With the increased regulatory conditions, compensation committees are finding themselves knee deep in overseeing compensation plans across their financial institutions. In this video, Robert Ventura, Compensation Committee Chairman, talks about the new normal at First Commonwealth Financial Corp. and how his committee has handled their biggest challenge over the past year.
In today’s risk-focused environment, financial institutions must ensure that their incentive compensation plans are meeting regulatory requirements. In this short video, Kevin Blakely, senior vice president and chief risk officer at Huntington Bancshares of Columbus, Ohio, talks about how his institution addressed this challenge and shares his role in balancing compensation plans throughout the organization.
Accounting fraud, terrorist attacks and economic meltdowns are the catalysts for many of today’s financial regulations. With so much focus recently on the Dodd-Frank Act, many financial institutions may be overlooking the compliance requirements for the Bank Secrecy Act (BSA), or anti-money laundering law. In this video, John ReVeal, attorney for Bryan Cave LLP, shares his insights into how BSA violations are perceived by the regulators.
“The corporations get what they want and the people don’t get anything,’’ says Elizabeth Johnson, with two pieces of duct tape stuck to her shirt with the words “Occupy Nashville” written on them.
She is taking part in Nashville’s version of Occupy Wall Street, where a loose group of protestors hang out on War Memorial Plaza playing the guitar, holding signs, and conducting organizational meetings to plan their marches and policies: keep the plaza clean, be respectful, don’t destroy property.
Johnson says she was originally in favor of the $700 billion rescue of the financial system until she realized the banks “kept that money for themselves.”
Other protestors include a call center worker who says she is disappointed her $100,000 in student loans for a master’s degree in communications landed her in call center doing customer service; a financial planner who says he is concerned about the future of Social Security, low wages and the loss of American jobs to developing countries; and a machinist who disagrees with the Federal Reserve’s control over monetary policy.
Occupy Wall Street’s protests in cities across the world over the weekend unveiled a groundswell of frustration against corporations, political systems, the global economy and the banking system, all rolled into one. Should the banking industry care? If so, what should be done about it?
After all, there doesn’t seem to be a lot of evidence that angry consumers are voting with their feet. The biggest banks in the country control most of the deposits. Account balances in checking and savings accounts are growing, not declining.
Bank of America just reported Tuesday deposits at the bank grew by $3 billion in the third quarter to $1.04 trillion. JP Morgan Chase & Co. reported deposits grew by $44 billion in the quarter to $1.09 trillion.
Still, many people think a bad image for banking isn’t good for business.
In June, GfK Custom Research North America, a division of market research company GfK Group, reported an online survey of 1,000 Americans where the financial services industry ranked third lowest for trustworthiness, ranking above only state and federal governments.
Only 35 percent found financial companies trustworthy. (Retail companies and packaged food manufacturers got the highest marks—71 percent and 65 percent, respectively—out of the 12 public and private sectors in the survey.)
“The fact is that the vast majority of financial services companies still generate substantial profits by fooling customers, or by capitalizing on their mistakes, or by taking advantage of them when they simply aren’t paying attention,’’ says a new report from the management consulting firm Peppers & Rogers Group. The group recommends increased transparency and practices that keep the customers’ best interests in mind, as a way to survive a future where customers can increasingly publicize their frustrations and bad experiences on everything from Facebook to Twitter.
In fact, making consumers happier could do something to push back the tidal wave of increased regulation of the banking industry, some think. Where did the Credit Card Act of 2009 come from, if not consumer frustration?
Plus, the volatile stock market, crashing home values, low wages and high unemployment set the stage for people to be angry at banks, says Gregg Poryzees, vice president, Consulting – GfK Financial Services.
“When the economy takes a hit, people are now unhappier with the financial firms they deal with,” Poryzees says. “This really is an opportunity to rise to the occasion. This is a great time to say ‘What can we do in terms of communication with our customers and designing innovative products, with brand positioning, managing the brand in a volatile market and a volatile consumer market?’”
Another GfKsurvey in July found that 88 percent of respondents strongly agree or moderately agree that consumers need an agency such as the Consumer Financial Protection Bureau to oversee the practices of banks and other financial institutions.
Waiting for new regulation from the Consumer Financial Protection Bureau is not a plan, Poryzees says. Getting ahead of regulation with consumer-friendly changes is a solution.
