In the wake of the recent bank failures, and the accompanying news that executives at these institutions recently paid themselves hefty bonuses, the Biden administration is calling for legislation authorizing the Federal Deposit Insurance Corp. to claw back executive payouts when a bank fails. Not a bad idea, but fortunately many large banks already have strong clawback measures in place. What's missing are regulations making those measures mandatory and applicable to all banks. And the legislation on which to base those regulations has been around for a dozen years — regulators have just failed to act on it.
Nearly all financial institutions with more than $100 billion in assets mandate deferral of a significant portion of senior executive officer (SEO) and senior risk taker (SRT) incentive compensation and for a significant period of time. Typically, these banks defer 60% of SEO and SRT incentive-based compensation for 3-5 years. Payouts of deferred awards may be adjusted downward to reflect poor risk outcomes or other information about risks taken that became available during the deferral period.
Further, SEO and SRT awards are subject to being clawed back for a variety of reasons, including failure to identify, raise or assess material risks. As receiver, the FDIC steps into the shoes of a failed bank's shareholders and appoints bank management. In this role, the FDIC can direct the new bank management to determine whether it would be appropriate to cancel or lessen the payout of deferred amounts and claw back all or some of recent payouts.
Nonetheless, President Biden is right to be concerned about the lack of regulations requiring banks to balance risk-taking and financial performance through well-tailored incentive compensation practices. There should be regulations like that. In the wake of the financial crisis, Section 956 of the Dodd-Frank Act mandated that the Federal Reserve, the Office of the Comptroller of the Currency, the FDIC, the National Credit Union Administration, the Securities and Exchange Commission, the FRB, the OCC and the Federal Housing Finance Agency prohibit incentive-based compensation arrangements that encourage inappropriate risks by a financial institution by providing excessive compensation; or that could lead to a material financial loss.
The agencies proposed two rules — one in 2011, and one in 2016 — to implement Section 956. Neither rule was ever finalized. As an OCC lawyer, I had a lead role in the initial proposal and in the run-up to the second. The agencies worked very hard on these efforts — meeting weekly for hours to try to find common ground. Ultimately, however, the principals at the agencies could not reach agreement and seemingly dropped further efforts to do so.
Thus, 13 years after President Obama signed Dodd-Frank, the agencies still have not acted to adopt the law's incentive compensation mandates. This, despite the agencies' assertion in the original 2011 proposal that "flawed incentive compensation practices in the financial industry" contributed to the financial crisis. Unfortunately, that seemed to be the only point on which the agencies could agree. With respect, I suggest that the Biden administration not waste time trying to pass more legislation, but instead ask the regulators to break this stalemate.
