Linking Compensation, Conduct, and Culture: Incentive-Based Compensation Arrangements – Interagency Notice of Proposed Rulemaking
Six federal regulatory agencies (Agencies) recently issued a joint proposed rule to prohibit incentive-based compensation arrangements that would encourage inappropriate risks by providing excessive compensation or that could lead to material financial loss. The issuance is a re-proposal of a joint proposed rule released by the Agencies in 2011. It includes some modifications to reflect the Agencies’ supervisory experiences and industry developments in the intervening five years. In general, the re-proposed rule would impose a tiered-approach based on asset size and apply increasingly more strict and prescriptive requirements to a larger group of individuals as the asset size of the covered institution increases.
Compensation arrangements that did not effectively consider risk management or risk governance and focused too heavily on revenue generation were widely thought to be a contributor to the 2007-2008 financial crisis. To address this concern, the Agencies jointly issued guidance on sound incentive compensation policies and conducted numerous examinations on the compensation practices at supervised entities. In addition, Congress prohibited certain incentive-based compensation arrangements in Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Agencies’ proposed rule is intended to implement those provisions. The Agencies note that “incentive-based compensation practices and the design of incentive-based compensation arrangements at banking organizations have improved significantly” and that many plans, especially in larger organizations, now provide for deferred compensation and risk adjustments. A final rule will provide more detail and specificity regarding supervisory expectations for incentive-based compensation arrangements. Supervisors conduct numerous examinations of banks regarding these issues. Banks that violate the final rule could be subject to fines and penalties.