“The implications are that the banking industry can turn this frustration into an opportunity, not so much different fees, but innovations that are more customer focused,’’ he says.
One can only wonder if the recent decisions of some large banks, including Bank of America and JP Morgan Chase to offset new restrictions on debit card interchange fees by charging customers a monthly fee, has further tarnished the industry’s image.
William Mills III, the CEO of Atlanta-based financial public relations firm the William Mills Agency, says bankers should think about how they will respond to the concerns of Occupy Wall Street and others. Community bankers in particular may have an opportunity to differentiate themselves from the bigger banks because they didn’t participate in the marketing and sale of risky bonds, equities and subprime mortgages.
“I hope bankers are thinking about how they would respond if a member of the media calls or a customer asks about it,’’ he says.
Scott Talbott, the senior vice president of government affairs at The Financial Services Roundtable, which represents 100 of the largest financial institutions in the country, says the industry understands the anger reflected in the Occupy Wall Street protests. The financial industry is carrying more capital, is safer, and has eliminated a lot of risky practices, such as subprime lending.
“We are working hard to restore the economy and trust in the banking system,’’ he says.
But the problem lies deeper than trust.
“What am I supposed to tell my children about what their goals should be?’’ says Felisha Cannon, the 33-year-old call center worker, saying she’s not sure there’s a better future for them. “I can’t tell them to buy a house, because it might not be worth anything. What should they be working for? Should they go to (college) and have $200,000 in debt?”
In the current economic climate, banks are rightly focusing on safety and soundness issues. Banks must ensure, however, that they also effectively manage their compliance function because banking regulators are increasingly focused on this area in response to the numerous regulatory changes that have recently occurred and are likely to occur in the near future. Even if a bank’s compliance practices have not been criticized in the past, there is no guarantee that they will be approved by regulators at the bank’s next examination. Here are some highlights from a recent report by the Financial Institutions Group of the law firm of Barack Ferrazzano Kirschbaum & Nagelberg LLP, in Chicago:
Banking regulators are significantly downgrading many banks’ consumer compliance ratings because they are concerned that their compliance management systems are not equipped to handle the potentially numerous regulatory changes to be implemented by the Consumer Financial Protection Bureau. Banking regulators view violations of recent regulations and/or repeat violations, even if such violations are minimal in number and the bank engages in minimal consumer banking activities, as being especially indicative of an ineffective compliance management system. Importantly, banks with weak compliance systems will likely have their management ratings downgraded as well.
Banking regulators are conducting in-depth reviews of lending practices and are increasingly referring cases of alleged discrimination by banks to the Department of Justice. Even long-standing lending practices have recently been criticized by examiners. Banking regulators are concerned with:1. the extent to which banks give their loan officers discretion regarding pricing and underwriting, 2.whether any pricing variances in any lending activity reflect discrimination against a particular group or in favor of another group, 3. if lending policies or practices may have a disparate impact on a protected class, 4. if assessment areas are appropriate, and the extent to which banks are lending throughout their entire assessment areas, 5. if changes in assessment areas reflect potential redlining, and 6. if banks are steering certain borrowers to particular loan products.
Section 5 of the Federal Trade Commission Act (the “UDAP law”) prohibits unfair or deceptive trade practices, and the Dodd-Frank Wall Street Reform and Consumer Protection Act expands this area further by prohibiting “abusive” acts or practices. It is increasingly common today for banking regulators to evaluate violations of compliance regulations under the UDAP law as well, and we will now likely see banking regulators evaluate such violations under the new “abusive” standard.
Banking regulators are delving deeply into mortgage loan originator compensation under the Truth in Lending Act and Regulation Z. Effective for compensation earned on applications received on or after April 1, 2011, a mortgage originator’s compensation cannot, with few exceptions, be based on any factor other than the amount of the credit extended. One general prohibition is the payment of compensation based on the profitability of the branch, division or entire bank.
Recently, several large banks settled lawsuits with the Department of Justice for allegedly violating the Servicemembers Civil Relief Act (the “SCRA”). These banks allegedly foreclosed on service members without obtaining court orders and/or charged service members interest rates in excess of the 6 percent interest rate cap under the SCRA. These settlements will likely prompt additional service members to file lawsuits against banks, or file complaints with their military offices for improper treatment under the SCRA.
