WASHINGTON — Federal financial regulators Monday issued a joint notice of proposed rulemaking to outline permissible practices for incentive-based executive compensation, a rule required by Dodd-Frank but that has remained dormant for more than a decade.
The proposal, issued by the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Federal Housing Finance Agency attempts to curb incentive-based compensation practices and ensure risk management and safety at banks are not compromised by perverse incentives in executive compensation.
"Poorly designed financial institution compensation programs can provide incentives for short-term risk taking that can jeopardize the safety and soundness of the institution," said FDIC Chair Martin Gruenberg.
The proposal introduces a tiered system tailored to the size and complexity of financial institutions, categorizing them into three levels: Banks with more than $250 billion of assets; banks with between $50 billion and $250 billion of assets; and banks with between $1 and $50 billion of assets.
The proposal emphasizes the importance of aligning incentive-based compensation with effective risk management and corporate governance, requiring recordkeeping and disclosure by firms to their primary federal regulators. Larger institutions face additional obligations, including minimum deferral amounts and time frames for incentive-based compensation for senior executives, coupled with provisions for forfeiture and clawback in case of undue risk-taking. Chairman Gruenberg also noted that alternative regulatory provisions are also being considered.
"Among these alternative provisions are establishing a two-tiered asset threshold structure rather than a three-tiered structure," he said. "[As well as] simplifying the definition of significant risk-taker and limiting the discretion of a larger covered institution to seek to recover incentive-based compensation by requiring, rather than mandating consideration of, forfeiture, downward adjustment, and clawback of incentive-based compensation when misconduct results in significant financial or reputational harm to the covered institution."
Section 956 of Dodd-Frank requires these agencies — as well as the Securities and Exchange Commission, National Credit Union Administration and the Federal Reserve Board — to enact regulations overseeing performance-based bonus arrangements at banks with $1 billion or more in assets that could incentivize inappropriate risk-taking or excessively compensate bank executives.
A Joint release noted other agencies subject to 956 — the SEC and NCUA — are both expected to take similar measures in the near future. The Fed — noticeably absent from the proposal — said when reached for comment it's committed to the principle of mitigating perverse incentives in executive compensation agreements. The central bank stopped short of affirmatively committing to join its regulatory counterparts in the proposed rule.
"We are committed to continuing to work with the other regulators to develop a joint rule … any rule should be considered following updated analysis so that it reflects current banking conditions and practices," said a Fed spokesperson. "Executives who are responsible for a failed bank should not profit from that failure, and bank executives' pay should appropriately take into account risk."
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The proposal reintroduces for comment regulatory text from the 2016 proposal as well as additional questions for interested parties to answer in comment letters.
FDIC Vice Chairman Travis Hill — a Republican appointee who opposed the measure — attributed his apprehension to the calibration of the rule and the absence of the Fed in the rulemaking.
"In contrast to the principles-based approach set forth by the 2010 guidance, this proposed rule would establish a highly prescriptive set of requirements," Hill said in a statement. "The proposal is too broad and too blunt, would impose highly subjective triggers for forfeitures and downward adjustments and would incentivize shifting a greater portion of compensation into base salary and out of incentive-based compensation.
"In addition, the extraordinarily long lookback period, which would allow recovery for seven years after compensation vests — or up to 12 years after the compensation is awarded — seems like overkill," Hill concluded.
The agencies' press release also notes that once all six agencies adopt the NPR, it will undergo a 60-day comment period following its publication in the Federal Register. In the meantime, each individual agency will accept comments on their own websites from parties interested in weighing in on the proposal.
"Comments received on this NPR, along with those previously submitted on the 2016 NPR, will play a pivotal role in shaping efforts to address incentive-based compensation arrangements as mandated under section 956," the release noted.
