New Rule Takes Aim at "Flawed Compensation Practices"

Several federal financial regulatory agencies proposed a new rule , pursuant to section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, that would prohibit certain financial institutions from creating incentive compensation arrangements that could encourage inappropriate risks. The rule takes aim at preventing what the agencies called “flawed incentive compensation practices in the financial industry [that] were one of many factors contributing to the financial crisis that began in 2007.”


The rule would apply to certain financial institutions with more than $1 billion in assets. Heightened standards would apply to larger institutions.


The Federal Reserve, the FDIC, the Federal Housing Finance Agency (FHFA), the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the SEC issued the joint proposal. Comments on the proposal are due within 45 days of its publication in the Federal Register, which is expected soon.


Separately, the SEC issued proposed rules directing the national securities exchanges to adopt certain listing standards related to the compensation committee of a company’s board of directors as well as its compensation advisers, implementing section 952 of the Dodd-Frank Act. The SEC’s proposal also would require new disclosures from companies concerning their use of compensation consultants and conflicts of interest. Comments on that proposal are due April 29.


The agencies issuing the joint proposal said it would require compensation practices at regulated financial institutions to be consistent with three key principles: (1) that incentive compensation arrangements appropriately balance risk and financial rewards; (2) are compatible with effective controls and risk management; and (3) are supported by strong corporate governance.  


The regulators said the proposal complements guidance previously issued by the agencies, including guidance on sound incentive compensation policies issued by the banking agencies last year (for past JofA coverage, see “ Banking Regulators Issue Final Guidance for Safe and Sound Compensation Practices ”).


The proposal would require financial institutions with $1 billion or more in assets to have policies and procedures to ensure compliance with the requirements of the rule, and submit an annual report to their federal regulator describing the structure of their incentive compensation arrangements. Larger financial institutions, generally those with $50 billion or more in assets, would be required to defer at least 50% of the incentive compensation of certain officers for at least three years, and the amounts ultimately paid would be required to reflect losses or other aspects of performance over time. For purposes of credit unions, large financial institutions would be defined as those with $10 billion or more in assets. The FHFA proposed that the income-deferral provisions apply to all entities it regulates, regardless of size.

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