The day Silicon Valley Bank failed on March 10, the bank paid out millions in bonuses to senior executives for its 2022 performance, according to the Federal Reserve’s April postmortem analysis and the bank’s proxy statement. Those bonuses were paid despite ongoing regulatory issues, including a May 2022 enforcement action.
As details trickle out about Silicon Valley Bank’s and Signature Bank’s failures, it’s becoming clear that regulators are interested in greater regulation and scrutiny of incentive plans.
Among key risk management gaps, Federal Reserve Vice Chair for Supervision Michael Barr found fault in Silicon Valley Bank’s board compensation committee, noting that holding company SVB Financial Group’s “senior management responded to the incentives approved by the board of directors; they were not compensated to manage the bank’s risk, and they did not do so effectively.” Further, he wrote in the Fed’s April report: “We should consider setting tougher minimum standards for incentive compensation programs and ensure banks comply with the standards we already have.”
It’s likely that supervisors will revisit examinations for banks between $50 billion and $250 billion in assets, which received regulatory relief following the 2018 rollback, says Todd Leone, a partner at the compensation firm McLagan. But supervisors recognized deficiencies in SVB’s incentive compensation governance prior to its failure, Barr revealed. Changes — via legislation and enhanced supervision — may occur, along with the finalization of incentive compensation and clawback rules coming out of the 2010 Dodd-Frank Act.
Following the failures of Silicon Valley Bank and Signature Bank, lawmakers including U.S. Sen. Gary Peters, D-Mich., urged regulators to finalize Section 956 of Dodd-Frank, which requires regulators to issue rules for institutions above $1 billion in assets around the prohibition of excessive incentive compensation arrangements that encourage inappropriate risks, and mandate disclosure of incentive compensation plans to a bank’s federal regulator. Leone says that the rule was proposed with credit risk in mind, but its application could be expanded to consider liquidity.
The agencies tasked with this joint rulemaking, which include the Federal Deposit Insurance Corp., Federal Reserve, and the U.S. Securities and Exchange Commission, issued a request for comment on a proposed rule in 2016.
For public banks, the SEC finally released its clawback rule tied to Dodd-Frank in 2022. Put simply, the rule will require public companies to adopt policies that allow for the recovery of compensation in certain scenarios, including earnings restatements. The policy must be disclosed. Troutman Pepper expects that companies will have to comply as early as August. Gregory Parisi, a partner at the law firm, believes additional scrutiny on clawback policies will trickle down through the industry to smaller banks.
Clawback policies should cover numerous scenarios. “If the only triggers you have are tied to financial restatements, then it’s probably not broad enough,” says Daniel Rodda, a partner at Meridian Compensation Partners.
U.S. Sen. Elizabeth Warren, D-Mass., and U.S. Rep. Josh Hawley, R-Mo., introduced legislation on March 29 that would authorize the FDIC to claw back compensation when a bank fails.
Beyond the Dodd-Frank rules, banks should consider how to strengthen their governance practices to better tie compensation to risk. “… Incentive compensation arrangements should be compatible with effective risk management and controls,” wrote Barr in April, citing the 2010 Interagency Guidance on Sound Incentive Compensation Policies. Those arrangements “should be supported by strong corporate governance practices, including active and effective oversight by boards of directors,” he added.
Barr also pointed out that SVB’s compensation committee didn’t receive performance evaluation materials from CEO Greg Becker, relying instead on his recommendations.
“There can be times where [the board relies] on a verbal discussion around performance with the CEO,” says Rodda, “but having it documented in the materials and making sure that those performance evaluation materials include commentary from risk as part of the performance evaluation, those are certainly good processes to have in place.”
SVB said risk management was a “key component of compensation decisions” in its proxy statement filed on March 3, just days before the bank’s failure, but listed return on equity, total shareholder return and stock price appreciation as specific measurements for 2022 incentive payments.
Rodda recommends that boards consider a combination of metrics that include capital ratios and risk-adjusted returns — not just profitability and growth — and incorporate qualitative approaches that could consider feedback from regulators and an overall view of risk management.
On May 31, 2022, supervisors flagged SVB’s incentive compensation process as a Matter Requiring Immediate Attention (MRIA) by the board, ordering the compensation committee to develop “mechanisms to hold senior management accountable for meeting risk management expectations.” SVB’s compensation committee was in the process of changing its incentive structure and approved bonuses in January 2023 that were paid out in March despite the bank’s dramatic deposit loss, according to the Barr report.
“There should be a structured opportunity within the incentive program to evaluate the effectiveness of risk management,” says Rodda. “And if there are items that have been flagged by the regulators as critical and indicate that risk is not being managed well, then the committee should use its judgment to impact payouts based on that.”
Compensation issues like these will be covered during Bank Director’s Bank Board Training Forum in Nashville, Sept. 11-12, 2023.
This article was updated to correct a reference to Section 956.