Inching forward with one of the most-delayed—and controversial—mandates of the Dodd-Frank Act, the National Credit Union Administration has re-proposed a stalled 2011 rule proposal targeting incentive-based executive pay that encourages inappropriate risks at banks and credit unions.
The proposed rules—which also apply to investment advisers, broker-dealers, and mortgage-finance companies Fannie Mae and Freddie Mac—would impose new clawback provisions, enhance compensation-related disclosures, and require executives and “significant risk takers” to defer as much as 60 percent of their incentive-based pay for up to four years.
The rulemaking is a multi-agency effort and will include the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission. NCUA is the first of the federal financial industry regulators to reissue the 2011 proposal, but it will not be published in the Federal Register until after all of the agencies have acted. The FDIC and OCC could issue their proposals as early as next week, but no timeline was announced by other regulators.
The NCUA’s proposed rule takes a tiered approach, based on institutional assets, to scale its requirements. “Level 1” institutions, facing the highest standards, are defined as having $250 billion or more in assets; “Level 2” institutions hold between $50 billion and $250 billion in assets; “Level 3” entities maintain between $1 billion and $50 billion in assets. The rule proposal exempts institutions with less than $1 billion of assets and does not require the disclosure of compensation that is not incentive-based.
Significant risk takers are defined as individuals receiving at least one-third of their pay in incentive-based compensation, are among the top 5 percent compensated individuals at a Level 1 firm, or aong the top 2 percent at Level 2 firms. Any individual who may commit or expose at least 0.5 percent of an institution's assets or who is specifically designated by regulators would also be designated.
The proposal calls upon institutions to clawback bonuses, as far back as seven years, if it comes to light that the recipient took inappropriate risks that caused a material loss, or was the target of an enforcement action.
The proposed rule also contains requirements for the board of directors of a covered institution, requiring them to conduct oversight of incentive-based compensation program; approve incentive-based compensation arrangements, including payouts under such arrangements; and approve material exceptions or adjustments to incentive-based compensation policies and arrangements.
Covered institutions would be required to create annually and maintain for at least seven years records that document the structure of incentive-based compensation arrangements and that demonstrate compliance with the proposed rule.
Level 1 and Level 2 covered institutions would be required to have a risk management framework in place for their incentive-based compensation programs that is independent of any lines of business; includes an independent compliance program that provides for internal controls, testing, monitoring, and training with written policies and procedures; and is commensurate with the size and complexity of the its operations.
“Without restrictions on incentive-based compensation arrangements, covered institutions may engage in more risk-taking than is optimal from a societal perspective, suggesting that regulatory measures may be required to cut back on the risk-taking incentivized by such arrangements,” the proposal says. “Particularly at larger institutions, shareholders and other stakeholders may have difficulty effectively monitoring and controlling the impact of incentive-based compensation arrangements throughout the institution that may affect the institution’s risk profile, the full range of stakeholders, and the larger economy.”
The regulators jointly crafting the rules are no strangers to compensation oversight. In 2009, the OCC and FDIC initiated a “horizontal review” of incentive-based compensation practices at 25 large banks. In 2010, bank regulators adopted principles-based guidance to ensure that compensation arrangements appropriately tie rewards to longer-term performance and do not create undue risks to the safety and soundness of the institution or broader financial system. The OCC reviews and assesses compensation practices at individual banks as part of its normal supervisory activities.
“Notwithstanding the recent progress, incentive-based compensation practices are still in need of improvement, including better targeting of performance measures and risk metrics to specific activities, more consistent application of risk adjustments, and better documentation of the decision-making process,” the proposal says.
The compliance date of the rule would be no later than the beginning of the first calendar quarter that begins at least 540 days after a final rule is published in the Federal Register.