Tuesday, February 8, 2011

Executive Compensation Rules Proposed

The FDIC on February 7 issued an interagency notice of proposed rulemaking to implement Section 956 of the Dodd-Frank Act, a provision aimed to prohibit executive and incentive compensation plans that encourage risk taking.

The proposal is a joint rulemaking by the five federal members of the Federal Financial Institutions Examination Council (FFIEC), the Securities Exchange Commission (SEC) and the Federal Housing Finance Agency (FHFA).

All depository institutions with assets greater than $1 billion will be required to file an annual report that details the structure of its incentive-based compensation plans. The report must include a clear narrative of incentive-based compensation arrangements, and specific reasons the institution believes the structure of its incentive-based compensation plan does not provide covered persons incentives to engage in behavior that is likely to cause a material financial loss, and does not provide excessive compensation.

The proposed rule asks whether there are other types of financial institutions, such as a credit union service organization (“CUSO”), that the Agencies should treat as a covered financial institution to better promote the purpose of section 956 and competitive equity. Currently, no CUSOs wholly owned by a federally insured credit union have total consolidated assets of $1 billion or more.

Larger covered institutions will also have to provide a succinct description of any specific incentive compensation policies for the institution’s executive officers, and others who individually have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance.

The term “larger covered financial institution” for the Federal banking agencies and the SEC means those covered financial institutions with total consolidated assets of $50 billion or more. For the NCUA, all credit unions with total consolidated assets of $1 billion or more are larger covered financial institutions. For the FHFA, all Federal Home Loan Banks with total consolidated assets of $1 billion or more are larger covered financial institutions.

Along with other restrictions, the rule requires that at least 50% of incentive-based payments be deferred for a minimum of three years for designated executives at larger covered institutions.

The proposed rule would move the U.S. closer to international compensation standards by

requiring deferral of a substantial portion of incentive compensation for executive officers of large institutions;
prohibiting incentive-based compensation that would encourage inappropriate risks by providing excessive compensation;
prohibiting incentive-based compensation arrangements that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss;
requiring policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution; and
requiring annual reports on incentive compensation structures to the institution's appropriate Federal regulator.

To read the proposed rule, click here.

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