Details Emerge: Proposed Regulation of Incentive Compensation at Large Financial Institutions; FDIC, FHFA and OCC Issue Proposed Rules Consistent with NCUA’s Proposal Last Week

Largest Financial Institutions Face New Risk Management and Governance Requirements and Tiered Restrictions on Incentive Pay

Sullivan & Cromwell LLP - April 27, 2016

Yesterday, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency and the Office of the Comptroller of the Currency each issued a notice of proposed rulemaking for a new interagency rule on incentive-based compensation arrangements consistent with the one released by the National Credit Union Association last Thursday.  The proposed rule seeks to implement the Dodd-Frank requirement that federal financial regulators prohibit, at any financial institution with consolidated assets of at least $1 billion, incentive-based compensation that encourages inappropriate risks.  The Board of Governors of the Federal Reserve System and the Securities and Exchange Commission are also expected to propose substantially the same rule, which replaces one originally released in the first half of 2011.  This memorandum supplements our April 21 memorandum, which set forth the highlights from the NCUA’s proposal, and includes a summary chart comparing the new proposed rule with the original proposed rule and the analogous U.K. compensation rules.

The new proposed rule establishes general qualitative requirements applicable to all covered institutions, additional specific requirements for institutions with total consolidated assets of at least $50 billion and further, more stringent requirements for those with total consolidated assets of at least $250 billion.  The general qualitative requirements include (1) prohibiting incentive arrangements that encourage inappropriate risks by providing excessive compensation, (2) prohibiting incentive arrangements that encourage inappropriate risks that could lead to a material financial loss, (3) establishing requirements for performance measures to appropriately balance risk and reward, (4) requiring board of director oversight of incentive arrangements and (5) mandating appropriate recordkeeping (which replaces the annual reporting contemplated by the 2011 proposal).

Although none of the proposals have been published in the Federal Register (and will not be published until all of the relevant Agencies have issued their versions), comments on the proposed rule are set to be due on July 22, 2016.  The requirements of the proposed rule would become effective on the first day of the calendar quarter that begins at least 540 days (about 18 months) after publication of the final rule in the Federal Register, and incentive-based compensation plans with an open performance period beginning before the effective date would be grandfathered.  Accordingly, the rules will not likely affect most covered institutions until the 2019 compensation year.