Bert Otto has been deputy controller for the central district of the Office of the Comptroller of the Currency since 1997. He is responsible for oversight of 545 community banks and federal savings associations and manages a staff of 480 employees in Chicago. He has worked for the OCC since 1973 and has supervised examiners in Peoria,Illinois; Boston; Washington, D.C.; and Syracuse, New York.
What do directors need to know about the regulatory exam and when should they get involved?
The first thing they need to understand is the areas that will be reviewed. It’s kind of the game plan for the examination process for the year. The directors will get a clear understanding of the safety and soundness areas, if it’s CRA (Community Reinvestment Act), if it’s fair lending, they learn what areas will be reviewed.
A lot of times, we will ask the directors how they want to beinvolved in the exam process. A lot of times, we will meet with these directors at their businesses, to make it a little bit informal for them. They can talk about management and we can talk about our assessment of management, too. A lot of directors have taken us up on that.
A lot of times the directors will really share a lot about the community, the bank itself, what their feelings are about management, about the bank’s business model. It’s a good opportunity for them to pick our brains, too, as to what the current issues are. They can do that at a board meeting, too, but a lot of times we will offer to have our examiners come out and talk to them informally.
Another way to get involved is to sit in on a loan discussion. The loan discussion is such a key area of an exam, especially in community banks, that they will get a good understanding of what that’s all about, plus they can get a sense of how much the loan officers know, how they can respond to questions from the examiners and the knowledge they have about their borrowers.
What should bank directors do during the exam?
My suggestion is for a lot of the outside directors to stay plugged into the exam process. They typically run for a couple of weeks. The audit chairman clearly needs to know what is happening with the exam process. There is nothing wrong with a couple of audit committee members meeting with examiners, not every day, but at the end of the week, to stay plugged into what the issues are.
What common mistakes do you see bank directors making?
A lot of times they will jump too quickly to change the institution’s’ business model or strategic plan. A lot of time we tell these directors: “Don’t just do what your competitors are doing.” We saw a lot of that during the last downturn, where commercial real estate in 2004, ’05 and ’06 was really growing, so everybody jumped in it, and jumped in it in big ways.
You need to have a well-conceived business model. You can tweak it some, but some of these institutions have been around for 100 or 150 years, and they’ve done some things right.
A lot of time we see directors not ask enough detail and probing questions of management. At the board meetings, they need to ask questions of management and hold management accountable. They need to have enough time prior to board meetings to review board packages. We see that a lot where directors get two- or three-inch thick packages and they don’t have enough time to review. They need concise summaries that show trends.
In our more problem banks, we have seen directors who are overly trusting of management. They put management in and they have a good working relationship. But not making sure they hold management accountable gets them into trouble.
How much time does the board need to review board packages?
The average board needs two or three days to review a board package, for your average community bank. You just can’t get it to them a day ahead of the board meeting or the day of the meeting and expect them to have a good understanding and ask good questions.
What kind of relationship should banks and their regulators have?
We need to have a good relationship so the bank and management understand why we’re there, and our knowledge for what’s going on in the industry, so we can provide them with some guidance. They might need clarification on guidance from Washington. We want management to pick up the phone and call if there is something that is not clear. I would rather not wait until the exam has already started because some action may have been taken that needs to be unwound. Each party needs to understand each other.
Communication is important because information needs to be shared. During the exam, we are going to be touching management quarterly with questions such as: How are your earnings? How is your capital position? Have you had any changes in management or other changes we need to know about? That helps us put together a supervisory strategy for when we come in. We want a good relationship with management because we will call them at least quarterly and we will be coming in yearly. If there is guidance coming out from Washington that they are not clear on, they need to call their portfolio manager, an individual from the OCC, who should be able to explain what that guidance is or what our expectations are.
How long do exams take and how often are they done?
It depends on the size and condition of the institution. If a smaller institution is (CAMELS) rated 1 or 2 (a good score on regulatory scale), it could happen every 18 months. Larger institutions could be every 12 months. Problem banks, with CAMELS ratings of 3 to 5, you could see us every six months.
How should you handle a disagreement with your regulator?
