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The federal banking agencies, together with the SEC, Federal Housing Finance Agency, Treasury Department and Credit Union Administration, recently adopted a proposed joint rule implementing the incentive compensation requirements of section 956 of the Dodd Frank Act.  This proposal is an iteration of a proposed rule that was published for comment in 2011 (but never finalized), and which is now being revised to reflect evolved incentive-based compensation practices and supervisory experience.  The revised proposal contains more specific and stringent requirements, particularly for the largest institutions and their subsidiaries.  Prior general agency policies regarding incentive compensation appear to remain applicable to all institutions and would be supplemented by the final version of the instant proposed rule.

The proposed rule is designed to prohibit covered institutions from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risk or could lead to material financial loss to the covered institution by providing covered persons (including directors) with excessive compensation, fees, or benefits. Its provisions are very complicated and will not be discussed in great detail here.  A copy of the rule as adopted by the agencies is found at 76 Federal Register 21170 (April 14, 2016).

For boards of directors, there are new and specific duties.  In particular, the board of directors (or a committee thereof) would be required to:

  • Conduct oversight of the covered institution’s incentive-based compensation program
  • Approve incentive-based compensation arrangements for senior executive officers, including the amounts of all awards and, at the time of vesting, payouts under such arrangements
  • Approve any material exceptions or adjustments to incentive-based compensation policies or arrangements for senior executive officers
  • Ensure that its compensation committee:  i) be composed solely of directors who are not senior executive officers; and ii) obtains input on the effectiveness of the institution’s incentive-based compensation program at balancing risk and reward from the risk and audit committees, management, and internal audit/risk management function

While this proposed rule does not technically affect banks with under $1 billion in assets (except if a subsidiary of a covered institution), the AABD is concerned that it might be the future standard by which the agencies view community banks’ compensation practices.  In addition, we also are concerned with the increased burden it places upon bank boards of directors.

The comment period on the proposed rule will close on July 22. Compliance to the final rule is expected to 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.  Finally, the rule would not apply to any incentive-based compensation plan with a performance period that begins before the compliance date.