On April 21, 2016, the National Credit Union Administration (NCUA) became the first agency to re-propose1 a Dodd-Frank-mandated rule on incentive-based compensation arrangements for covered financial institutions (the original proposed rule was issued in 2011). The Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the Federal Housing Finance Agency adopted substantively identical versions of the proposal on April 26, 2016. The remaining two agencies required by Section 956 of Dodd-Frank to jointly issue the rule—the Federal Reserve Board (FRB) and Securities and Exchange Commission (SEC)—are expected to adopt the proposal shortly.
FDIC Chairman Marty Gruenberg characterized the proposal, which is intended to prohibit incentive-based compensation arrangements that would encourage “inappropriate risks” by providing excessive compensation or that could lead to material financial loss, as “perhaps the most important Dodd-Frank rulemaking remaining to be implemented.” 2
The proposal would apply to a wide variety of financial institutions—including US banks, US operations of foreign banks, SEC-registered broker-dealers, and investment advisers (both registered and unregistered)—with assets of $1 billion or more, divided into three categories:
While Level 3 institutions would only be subject to the basic set of prohibitions from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risks, the proposal would apply heightened requirements to Level 1 and Level 2 institutions, including deferrals of incentive-based compensation and clawback provisions for “senior executive officers” and “significant risk takers.”
Public comments on the proposal rule are due by July 22, 2016.
Overall, the proposed rule is more stringent than the agencies’ original 2011 proposal, as it covers a wider range of employees—including an expanded definition of senior executive officers and a new category for significant risk takers—and increases the percentage of deferred compensation for “senior executive officers.”
Specifically, Level 1 institutions would be required to defer at least 60 percent of a senior executive officer’s qualifying incentive-based compensation and at least 50 percent of such compensation for a significant risk taker for at least four years. Similarly, Level 2 institutions would be required to defer at least 50 percent of a senior executive officer’s qualifying incentive-based compensation and at least 40 percent of such compensation for a significant risk taker for at least three years.
Unlike the 2011 proposal, Level 1 and Level 2 institutions would be required to include clawback provisions that allow them to recover incentive-based compensation from these employees after such compensation vests for seven years.
Importantly, unlike international rules, the agencies do not propose a limit on the absolute size of potential target amounts; however Level 1 and Level 2 institutions would be prohibited from awarding incentive-based compensation to a senior executive officer in excess of 125 percent of the target amount for that compensation (the prohibition for a significant risk taker would be 150 percent of the target amount).
Finally, Level 1 and Level 2 institutions would be required to establish a compensation committee composed solely of directors who are not senior executive officers to assist the board of directors.
What does this mean for institutions?
Covered institutions—including US and foreign banks, asset managers, and broker-dealers—should participate in and closely monitor the notice-and-comment process, which may lead to certain changes in the final rule. These institutions should analyze the proposed rule and seek regulatory clarity on areas of uncertainty.
Although several of the proposed requirements, such as deferred compensation for senior executive officers, align with existing leading practices in the banking industry, institutions should seek to understand how they would be impacted by the rule should it be finalized as proposed. By assessing what changes they need to make now, firms may be able to comply with the rule more easily in the future.
Analyzing the culture within organizations, and identifying the key conduct risks, will be an important first step in performing this assessment. By recognizing and addressing these risks early, firms could gain a head start in understanding the impacts that this rule could have.
As the comment period continues, Deloitte will issue additional analyses of the proposal as appropriate.
For more information regarding the proposed rule, refer to our analysis here.
1 Department of the Treasury, Federal Reserve System, Federal Deposit Insurance Corporation, Federal Housing Finance Agency, National Credit Union Administration, Securities and Exchange Commission, “Incentive-based Compensation Arrangements,” Notice of Proposed Rulemaking and Request for Comment, April 21, 2016, available at https://www.ncua.gov/About/Documents/Agenda%20Items/AG20160421Item2b.pdf
2 Statement by Martin J. Gruenberg, Federal Deposit Insurance Corporation Notice of Proposed Rulemaking on Incentive-Based Compensation Arrangements, April 26, 2016, available at https://www.fdic.gov/news/news/speeches/spapr2616a.html