In an attempt to prevent banks and other financial institutions from the excessively risky practices that led to the financial crisis and Great Recession, financial industry regulators are seeking comment on a proposed rule that would implement Section 956 of the Dodd-Frank Act and change compensation structures and align banks’ incentives.
The new proposed rule is a revision of a rule that was proposed in April 2011 and is developed jointly by six federal regulatory agencies: the Office of the Comptroller of the Currency, the FDIC, the Federal Reserve Board, the Federal Housing Finance Agency (FHFA), the SEC, and the National Credit Union Administration (NCUA).
Section 956 of the Dodd-Frank Act requires that federal regulating agencies jointly issue guidelines “(1) prohibiting incentive-based payment arrangements that the Agencies determine encourage inappropriate risks by certain financial institutions by providing excessive compensation or that could lead to material financial loss; and (2) requiring those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate Federal regulator,” according to the proposed rule.
Under Dodd-Frank, financial institutions covered are any of the following types of institutions that have $1 billion or more in assets:
- Depository institutions or depository institution holding companies
- Broker-dealers registered under section 15 of the Securities Exchange Act of 1934
- Credit unions
- Investment advisers
- Fannie Mae and Freddie Mac
- Any other institution the regulators jointly decide should be covered
“By requiring proper alignment of compensation incentives with an organization’s risk appetite, the rule calls on lending officers and other employees to put the interests of their institution above their own,” Comptroller of the Currency Thomas J. Curry said. “The rule will play an important role in helping safeguard financial institutions against practices that threaten safety and soundness, or could lead to material financial loss for the institution. It will also complement the OCC’s Heightened Standards guidelines, which address risk governance at large national banks and federal savings associations.”
According to Terence Roche, principal at Cornerstone Advisors, “The incentive-based compensation rule certainly has good intent, which is to ensure that management is not incented for activities that constitute taking unnecessary risk. For banks with assets of $1-$50 billion, the biggest initial impact will be that incentive plans may be reviewed and adjusted to pay less on factors that could lead to risk-taking – growth, short-term profit contributors. For banks over $50 billion in assets, the biggest initial impact is that executives will have to defer 50 percent of their incentive-based compensation for up to three years.”
Representatives from JPMorgan Chase, Citigroup, and Bank of America all declined to comment on the new proposed rule. Some industry analysts were not too sure about how effective the rule will actually be.
“This rule has the 'Duh' factor of ATR (Ability to Repay) by requiring corporate boards to 'conduct oversight' of the incentive-based compensation programs for its executives and significant risk-takers,” said Eric Chader, SVP of the business advisory firm The Collingwood Group. “The risk, however appears to be a pass-through to those executives, who are subject to clawbacks, deferrals, and forfeitures within the plans that had been approved by a compensation committee to begin with. This seems like misplaced accountability to me. Applied across all financial institutions, it probably won't have the effect of shrinking the talent pool for executive positions—there are many other more substantial risks for potential candidates that would do that—like putting executives at the GSEs on the GS scale.”
Comments on the proposed rule must be received by July 22, 2016.
Click here to view the proposed rule.