The banking agencies dusted off a proposed compensation regulation re reproposed it yesterday.
Dodd-Frank required a proposal of some sort. It appears that the Biden Administration and its appointed regulators are trying to check the box prior to the election.
While the proposed rule is 200 pages - a summary of its requirements follows:
The proposed rule would establish general requirements applicable to incentive-based compensation arrangements at all covered financial institutions with over $1 billion in assets. It would also establish more stringent requirements for institutions with $50 billion or more in total consolidated assets.
The key requirements and prohibitions that would apply to all covered institutions over $1 billion in assets include:
- Prohibiting incentive arrangements that encourage inappropriate risks by providing excessive compensation or that could lead to material financial loss
- Requiring incentive arrangements to balance risk and reward appropriately
- Requiring the board of directors to conduct oversight of the incentive compensation program
- Requiring policies and procedures, as well as record-keeping requirements
For larger institutions with $50 billion or more in assets (Level 1 and Level 2 institutions), additional requirements would apply, including:
- Minimum deferral periods and amounts for incentive compensation
- Review and potential adjustment/forfeiture of incentive compensation amounts in certain situations
- Clawback provisions to recover incentive compensation for up to 7 years after vesting
- Additional risk management, controls, governance, and policies/procedures requirements
- Prohibitions on hedging incentive compensation, maximum incentive opportunity limits, and prohibitions on volume-driven incentive plans without regard to transaction quality or sound risk management
So in summary, the proposed rule establishes baseline requirements for all larger institutions, with substantially more rigorous requirements for the largest and most complex firms. The stated goal is to better align incentives with appropriate risk-taking.
Curbing inappropriate risk proposals include is complicated and a summary of how the proposal plans to achieve this goal follows.
The proposed rule aims to address incentive-based compensation arrangements that could encourage employees to take inappropriate risks that may lead to material financial losses for the institution. There are two main aspects to this prohibition:
1. Excessive Compensation: Compensation, fees, and benefits are considered excessive when they are unreasonable or disproportionate to the value of the services performed by the covered person. The proposed rule outlines several factors that should be considered when determining whether compensation is excessive, such as:
- The combined value of all compensation, fees, or benefits provided to the covered person
- The compensation history of the covered person and other individuals with comparable expertise at the institution
- The financial condition of the covered institution
- Compensation practices at comparable institutions
- For post-employment benefits, the projected total cost and benefit to the covered institution
2. Encouraging Inappropriate Risks: An incentive-based compensation arrangement is considered to encourage inappropriate risks that could lead to material financial loss unless it:
- Appropriately balances risk and reward
- Is compatible with effective risk management and controls
- Is supported by effective governance
The proposed rule requires that incentive-based compensation arrangements include financial and non-financial performance measures, allow non-financial measures to override financial measures when appropriate, and be subject to adjustment to reflect actual losses, inappropriate risks taken, or compliance deficiencies.
This prohibition aims to ensure that incentive-based compensation arrangements are designed to balance risk and reward appropriately and do not encourage employees to take excessive risks that could lead to material financial losses for the institution. By requiring institutions to consider various factors when determining compensation and to design incentive arrangements that balance risk and reward, the proposed rule seeks to mitigate the potential for incentive-based compensation to contribute to inappropriate risk-taking and financial instability.
The entire proposal can be found on NCUA's website by clicking HERE.