WASHINGTON – Federal regulators' plan to rein in incentive-based compensation for top financial institution executives and designate certain risk-takers at large institutions is riddled with loopholes that allow firms to escape the harshest penalties envisioned in the proposal, according to financial industry critics.
In comment letters to the regulatory agencies, several reform organizations and trade associations took aim at various aspects of an April proposal that they consider too lax or lacking in clarification.
Reclaiming Reimbursements
Chief among them is the implementation language that would lay out when firms might "consider" reclaiming compensation from executives who engaged in misconduct, fraud or intentional misrepresentation. Critics argued that the voluntary nature of the "clawback" provision undercuts the proposal.
"Leaving the use of clawbacks completely to the discretion of the regulated industry, without even specifying required procedures or guidelines, severely weakens the clawback provision in the re-proposal," said Dennis Kelleher, president of the advocacy group Better Markets. "Without question, the result will be cases where executives are able to retain incentive-based compensation even though it led to a material financial loss to the firm."
Americans for Financial Reform, meanwhile, said that by limiting the types of activities that might cause a board of directors to even consider implementing clawbacks, the proposal further buffers boards of directors from actually taking compensation back. Misconduct is notoriously vague, the letter said, and makes no consideration for whether executives would be only held accountable for their own misconduct or that of their subordinates – creating a sort of plausible deniability for executives suspected of wrongdoing. Fraud and intentional misrepresentation require proof of intent, which is difficult to demonstrate.
"A close reading of this rule shows that at multiple points the agencies have inserted 'back doors' that would permit large financial institutions to escape full compliance with key requirements to hold incentive pay at risk long-term," the AFR letter said. "These loopholes could potentially allow financial firms to pay the great majority or all of bonus compensation to key personnel even if inappropriate risk-taking or misconduct occurred."
IBC Five Years Later
The agencies reissued the joint proposal in April after the initial plan, which was published in 2011 by the, foundered for almost five years. The proposal implements Section 956 of the Dodd-Frank Act and is meant to curb the kinds of incentive-based compensation packages that were widely criticized as contributing to a culture of excessive risk-taking leading up to the financial crisis. President Obama in March pressed the agencies to finish the rule during a press event at the White House.
The proposal laid out three tiers of regulation based on a financial firm's asset size – the most stringent requirements are reserved for institutions with more than $250 billion in assets, followed by firms with between $50 billion and $250 billion in assets, and finally those with assets between $1 billion and $50 billion. Firms with less than $1 billion in assets are exempt.
Within those tiers, certain executives and other "significant risk-takers" would be subject to prescribed deferrals of compensation, with the more senior executives and the largest firms having to push back a larger portion of compensation for a longer period.
The groups also targeted other provisions of the plan. Public Citizen argued that the draft did not explicitly bar "hedging" of deferred compensation packages – arrangements whereby executives can take out a sort of insurance policy on their deferred compensation. Such an arrangement effectively makes any clawbacks or other forfeiture of compensation moot, Public Citizen said.
"If a manager can purchase an insurance contract that protects against loss of future income … then incentive-based compensation is rendered useless," Public Citizen said in its letter. "These contracts should be written such that any proceeds from an illicit insurance claim would be returned in even shares to the insurance company, the bank, and any whistleblower upon detection."
Credit Unions Seek Clarification
Credit union trade associations called for the plan, initially introduced by the NCUA, to be rethought with clearer standards regarding certain provisions. The Credit Union National Association suggested credit unions were not the culprits involved in the crisis these regulations stemmed from.
"This is another one-size-fits-all rule from regulators. While the intent is to rein in the bad actors who brought upon the economic crisis, credit unions are yet again being saddled with regulatory burden," Jim Nussle, president/CEO of the Credit Union National Association said in a letter to the regulator. "Furthermore, the agency should study in detail the relationship between incentive-based compensation and credit union performance," he added.
The trade association had requested clarification on some provisions of the compensation ruling. CUNA had stated the NCUA "needs to clarify and provide guidance" on grandfathering of plans. "It is our understanding that a grandfathered plan runs until a performance period that started before the credit union became subject to the incentive-based compensation regulation expires," Lance Noggle, senior director of advocacy and counsel at CUNA said.
CUNA expressed concerns about the provisions that will determine if a Level 1 credit union would be subject to Level 2 requirements. "This could lead to credit unions following Level 2 requirements out of fear that NCUA staff could require compliance with these requirements with little notice," Noggle suggested.
The National Association of Federal Credit Unions shared these concerns as well. "In particular, many of our members are concerned about section 751.6, which would allow examiners to require certain Level 3 credit unions to comply with some or all of the more rigorous requirements applicable to Level 1 and Level 2 credit unions, depending on the complexity of the credit union's operations or compensation practices," NAFCU's President and CEO Dan Berger said in a letter to NCUA.
The incentive-based compensation rule will only affect 258 total credit unions according to the NCUA, one credit union is categorized as Level 2 and 257 are in Level 3. Credit unions classified in the Level 1 category are exempt from the ruling. CUNA's Noggle had also mentioned that the ruling will, "at minimum," require additional management of record-keeping practices within a CU.
Berger also suggested the section of Dodd-Frank that deals with compensation, Sec. 956, "should not apply to credit unions." Moreover, Berger mentioned that the Dodd-Frank was designed to be directed at those who "sparked the crisis, not credit unions," he said. "As countless regulators, legislators, and policy experts have repeatedly stated, credit unions did not cause the financial crisis, nor engage in risky behavior that Section 956 is intended to address," he said.
The National Association of State Credit Union Supervisors (NASCUS) sought clarification from the NCUA regarding non-federally insured credit unions and if they are covered by the rules. "It is unclear from the text of the proposed rule what exactly is meant by a credit union 'eligible to make an application' for federal share insurance," NASCUS said. While they suggested this was most likely not the intent of the regulator they added, "However, if it is NCUA's intent to extend the rules to non-federally insured credit unions, then NCUA should include provisions codifying consultation with the prudential state regulator.
Bankers Bite Back
For its part, the financial industry lambasted the proposal as being too harsh on financial firms. In a letter signed by the American Bankers Association, Center for Executive Compensation, Financial Services Roundtable, Securities Industry and Financial Markets Association, the Clearing House Association and U.S. Chamber of Commerce, industry groups said the proposal as written would effectively drive qualified, competent executives out of the sector entirely and into other industries where these restrictions were not in place. Reducing the quality of the talent at the top of the U.S. financial system would do little to improve its resilience, the letter argued.
"It is difficult to overstate the significance of any rule that places artificial, non-market-based restraints on the fiercely competitive global market for the services of talented professionals," the coalition letter said. "The likely result of a failure to revisit much of the structure of the re-proposal is that professionals may flee covered businesses in favor of others or seek opportunities at financial services firms which are not covered by Section 956 or outside the industry altogether."
Kenneth Bentsen, President and CEO of SIFMA, said in a separate comment letter that the main concern is the "formulaic" approach that regulators had taken to writing the proposal, making little consideration for the differences between covered firms. What might be acceptable or competitive for a bank may not be workable for a hedge fund or broker-dealer, Bentsen said, and so the agencies should re-propose rules that take the particularities of their jurisdictions into account, using principles-based approach that has prevailed to date.
"The financial services industry will inevitably evolve, and prescriptive requirements that remain fixed will, in the long term, fail to properly address the policy objectives of Section 956 in this changing landscape," Bentsen said.