If it’s a (CAMELS) rating or a classified loan disagreement, the first point of contact should be the assistant deputy comptroller of the local field office. The next step would be coming to me, the OCC deputy controller, or the ombudsman. The ombudsman reports directly to the comptroller. We hope all our disagreements are worked out on a local level, but if they can’t, that’s the process. All of our conclusions should be supported by facts. If we say we have an unsafe and unsound business practice, because the bank is extending loans without satisfactory credit information, those are hard to disagree with. We need to base all our conclusions on facts.
How often would a conclusion from a regulator be reversed after a disagreement?
Ninety-nine percent of the disagreements get worked out at the local level; very seldom do we get some at my level or the ombudsman. They get some, but they are more often related to CRA issues or fair lending issues. We haven’t had a lot related to CAMELS ratings. Most of this is a give and take. If there is an unsafe and unsound banking practice, or if there is a violation of law, those tend to not be overturned. There might be a case where there are some new facts that come in on a loan classification, where during an exam the examiner may have looked at a loan as substandard. We may get new information later on where that decision gets overturned, but I don’t have numbers on how many decisions get overturned.
How do you think Dodd-Frank will impact community banks, even though they were exempted from many of the provisions?
There will be some impact. Clearly the challenges facing community banks, just the volume of compliance activities they need to be focused on, it does concern us. Where is the tipping point, causing community banks to exit the business?It depends on how the regulations are going to be written, the Consumer Financial Protection Bureau obviously has the pen, but clearly it’s going to affect all banks.
In terms of unfair, deceptive or abusive practicesandin general all regulations, the larger institutions have a lot more resources to understand these rules than smaller banks do.
Community banks are going to be impacted by Dodd-Frank’s directive that federal agencies modify regulations to remove references to credit ratings for determining creditworthiness. You wouldn’t think that impacts community banks, but it does.
The institutions use credit ratingagenciesfor ratings for permissible investment securities. Dodd-Frank has done away with that, so institutions of all sizes are going to have to do independent analysis, a lot more than what they’ve done in the past, in investment securities.
Are regulators or Congress trying to cut down on the number of community banks in this country?
We don’t want to cut down on community banks; they provide a lot of services to their communities. There are challenges. Interest margins have been cut quite a bit. They are struggling with high concentrations of commercial real estate. Community banks are struggling. I think what’s going to happen, is some banks do very well, and some aren’t going to do very well. That’s why it’s so important to have a strong business model and to stick to what you do well. Some banks become niche players, and there are some risks associated with that, but you get good at something. Quite honestly, with the stresses of the compliance costs from Dodd-Frank, there may be banks that exit the business. We’re not pushing that and Congress isn’t pushing that, but there is some inevitability here: Where is that tipping point for a community bank?
Don Norman and Andy Strimaitis, partners in Chicago-based law firm Barack Ferrazzano who specialize in executive compensation matters for financial institutions, will be speaking at Bank Director’s compensation conference November 8-9 in Chicago.Here, they discuss the legacy issues from the TARP compensation limits that may remain after repayment of TARP funds.
When a banking organization participating in Treasury’s Troubled Asset Relief Program, better known as TARP, considers repayment, it is commonplace to presume that the organization will be free from the shackles of various compensation limitations, governance rules and reporting requirements that applied during the TARP period. Unfortunately, upon closer examination, it becomes apparent that several areas will require ongoing vigilance to ensure full compliance with the TARP rules.
Generally, following the repayment date, the organization and its employees will no longer be subject to the TARP rules with respect to future compensation decisions (i.e., with respect to time periods following the repayment date).There are, however, a few important exceptions and distinctions to note with respect to this general rule.
Bonus Restriction. Even after the repayment date, an organization will continue to be prohibited from paying to, or accruing on behalf of, any employee who was subject to the bonus prohibition any bonus, retention award or incentive compensation with respect to the time period during which that employee was subject to the TARP bonus restriction.This is supported by an interpretive letter from the Secretary of the Treasury Timothy F. Geithner to Elizabeth Warrren, then-chairman of the Congressional Oversight Panel, dated February 16, 2010, concerning certain aspects of the TARP-related executive compensation restrictions.
