In February 2011, the Federal Deposit Insurance Corporation (the “FDIC”), acting in conjunction and coordination with the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, the National Credit Union Administration, the Securities and Exchange Commission and the Federal Housing Finance Agency (collectively, the “Agencies”), approved an interagency Notice of Proposed Rulemaking (“NPR”) on incentive-based compensation arrangements as required by Section 956 of the Dodd- Frank Wall Street Reform and Consumer Protection Act (the “Act”).
The Act requires the Agencies to coordinate on developing regulations or guidelines regarding to incentive-based compensation practices at “covered financial institutions”. In particular, the Act requires that the Agencies prohibit incentive-based payment arrangements, or any feature of any such arrangement, at a covered financial institution that the Agencies determine encourage inappropriate risks by a financial institution by providing excessive compensation or that could lead to a material financial loss. Under the Act, a covered financial institution also must disclose to its appropriate Federal regulator the structure of its incentive-based compensation arrangements sufficient to determine whether the structure provides “excessive compensation, fees, or benefits” or “could lead to material financial loss” to the institution – although the Act does not require a covered financial institution to report the actual compensation of particular individuals as part of this requirement.
A “covered financial institution” includes any of the following types of institutions that have $1 billion or more in assets:
(A) a depository institution or depository institution holding company, as such terms are defined in the Federal Deposit Insurance Act (“FDIA”);
(B) a broker-dealer registered under the Securities Exchange Act of 1934;
(C) a credit union, as described in the Federal Reserve Act;
(D) an investment adviser, as defined in 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 these purposes.
“Incentive-based compensation”, for the purposes of the proposed rule, is any variable compensation that serves as an incentive for performance, but would not include base salaries, retirement plan contributions based upon a fixed percentage of the covered person’s base salary, or dividends paid and appreciation realized on stock or other equity instruments owned outright by a covered person (stock and equity instruments subject to vesting would not be considered to be “owned outright”).
The key components of the proposed rule are as follows:
- prohibit incentive-based compensation arrangements for executive officers, employees, directors or principal shareholders (“covered persons”) that would encourage inappropriate risks by providing excessive compensation;
- prohibit incentive-based compensation arrangements for covered persons that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss;
- require deferral of at least 50% of incentive compensation for a minimum of three years for executive officers of large covered financial institutions with $50 billion or more in total consolidated assets;
- require policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution to help ensure compliance with the requirements and prohibitions set forth in the NPR; and
- require annual reports on incentive compensation structures to the institution’s appropriate federal regulator.
The proposed rule would supplement existing rules and guidance adopted by the Agencies regarding incentive-based compensation.