Three Reasons Why You Should Care About the New Proposed Incentive Compensation Rules


compensation-7-4-16.pngOne of the dangers of the snail-paced rulemaking under certain sections of the Dodd-Frank Act (DFA) is that we all get lulled to sleep and simply yawn when another set of proposed rules surfaces—especially when five years elapse between proposals. But here we are. Another round of proposed rules under DFA Section 956 was jointly released by six regulatory agencies in April and is intended to establish incentive compensation rules for financial institutions with assets greater than $1 billion.

Here are three reasons why you should care.

Reason #1: These will be rules—not guidance.
The underlying intent of the proposed rules should be familiar to banks and thrifts, as the foundation for the rulemaking is taken directly from the interagency Guidance on Sound Incentive Compensation Policies (SICP Guidance) which has applied to all banks and thrifts since June 2010. However, not all institutions have made a serious effort to comply with the spirit of the SICP Guidance and bank regulators have been somewhat lax in this area for community and regional institutions unless there have been problems in other areas of the bank. But under the pending rules, covered institutions will be required to create and maintain records for a minimum period of seven years, demonstrating compliance with the rule. Presumably, that means noncompliance in any given year could be challenged by regulators during an examination conducted up to seven years later, heightening the importance of ensuring compliance from the very first year the rules are in effect (as early as 2019). We encourage covered institutions to use this interim time in advance of the final rules to reevaluate policies, procedures and documentation related to incentive compensation risk management to determine if they are prepared for compliance.

Reason #2: There are certain plan features you must include.
A more prescriptive tone is being set by this round of the proposed rules, with three “musts” outlined for incentive arrangements at all covered institutions:

  • Must include both financial and non-financial measures;
  • Must allow non-financial measures to override financial measures, if appropriate; and
  • Must provide for downward adjustments to reflect actual losses, certain risk-taking, compliance deficiencies, and other measures or aspects of performance.

The concept of non-financial performance measures in incentive arrangements is not new for banks. But a regulator’s definition of “non-financial” almost certainly is focused on safety and soundness, and not necessarily on business or leadership strategy. Start thinking about how your incentive arrangements will address the “musts,” particularly related to the ways in which risk-oriented non-financial performance measures might be incorporated in a way that doesn’t diminish the incentive plan’s effectiveness.

Reason #3: You may need to punch above your weight class.
Sure, the most rigorous requirements under the proposed rules appear to be focused on institutions with assets over $50 billion. But don’t take too much comfort in being under $50 billion in assets, or under $1 billion, for that matter. The proposed rules explicitly provide for the relevant agency to treat a covered institution with $10 billion in assets as though it’s the one of the big guys if it deems the institution warrants such treatment. And since there are explicit provisions for ignoring the size of an organization under the rules, trickle-down regulatory expectations will inevitably reach institutions not technically covered under the rules, even if only through deeper review of compliance with the SICP Guidance. Our advice: err toward complying with the requirements of the next level up.

Given this is round two of the proposed rules, the final rules will likely be very similar to the April proposal. So, if we caught you yawning, we encourage you to wake up, grab a cup of coffee, and take some productive steps. Now is the time for action, so you can rest assured your institution will be ready.