For example, assume that for 2011, Joe Smith is the highest paid employee of XYZ, Inc. (based on 2010 compensation).Further, assume that XYZ, Inc. repays 100 percent of its TARP funds on June 30, 2011.In determining annual bonuses for 2011, XYZ, Inc. could pay to, or accrue on behalf of, Joe Smith a bonus with respect to the performance period from July 1, 2011 through December 31, 2011.However, even though its TARP funds have been repaid, it could not pay to, or accrue on behalf of, Joe Smith a bonus with respect to the performance period from January 1, 2011 through June 30, 2011.
The same treatment also applies to equity awards that were granted during the TARP period and after February 17, 2009, to employees who became subject to the bonus prohibition during a year following the year of grant (these awards would not be qualified “long term restricted stock” awards, as they would have been granted to employees not subject to the bonus prohibition).In this case, while the employee was subject to the bonus prohibition, the employee could not continue to vest in the equity award.Once the employee is no longer subject to the bonus prohibition (because TARP was repaid, or the employee was no longer one of the highly compensated employees subject to the prohibition), the employee cannot “catch up” the vesting that was tolled during the bonus prohibition period.Thus, an equity award that may have had a five-year vesting period, will now have a total vesting period equal to five years plus the period the employee was subject to the bonus prohibition.
Severance Restriction. Pursuant to the TARP rules, a “golden parachute” payment (i.e., severance) is considered to be made at the time of termination rather than at the time of payment.As such, after the TARP repayment date, an organization cannot revisit a termination that occurred during the TARP period and make a severance payment or provide other post-termination benefits to an employee who left the company while subject to the TARP severance restriction.
Deduction Limitation. A TARP participant is also prohibited from deducting, with respect to its “senior executive officers,” more than $500,000 of compensation expense per year during the TARP period.Under the TARP rules, the deduction limitation applies to currently available compensation as well as deferred compensation earned during the TARP period.As such, an organization participating in TARP is obligated to continue to track, post-TARP repayment, the deduction limitation with respect to compensation earned during the TARP period even if those amounts are paid after the repayment date.
Reporting Requirements.After the end of the year that includes the TARP repayment, the organization will be required to submit its annual PEO/PFO and compensation committee certifications, risk assessment analysis and narrative and other disclosures with respect to the period preceding the repayment date.For public companies, this will include attaching the PEO/PFO certifications to the annual Form 10-K and also including the compensation committee certification and narrative summary in the annual proxy statement.For public and private organizations, all required disclosures will also have to be submitted to the Treasury electronically, and in some cases, to the organization’s primary federal regulator.
The Community Reinvestment Act (CRA) requires that every insured depository institution meet the needs of its entire community. It also requires the periodic evaluation of depository institutions’ records in helping meet the credit needs of their communities. Proactively monitoring CRA performance is important for several reasons. The record is taken into account when considering an institution’s application for deposit facilities, meaning it will directly impact any contemplated acquisitions and/or branch openings. Additionally, the record will be regularly examined by the federal agencies that are responsible for supervising depository institutions and a rating will be assigned. Since the results of the exam and the rating are available to the public—customers, competitors and community groups—an institution’s CRA performance can impact its reputation. Banks must understand the characteristics of their assessment area and regularly monitor their performance to ensure the equal credit extension throughout their entire customer base.
This paper will explain the purpose and requirements of CRA and how as a board member, you can provide oversight regarding your institution’s CRA obligation.
The Grant Thornton LLP Bank Executive Survey polled nearly 400 bank CEOs and CFOs in April and May about the economy and regulatory reform’s impact. Nichole Jordan, Grant Thornton’s national banking and securities industry leader, talks about some of the highlights, and offers some insights on the new compliance burden.
What did you find particularly significant about the survey’s findings?
Thirty-nine percent of respondents indicated they thought the Dodd-Frank Act would be effective or somewhat effective in preventing or reducing the threat of a future taxpayer-funded bailout.As we take a look at Dodd-Frank one year later, we’ve been evaluating some of the more positive benefits: having compensation linked more closely to long-term performance with a focus on reducing riskier behavior and having more data transparency with a greater focus on risk management and an emphasis on a culture of compliance.In addition, living wills create a formal structure that will benefit both those within and outside of the systemically important institution.
What did you think of the more stringent capital requirements in Dodd-Frank?
Internally within an institution, those are heavy demands to meet and it certainly limits growth in certain aspects.However, the perception externally and in the marketplace is that having increased capital requirements is very important in this environment, especially with what we’ve seen over the last 18 months.
