Federal Regulators Issue Proposed Rule on Incentive-Based Compensation

The OCC, FDIC, NCUA, and FHFA issued a proposed rule creating new prohibitions in connection with incentive-based compensation arrangements that could encourage inappropriate risks.  At this time, the Federal Reserve Board has not joined the proposed regulation.

The Dodd-Frank Act requires the regulators to issue rules: (1) prohibiting incentive-based compensation arrangements at financial institutions that encourage inappropriate risks by providing excessive compensation or that could lead to material financial loss; and (2) requiring those covered financial institutions to disclose information concerning any such incentive-based compensation arrangements to their regulator.

The new proposed rule applies to certain financial institutions with assets greater than $1 billion, and would further separate financial institutions into three tiers, based on size.  Among other things, it prohibits incentive-based payments that: are unreasonable or disproportionate to the value of services performed (which could encourage inappropriate risks); do not appropriately balance risk and reward; are not compatible with effective risk management and controls; are not supported by effective governance; or could otherwise lead to material financial loss.  In addition, the rule would require that larger financial institutions’ incentive-based compensation arrangements include performance measures and be more sensitive to risk, such as by including risk adjustments of awards, deferral of payments, and forfeiture and claw back provisions due to loss or poor performance.

The rule also creates additional recordkeeping requirements, with larger institutions subject to stricter obligations.

The agencies are requesting comments on the new rule within 60 days of its publication in the Federal Register.