The Dodd-Frank Reform Act mandates the development of rules or guidelines governing incentive-based compensation practices at certain financial institutions with total assets of $1 billion or more.  Accordingly, regulators - SEC, Federal Reserve, OCC, FDIC, OTS, FHFA, NCUA - jointly write rules or guidelines that:

• Require these “covered financial institutions” to disclose to their appropriate federal regulator the structure of their incentive-based compensation arrangements so the regulator can determine whether such compensation is excessive or could lead to material financial loss to the firm.

• Prohibit any type of incentive-based compensation that the regulators determine encourages inappropriate risks by providing excessive compensation or that could lead to material financial loss to the covered firm.

• Are substantially similar from agency to agency - though they will differ so as to account for the types of entities the various agencies regulate. 

    Proposed Rule's Three Element.   As noted above, the SEC proposed rule would apply to SEC-registered brokers, dealers or investment advisers with assets of at least $1 billion in assets.  The proposed rule contains 3 elements:

Element One:  Disclosures About Incentive-Based Compensation ("IBC") Arrangements.   A covered financial institution would be required to file annually with its appropriate federal regulator a report describing the firm’s IBC arrangements - including, but not be limited to:

• Narrative description of the components of firm’s IBC arrangements.
• Succinct description of firm’s pols and procedures governing its IBC arrangements.
• Statement of specific reasons as to why firm believes the structure of its IBC arrangement will help prevent it from suffering a material financial loss or does not provide covered persons with excessive compensation.

Element Two:  Prohibition on Encouraging Inappropriate Risk.    There are General Prohibitions and Prohibitions for Larger Institutions.   All covered financial institutions would be prohibited from establishing or maintaining an IBC arrangement that encourages inappropriate risks by providing covered persons with excessive compensation, or that could lead to material financial loss.  The proposed rule defines "Covered persons" as applying to executives, employees, directors, or principal shareholders. 

• IBC arrangements would be deemed to encourage inappropriate risks unless they meet certain standards - drawn from standards established in prior legislation and from guidance published by bank regulators last July.
• More specific requirements for executives and certain other designated individuals are spelled out for those institutions with $50 billion or more in total consolidated assets.
  
  • As it applies to executive officers, larger firms would be required to defer for 3 years at least 50% of any IBC for executives - and award such compensation no faster than on a pro rata basis.  Any IBC payments must be adjusted for losses incurred by the covered institution after the compensation was initially awarded.
• The proposed rule recognizes that some employees of a firm other than the executive officers may have the ability to impact the risk profile of the covered financial institution.  Accordingly, at larger covered financial institutions, the proposed rule would set forth additional requirements for employees exposing such institution to risk of significant loss.

Prohibitions for larger financial institutions.  More specific requirements are in place for institutions with $50 billion or more in assets. 

• For executive officers, firms would have to defer for 3 years at least 50% of any IBC - and award such compensation no faster than on a pro rata basis.  Any IBC payments must be adjusted for losses incurred by the institution after the compensation was initially awarded.
• Additional requirements will be in place for employees who are not executives, but who have the ability to impact the risk profile of the covered financial institution. 
• The board of directors or a committee of the board would be charged with identifying such other covered persons - e.g., a trader with large position limits relative to the institution’s overall risk tolerance. 
• Once the board identifies such covered persons, the board or a committee would need to approve the IBC arrangement for each such person.

Element Three:  Establishing Policies and Procedures.   A covered financial institution would be barred from establishing an IBC arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.  The proposed rule recognizes the diversity of institutions covered by the rule and explicitly states that the policies and procedures should be commensurate with the size and complexity of the organization, as well as the scope and nature of its use of incentive-based compensation.   [SEC PR 11-57, 3/3]