It certainly would seem to put more pressure on management teams.
We are seeing management teams making a shift in focus as they look at how to increase margins and overall, how to improve profitability in the institutions. We’re seeing an emphasis on trying to increase growth, but at the same time, recognizing the challenges associated with that in the current environment. Efficiency initiatives are increasing as well in banks from the standpoint of striving to develop efficiency enhancements into various processes and ensure internal controls are properly in place.
Where do you see the greatest potential for efficiency gains?
There has been a lot of success within certain institutions as they evaluate the centralization of various processes handled in multiple locations.One example to look at from an accounting standpoint: If there are several individuals at multiple locations handling accounting for a particular branch or the reporting structure at various branches, you could centralize that process, not to reduce headcount, but to centralize by region or even at the headquarter’s location.
In the survey, there was a nearly unanimous agreement that the regulatory burden is the top concern and yet, half feel it won’t be effective at all in preventing the next crisis.
How do you react to that?
It’s difficult for any law to fully reduce the risk of the failures. Dodd-Frank would likely mitigate the risk scenario that we have just experienced, so if the pattern stays the same from what we have had over the past couple of years, Dodd-Frank would have a significant impact in reducing the risk of economic failure.The likelihood of that same pattern occurring is relatively small, but do I think it will reduce risk? Yes.
What should the banks be doing from a compliance standpoint right now to get ready for Dodd-Frank?
One best practice would be to fully evaluate the impact and develop a timeline and an action plan that will address some of the key areas.As we have seen, in today’s climate, an enterprise risk management process, a risk management committee and a chief risk officer are the new normal.
How should management decide whether to invest internal resources to handle the increased compliance burden or engage third parties?
Because everything is so new, it lends itself more toward being outsourced and hiring individuals who live and breathe this every day and can share that knowledge gained from serving a variety of institutions.In future years, the inside management team can then lead the maintenance and compliance effort after the complexities of the implementation phase have been addressed.
Audit committee members who participated in two separate roundtable discussions for public community banks at the Bank Director Peer Group sessions, held as part of the Bank Director Audit Committee Conference in Chicago on June 13, were able to let down their guard and share with their counterparts their experiences, uncertainties and pearls of wisdom. Despite being separated by thousands of miles, participants in both roundtable discussions shared their views on similar issues as if they were next-door neighbors.
It quickly became clear that the institutions represented in both groups are very focused on responding to an increase in regulatory scrutiny of how audit committees oversee the management of certain risks. This increasing level of scrutiny is being experienced now and is expected only to increase further in the foreseeable future.
Historically, audit committee members have focused primarily on their institutions’ higher-level financial measures and performance against budgets. In addition, audit committees have devoted a significant amount of attention to the results of exams such as internal audit, regulatory safety and soundness, and external audit findings.
In response to the expected increase in the level of regulatory oversight, however, additional areas of focus are now becoming part of the regular responsibilities of audit committees over and above their past approach. These include:
Monitoring credit concentrations
Monitoring classified loans
Monitoring the remediation of exceptions noted by regulatory examiners, as well as internal and external audit
Understanding new initiatives and their related risks
Furthermore, to remain current on new issues, audit committee members are using tools such as self-assessment checklists, while also seeking out educational opportunities about new and emerging regulatory and accounting matters. Clearly, expectations are rising regarding engaging in and documenting participation in learning activities.
The members also discussed their interactions with and expectations of management. Because their relationships with management are generally collegial, it can be challenging at times to maintain the fierce independence that is expected of audit committees. Members agreed that reminding each other on a regular basis of their responsibilities helps them meet this challenge.
In addition, roundtable participants considered other approaches to holding their colleagues accountable for being productive committee members including attendance and participation requirements and peer evaluations. They also agreed that maintaining a culture of open and frank communication is vital in maintaining effective audit committee performance.
A few distinctions emerged between the two community bank roundtable groups, which were divided by size of institution. For example, members representing larger institutions (generally with more than $1 billion in total assets) have heard more from their regulators about formally documenting the identification and measurement of risks their institutions face as well as the mitigation of those risks – in other words, enterprisewide risk management. Members from smaller institutions indicated that risk identification, measurement, and mitigation were being documented less formally and generally their regulators have not asked them to do more.