SEC Votes to Propose New Rules Related to Executive Compensation at Financial Institutions

By Cydney Posner

At an open meeting this morning, by a vote of three to two, the SEC proposed new rules related to executive compensation at financial institutions. The rules stem from Section 956 of the DFA, which required the SEC (and six other financial regulators) to jointly adopt regulations or guidelines governing the incentive-based compensation arrangements of certain financial institutions, including broker-dealers and investment advisers, with $1 billion or more in assets. The proposed rules appear to be significantly more intrusive than the types of disclosure-only rules that we are used to seeing from the SEC, and it will be interesting to see if any variants of these rules percolate up to affect a broader cross-section of companies at a later date. Here is the SEC's press release on the proposal, , and here is a piece on it from The New York Times.

Section 956 requires the SEC and other regulators to adopt rules to require each covered financial institution to disclose to the appropriate federal regulator the structures of all incentive-based compensation arrangements offered by those institutions in sufficient detail to allow the regulator to determine whether the compensation structure provides "excessive compensation" to an executive officer, employee, director or principal shareholder or could lead to material financial loss to the institution. The Section also requires these regulators to jointly prescribe regulations that prohibit any types of incentive-based payment arrangements that the regulators determine either encourage inappropriate risks by the institutions by providing an executive officer, employee, director or principal shareholder with excessive compensation or could lead to material financial loss to the institution.

The proposed rules would mandate the following:

• Require the covered financial institutions to file reports annually with the SEC related to incentive-based compensation (apparently only to the regulator, not to the public)
  • The required annual report must describe the specific reasons "why the firm believes the structure of its incentive-based compensation arrangement will help prevent it from suffering a material financial loss or does not provide covered persons with excessive compensation"
  • Prohibit incentive-based compensation arrangements at financial institutions that encourage inappropriate risk taking by providing excessive compensation or that could lead to material financial loss to the firm
    • According to the press release, the incentive-based compensation arrangements would be deemed to encourage inappropriate risks unless the incentive-based compensation arrangements met certain standards drawn from those established in prior legislation and from guidance published by bank regulators last July
      • At the meeting, the SEC staff noted that these standards would include generally whether there is a balance of risk and reward, whether the compensation is compatible with effective controls and risk management and whether it is supported by strong corporate governance
      • For financial institutions with $50 billion or more in assets, the proposal would also require deferral of incentive-based compensation of executive officers and board approval of the compensation of those persons within a firm whose job functions give them the ability to expose the firm to a substantial amount of risk (i.e., not just executives)
        • At least 50% of incentive compensation payable to executives would be deferred over three years, payable not faster than pro rata, and subject to clawback for losses incurred by the institution after the compensation was initially awarded
          • The board or a board committee would also be required to identify employees who "individually have the ability to expose the firm to possible losses that are substantial in relation to the institution's size, capital or overall risk tolerance," and approve the incentive compensation for each of those individuals
          • Require the financial institutions to develop policies and procedures to ensure and monitor compliance with the requirements related to incentive-based compensation
            • Policies and procedures should provide that risk management personnel have an integral role in compensation

The SEC recognized that there were a number of challenges inherent in implementing the Congressional mandate and reiterated the desire for comments on the proposal, especially with regard to potential unintended consequences. The two dissenters were obviously not keen on having regulators micro-manage incentive compensation. Commissioner Casey dissented primarily because she believed that the proposal's prescriptive approach was not necessary and removed important decision-making authority from those who, she argued, were in a better position to make those decisions. Commissioner Paredes objected primarily to the proposed rules applicable to institutions with $50 billion or more in assets, contending that the SEC was not in a position to dictate rules that should apply generally across the board and that did not take individual differences into account, that the rules could make it difficult for larger institutions to recruit and that the rules could discourage even prudent risk taking.

This content is provided for general informational purposes only, and your access or use of the content does not create an attorney-client relationship between you or your organization and Cooley LLP, Cooley (UK) LLP, or any other affiliated practice or entity (collectively referred to as “Cooley”). By accessing this content, you agree that the information provided does not constitute legal or other professional advice. This content is not a substitute for obtaining legal advice from a qualified attorney licensed in your jurisdiction and you should not act or refrain from acting based on this content. This content may be changed without notice. It is not guaranteed to be complete, correct or up to date, and it may not reflect the most current legal developments. Prior results do not guarantee a similar outcome. Do not send any confidential information to Cooley, as we do not have any duty to keep any information you provide to us confidential. This content may be considered Attorney Advertising and is subject to our legal notices.