FDIC Releases Notice of Proposed Rulemaking on Incentive Compensation Pursuant to Dodd-Frank Act

Today, the Board of Directors of the Federal Deposit Insurance Corporation (the “FDIC”) approved a Notice of Proposed Rulemaking on incentive-based compensation arrangements pursuant to Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “NPR”). The NPR (attached below) is an interagency publication created jointly by the FDIC, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, the National Credit Union Administration, the Securities and Exchange Commission and the Federal Housing Finance Agency.

The NPR has five key components: (1) requiring deferral of at least 50% of incentive compensation for a minimum of three years for executive officers of covered financial institutions with $50 billion or more in total consolidated assets; (2) prohibiting incentive-based compensation arrangements for executive officers, employees, directors or principal shareholders (“covered persons”) that would encourage inappropriate risks by providing excessive compensation; (3) prohibiting incentive-based compensation arrangements for covered persons that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss; (4) requiring policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution to help ensure compliance with the NPR’s requirements and prohibitions; and (5) requiring annual reports on incentive compensation structures to the institution’s appropriate Federal regulator.

As noted above, the NPR’s mandatory deferral requirement applies only to “executive officers,” which is defined as those persons holding the title or performing the function of one more of the following positions: (1) president, (2) chief executive officer, (3) executive chairman, (4) chief operating officer, (5) chief financial officer, (6) chief investment officer, (7) chief legal officer, (8) chief lending officer, (9) chief risk officer, or (10) head of a major business line. However, the NPR also specifically requests public comment on whether the mandatory deferral provisions should apply to a differently defined group of individuals, such as the institution’s top 25 earners of incentive-based compensation.

In addition to the mandatory deferral provisions described above, covered financial institutions with total consolidated assets of $50 billion or more will be required to take additional steps with respect to incentive compensation paid to “employees presenting particular loss exposure.” The institution’s board of directors (or a committee thereof) will be required to identify those covered persons (other than executive officers) who “individually have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance.” The board or committee will then be required to approve the incentive-based compensation arrangement for each identified covered person by specifically determining that the arrangement “effectively balances the financial rewards to the employee and the range and time horizon of risks associated with the employee’s activities, employing appropriate methods for ensuring risk sensitivity such as deferral of payments, risk adjustment of awards, reduced sensitivity to short-term performance, or extended performance periods.” Finally, the board or committee will be required to perform an evaluation of the effectiveness and suitability of the balancing methods used, as well as their ability to “make payments sensitive to all the risks arising from the employee’s activities, including those that may be difficult to predict, measure or model.”

The NPR will have a 45-day public comment period beginning after its publication in the Federal Register. Publication will occur after all seven of the Federal agencies listed above have formally approved its text, a process which is expected to be completed within the next several weeks.