

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In June 2016, the Securities and Exchange Commission, Office of the Comptroller of the Currency, FDIC, Federal Reserve, and two other agencies (the Agencies) published a proposed rule on incentive-based compensation arrangements, which implements an important section of the Dodd-Frank Act. The rules will have significant implications for a wide swath of financial institutions with assets of at least $1 billion, including banks, broker-dealers, credit unions, investment advisers, Fannie Mae and Freddie Mac, and other financial institutions under the purview of the Agencies. The most stringent of the new requirements is reserved for institutions with over $50 billion in assets.

Scope of the Proposal

The proposal would apply to any covered institution with average total assets of at least $1 billion that offers incentive-based compensation to “covered persons,” which includes any executive officer, employee, director, or principal shareholder. The proposal further distinguishes covered institutions by asset size and applies specific rules based on the following categories:

  • Level 1 includes those covered institutions with total assets of at least $250 billion;
  • Level 2 includes covered institutions with total assets of at least $50 billion, but less than $250 billion;
  • Level 3 includes covered institutions with total assets of at least $1 billion, but less than $50 billion.

Let’s take a look at what the Agencies have developed based on these categories.

Requirements for All Covered Institutions

For all covered institutions, the proposal would prohibit establishing or maintaining “incentive-based compensation arrangements that encourage inappropriate risk by providing covered persons with excessive compensation, fees, or benefits or that could lead to material financial loss to the covered institution.” In this regard, an incentive-based compensation arrangement will not be considered to encourage inappropriate risks that could lead to material financial loss if it “appropriately balances risk and reward; is compatible with effective risk management and controls; and is supported by effective governance.” Failure to comply with these requirements could lead to, among other things, enforcement action by the applicable Agency.

Under the proposal, an appropriate balance of risk and reward can only be struck where the arrangement “includes financial and nonfinancial measures of performance; is designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and is subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance.” For example, an executive officer whose performance is evaluated based on both financial measures (such as return on equity) and non-financial measures (such as individual efforts to promote sound risk management practices or strategic leadership) would satisfy the requirements.

Compensation, fees, and benefits will be considered excessive when amounts paid are unreasonable or disproportionate to the value of the services performed. Such an analysis would consider the following factors:

  • The combined value of all compensation, fees, or benefits provided to a covered person;
  • The compensation history of the covered person and other individuals with comparable expertise;
  • The financial condition of the covered institution;
  • Compensation practices at comparable institutions.

Additionally, the board of directors of each covered institution (or a committee thereof) would be required to oversee the incentive-based compensation program and approve such arrangements for senior executive officers. Covered institutions would also be required to create annually, and maintain for at least seven years, records that document the structure of incentive-based compensation arrangements and that demonstrate compliance with the proposal. These disclosure and recordkeeping requirements would include more detailed requirements for Level 1 and Level 2 covered institutions.

Additional Requirements for Level 1 and Level 2 Covered Institutions

Level 1 and Level 2 institution-specific rules would also require that incentive-based compensation arrangements include deferral of payments, risk of downward adjustment and forfeiture, and clawback provisions to appropriately balance risk and reward. The proposal would apply deferral requirements to significant risk-takers as well as senior executive officers and would require a 40, 50, or 60 percent deferral depending on the size of the covered institution and the covered person receiving the incentive-based compensation. Significant risk-takers are generally defined to include individuals with the authority to put the institution at risk of a material financial loss.

The proposal also provides more detailed requirements and prohibitions on incentive compensation “with respect to the measurement, composition, and acceleration of deferred incentive-based compensation; the manner in which deferred incentive-based compensation can vest; increases to the amount of deferred incentive-based compensation; and the amount of deferred incentive-based compensation that can be in the form of options.”

Transition Period

Under the current framework, the compliance date under the proposal would be set for the start of the first calendar quarter that begins at least 18 months after a final rule is published in the Federal Register. Given the number of comments likely to be received by the Agencies, as well as the time it will take the Agencies to agree to any modifications to the proposal, it appears that the compliance date is at least 2 years away. Until that time, we will be monitoring any comments and modifications to the rules.

To discuss how this proposal might affect your institution, please contact Ed Spacapan, or any attorney in our Financial Institutions or Executive Compensation and Employee Benefits Groups.