A group of financial regulatory agencies has released for comment revised proposed rules under Section 956 of the Dodd-Frank Act Wall Street Reform and Consumer Protection Act. The rules provide for regulations and guidelines with respect to incentive-based compensation practices at financial institutions with $1 billion or more in assets (Covered Institutions).

The agencies that released the proposed rules are the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the National Credit Union Administration, and the Federal Housing Finance Agency.

Covered Institutions include the following financial institutions with average total consolidated assets of $1 billion or more:

  • Depository Institutions or depository institution holding companies (as defined in Section 3 of Federal Deposit Insurance Act)

  • Investment advisers (as defined in Section 202(a)(11) of the Investment Advisers Act of 1940)

  • Credit Unions (as described in Section 19(b)(1)(A)(iv) of the Federal Reserve Act)

  • Broker-Dealers (registered under Section 15 of the Exchange Act of 1934)

  • Federal National Mortgage Association (Fannie Mae)

  • Federal Home Loan Mortgage Corporation (Freddie Mac)

The proposed rules (Proposed Rules) replace the proposed rules issued by the agencies in 2011. The new rules will likely not be effective until at least January 2019, if not later. However, these rules introduce new concepts and rules that Covered Institutions should begin to address sooner, rather than later, to ensure compliance when the rules ultimately become effective.

For example, Covered Institutions will not only need to comply with the rules involving incentive compensation plan design, but also with certain governance and risk management rules related to how a company monitors its incentive compensation programs. In addition, the Proposed Rules will limit incentive-based compensation for most key executive officers and others considered to be "significant risk-takers" (Covered Persons). The significant risk-taker is a new concept introduced by the Proposed Rules, and companies should be prepared to identify those persons.

Generally, the Proposed Rules prohibit Covered Institutions from providing incentive-based compensation arrangements that encourage inappropriate risk-taking by providing a Covered Person with excessive compensation, fees, or benefits; or that could lead to material financial loss to a Covered Institution. A compensation arrangement would be considered excessive if the amounts paid are unreasonable or disproportionate to the value of services performed when considering all relevant factors, such as, a Covered Person's compensation history compared to persons with comparable expertise and the financial condition of the Covered Institution. An incentive compensation arrangement would be considered to encourage taking inappropriate risks that could lead to material financial loss unless the arrangement "appropriately balances risk and reward," is compatible with "effective risk management and controls," and is supported by "effective governance."

Unlike previously issued rules and guidance, the Proposed Rules now specifically state that an incentive compensation arrangement will not be considered to appropriately balance risk and reward unless:

  • the arrangement includes financial and non-financial measures of performance, including considerations of risk-taking;

  • the arrangement is designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and

  • amounts to be awarded are subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance.

Additionally, the Proposed Rules provide specific requirements for incentive-based compensation arrangements to be considered appropriately balanced for risk and reward. Such requirements include mandatory deferral periods, mandatory forfeiture and downward adjustment considerations, and mandatory clawback periods. Maximum limits on the amount of incentive-based compensation that can be earned also will be imposed under the proposed rules. Furthermore, the Proposed Rules require Covered Institutions to provide for "effective risk management and controls" to help ensure a robust and independent risk management framework.

Companies should consider various next steps as a result of the Proposed Rules. First, they should determine whether their company is a "Covered Institution." If so, then they must determine whether it is a Level 1, Level 2, or Level 3 Covered Institution. All Covered Institutions should begin identifying those persons considered "Covered Individuals" to determine who will be affected by the Proposed Rules.

Next, companies should consider the impact of the Proposed Rules. We recommend revisiting incentive compensation arrangements and deferred compensation plans as they relate to the Proposed Rules to determine if any proactive changes are warranted. Covered Institutions also should begin to evaluate existing governance and risk management functions to determine if they would be in compliance with the Proposed Rules if they were effective today. This evaluation will uncover changes that may be needed to any governance and risk management structures.

All agencies that have released the Proposed Rules are requesting comments. Should you wish to do so, we can be of assistance in drafting or reviewing comments. The comment period ends July 22, 2016.

For more information regarding the Proposed Rules, please read our more detailed memorandum. Ballard Spahr will conduct a webinar on this subject at 12 p.m. ET on July 18, 2016. The webinar registration form is available here.

Ballard Spahr's Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products, its experience with the full range of federal and state consumer credit laws, and its skill in litigation defense and avoidance (including pioneering work in pre-dispute arbitration programs). Our Employee Benefits and Executive Compensation Group helps clients design and implement compensation and benefits packages that comply with today's complex regulatory requirements, attract and retain a quality workforce, and maintain fiscal and fiduciary responsibility.


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