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Committees : Compensation

You Are Not Alone: Reflections on Compensation and Succession Planning Problems

November 21st, 2011 |

In connection with another successful Bank Director & Bank Executive Compensation conference, I thought it would be helpful to recap three important issues raised by the attendees, as well as some of the action items that need to be addressed in the short time left before year-end.

You are Not Alone

During the day-long Peer Exchange held prior to the conference, compensation committee directors met in small groups to discuss issues of common interest.  One of the universal feelings was that the directors are feeling awash in new regulations and regulatory guidance that are making it very difficult to do their jobs.  One director noted, to everyone’s agreement, that focusing so heavily on all of the new rules has materially detracted from time spent on truly strategic matters.

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Consistent with prior years, directors conveyed that their time commitment to board activities and the complexity of the rules they have to work through in compensation continue to increase.  When this is combined with the minimal annual increases in director compensation and the increasing threat of personal liability, it is a wonder that these directors continue to be as focused and committed to their institutions as they are.

Succession Planning at the Board Level

Though most directors felt that their boards are in a position to actively oversee their senior executives, including the wherewithal to replace underperforming or otherwise problematic individuals, there was almost universal agreement that this is very difficult (and increasingly more difficult) to do so at the board level.  The smaller the institution, the more likely it is that any given director may be either a founding investor, major business producer or both.  Though many directors indicated they had some level of succession planning for their executive ranks, few have actively planned for succession at the board level, other than using a mandatory retirement age for directors, which only guarantees transition rather than improvement.  This is consistent with the difficulties faced by many of our clients.  We frequently meet with board members to discuss proper succession planning at both the executive and board levels.

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The directors agreed that one of the best methods to surface these issues is to perform a review of each board member and the functionality of each committee.  Prior to nominating board members for each successive term, a summary of these reviews should be considered by the board, or its nominations committee.  If necessary, to arrive at the conclusion to remove a board member, it can be helpful to have a third party involved in the evaluation process.  A third party can take an independent role in the process and may also have a much more robust review process than would otherwise be developed internally.  The resulting evaluation report should be circulated to the relevant board members as part of the annual nominations process.  One director noted at the Peer Exchange that after the first 360-degree review was completed at the board level, the CEO/chairman decided it was best to keep the results of future reviews confidential from the other board members, so as to avoid conflict.  Unfortunately, this is not the end result you would hope for.

Risk is All Around Us

Not surprisingly, the general theme of the conference seemed to be risk.  The issue of risk, as it relates to compensation, was raised and discussed in almost every presentation and each director exchange.  This echoes our experience with our own clients over the past year.  For public and private banks of all sizes, the universal set of rules applicable to incentive compensation and risk is the Joint Guidance on Sound Incentive Compensation Policies (effective June 2010).  This guidance provides the principles-based approach to identifying, monitoring and mitigating risk as it may exist in your incentive compensation plans.  Subsequent risk-based rules found in Section 956 of Dodd-Frank and the proposed Interagency Guidance on Incentive-Based Compensation Arrangements (proposed April 2011) provide great direction on how Congress and the regulatory bodies will look at the risk associated with incentive compensation plans for banks with assets in excess of $1 billion, though they are not all currently effective. 

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Consistent with the Joint Guidance that is currently effective, every banking organization should be reviewing their incentive compensation arrangements to assess the risk such arrangements may pose to the institution.  The company should insure that proper oversight and controls are in place with respect to each plan to monitor ongoing risk and to participate in the design and development of new plans in a manner so that risk is fully understood and actively managed.  Lastly, the board, or a committee of the board, should regularly meet with the individuals responsible for the oversight and controls of these plans and the board minutes should reflect this process.  Together, they can properly judge whether changes need to be made to either the incentive compensation arrangements, or to the procedures and controls to monitor such programs, in order to protect the institution from unreasonable risk.  The board must be actively engaged in this process and have a good understanding of each element of incentive compensation as it exists at the bank.

dnorman

Don Norman heads Barack Ferrazzano's Compensation & Employment practice. He offers clients more than 25 years of experience dealing with complex compensation matters and works closely with the firm's large Financial Institutions Group to assist banking clients with succession planning for executives and directors across the country.

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