# Incentive-Based Compensation Arrangements > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2016-11788 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** June 10, 2016 - **Citation:** 81 FR 37670 ## Text DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Part 42 [Docket No. OCC-2011-0001] RIN 1557-AD39 FEDERAL RESERVE SYSTEM 12 CFR Part 236 [Docket No. R-1536] RIN 7100 AE-50 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 372 RIN 3064-AD86 NATIONAL CREDIT UNION ADMINISTRATION 12 CFR Parts 741 and 751 RIN 3133-AE48 FEDERAL HOUSING FINANCE AGENCY 12 CFR Part 1232 RIN 2590-AA42 SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 240, 275, and 303 [Release No. 34-77776; IA-4383; File No. S7-07-16] RIN 3235-AL06 Incentive-Based Compensation Arrangements AGENCY: Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board); Federal Deposit Insurance Corporation (FDIC); Federal Housing Finance Agency (FHFA); National Credit Union Administration (NCUA); and U.S. Securities and Exchange Commission (SEC). ACTION: Notice of proposed rulemaking and request for comment. SUMMARY: The OCC, Board, FDIC, FHFA, NCUA, and SEC (the Agencies) are seeking comment on a joint proposed rule (the proposed rule) to revise the proposed rule the Agencies published in the Federal Register on April 14, 2011, and to implement section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Section 956 generally requires that the Agencies jointly issue regulations or guidelines: (1) Prohibiting incentive-based payment arrangements that the Agencies determine encourage inappropriate risks by certain financial institutions by providing excessive compensation or that could lead to material financial loss; and (2) requiring those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate Federal regulator. DATES: Comments must be received by July 22, 2016. ADDRESSES: Although the Agencies will jointly review the comments submitted, it would facilitate review of the comments if interested parties send comments to the Agency that is the appropriate Federal regulator, as defined in section 956(e) of the Dodd-Frank Act, for the type of covered institution addressed in the comments. Commenters are encouraged to use the title “Incentive-based Compensation Arrangements” to facilitate the organization and distribution of comments among the Agencies. Interested parties are invited to submit written comments to: Office of the Comptroller of the Currency: Because paper mail in the Washington, DC area and at the OCC is subject to delay, commenters are encouraged to submit comments by the Federal eRulemaking Portal or email, if possible. Please use the title “Incentive-based Compensation Arrangements” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods: • Federal eRulemaking Portal—Regulations.gov: Go to www.regulations.gov . Enter “Docket ID OCC-2011-0001” in the Search Box and click “Search.” Click on “Comment Now” to submit public comments. • Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov , including instructions for submitting public comments. • Email: regs.comments@occ.treas.gov . • Mail: Legislative and Regulatory Activities Division, Office of the Comptroller of the Currency, 400 7th Street SW., Suite 3E-218, Mail Stop 9W-11, Washington, DC 20219. • Fax: (571) 465-4326. • Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218, Mail Stop 9W-11, Washington, DC 20219. Instructions: You must include “OCC” as the agency name and “Docket ID OCC-2011-0001” in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, email addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. You may review comments and other related materials that pertain to this proposed rule by any of the following methods: • Viewing Comments Electronically: Go to www.regulations.gov . Enter “Docket ID OCC-2011-0001” in the Search box and click “Search.” Click on “Open Docket Folder” on the right side of the screen and then “Comments.” Comments can be filtered by clicking on “View All” and then using the filtering tools on the left side of the screen. • Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov . Supporting materials may be viewed by clicking on “Open Docket Folder” and then clicking on “Supporting Documents.” The docket may be viewed after the close of the comment period in the same manner as during the comment period. • Viewing Comments Personally: You may personally inspect and photocopy comments at the OCC, 400 7th Street SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 649-6700 or, for persons who are deaf or hard of hearing, TTY, (202) 649-5597. Upon arrival, visitors will be required to present valid government-issued photo identification and to submit to security screening in order to inspect and photocopy comments. Board of Governors of the Federal Reserve System: You may submit comments, identified by Docket No. 1536 and RIN No. 7100 AE-50, by any of the following methods: • Agency Web site: http://www.federalreserve.gov . Follow the instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm . • Federal eRulemaking Portal: http://www.regulations.gov . Follow the instructions for submitting comments. • Email: regs.comments@federalreserve.gov . Include the docket number and RIN number in the subject line of the message. • Fax: (202) 452-3819 or (202) 452-3102. • Mail: Address to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW., Washington, DC 20551. All public comments will be made available on the Board's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper form in Room 3515, 1801 K Street NW. (between 18th and 19th Streets NW.), Washington, DC 20006 between 9:00 a.m. and 5:00 p.m. on weekdays. Federal Deposit Insurance Corporation: You may submit comments, identified by RIN 3064-AD86, by any of the following methods: • Agency Web site: http://www.FDIC.gov/regulations/laws/federal/propose.html . Follow instructions for submitting comments on the Agency Web site. • Email: Comments@FDIC.gov . Include the RIN 3064-AD86 on the subject line of the message. • Mail: Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429. • Hand Delivery: Comments may be hand delivered to the guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7:00 a.m. and 5:00 p.m. • Public Inspection: All comments received, including any personal information provided, will be posted generally without change to http://www.fdic.gov/regulations/laws/federal . Federal Housing Finance Agency: You may submit your written comments on the proposed rulemaking, identified by RIN number, by any of the following methods: • Agency Web site: www.fhfa.gov/open-for-comment-or-input . • Federal eRulemaking Portal: http://www.regulations.gov . Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by email to FHFA at RegComments@fhfa.gov to ensure timely receipt by the Agency. Please include “RIN 2590-AA42” in the subject line of the message. • Hand Delivery/Courier: The hand delivery address is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA42, Federal Housing Finance Agency, Eighth Floor, 400 7th Street SW., Washington, DC 20219. The package should be delivered at the 7th Street entrance Guard Desk, First Floor, on business days between 9 a.m. and 5 p.m. • U.S. Mail, United Parcel Service, Federal Express, or Other Mail Service: The mailing address for comments is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA42, Federal Housing Finance Agency, 400 7th Street SW., Washington, DC 20219. Please note that all mail sent to FHFA via U.S. Mail is routed through a national irradiation facility, a process that may delay delivery by approximately two weeks. All comments received by the deadline will be posted without change for public inspection on the FHFA Web site at http://www.fhfa.gov , and will include any personal information provided, such as name, address (mailing and email), and telephone numbers. Copies of all comments timely received will be available for public inspection and copying at the address above on government-business days between the hours of 10:00 a.m. and 3:00 p.m. To make an appointment to inspect comments please call the Office of General Counsel at (202) 649-3804. National Credit Union Administration: You may submit comments by any of the following methods (please send comments by one method only): • Federal eRulemaking Portal: http://www.regulations.gov . Follow the instructions for submitting comments. • Agency Web site: http://www.ncua.gov . Follow the instructions for submitting comments. • Email: Address to regcomments@ncua.gov . Include “[Your name] Comments on “Notice of Proposed Rulemaking for Incentive-based Compensation Arrangements” in the email subject line. • Fax: (703) 518-6319. Use the subject line described above for email. • Mail: Address to Gerard S. Poliquin, Secretary of the Board, National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314-3428. • Hand Delivery/Courier: Same as mail address. • Public Inspection: All public comments are available on the agency's Web site at http://www.ncua.gov/Legal/Regs/Pages/PropRegs.aspx as submitted, except when not possible for technical reasons. Public comments will not be edited to remove any identifying or contact information. Paper copies of comments may be inspected in NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by appointment weekdays between 9:00 a.m. and 3:00 p.m. To make an appointment, call (703) 518-6546 or send an email to OGCMail@ncua.gov . Securities and Exchange Commission: You may submit comments by the following method: Electronic Comments • Use the SEC's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); • Send an email to rule-comments@sec.gov . Please include File Number S7-07-16 on the subject line; or • Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments. Paper Comments • Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549. All submissions should refer to File Number S7-07-16. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The SEC will post all comments on the SEC's Internet Web site ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for Web site viewing and printing in the SEC's Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; the SEC does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. Studies, memoranda or other substantive items may be added by the SEC or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the SEC's Web site. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: OCC: Patrick T. Tierney, Assistant Director, Alison MacDonald, Senior Attorney, and Melissa Lisenbee, Attorney, Legislative and Regulatory Activities, (202) 649-5490, and Judi McCormick, Analyst, Operational Risk Policy, (202) 649-6415, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219. Board: Teresa Scott, Manager, (202) 973-6114, Meg Donovan, Senior Supervisory Financial Analyst, (202) 872-7542, or Joe Maldonado, Supervisory Financial Analyst, (202) 973-7341, Division of Banking Supervision and Regulation; or Laurie Schaffer, Associate General Counsel, (202) 452-2272, Michael Waldron, Special Counsel, (202) 452-2798, Gillian Burgess, Counsel, (202) 736-5564, Flora Ahn, Counsel, (202) 452-2317, or Steve Bowne, Senior Attorney, (202) 452-3900, Legal Division, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. FDIC: Rae-Ann Miller, Associate Director, Risk Management Policy, Division of Risk Management Supervision (202) 898-3898, Catherine Topping, Counsel, Legal Division, (202) 898-3975, and Nefretete Smith, Counsel, Legal Division, (202) 898-6851. FHFA: Mary Pat Fox, Manager, Executive Compensation Branch, (202) 649-3215; or Lindsay Simmons, Assistant General Counsel, (202) 649-3066, Federal Housing Finance Agency, 400 7th Street SW., Washington, DC 20219. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339. NCUA: Vickie Apperson, Program Officer, and Jeffrey Marshall, Program Officer, Office of Examination & Insurance, (703) 518-6360; or Elizabeth Wirick, Senior Staff Attorney, Office of General Counsel, (703) 518-6540, National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314. SEC: Raymond A. Lombardo, Branch Chief, Kevin D. Schopp, Special Counsel, Division of Trading & Markets, (202) 551-5777 or tradingandmarkets@sec.gov ; Sirimal R. Mukerjee, Senior Counsel, Melissa R. Harke, Branch Chief, Division of Investment Management, (202) 551-6787 or IARules@SEC.gov , U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction A. Background B. Supervisory Experience C. Overview of the 2011 Proposed Rule and Public Comment D. International Developments E. Overview of the Proposed Rule II. Section-by-Section Description of the Proposed Rule § __.1 Authority, Scope and Initial Applicability § __.2 Definitions Definitions Pertaining to Covered Institutions Consolidation Level 1, Level 2, and Level 3 Covered Institutions Definitions Pertaining to Covered Persons Relative Compensation Test Exposure Test Exposure Test at Certain Affiliates Dollar Threshold Test Other Definitions Relationship Between Defined Terms § __.3 Applicability (a) When Average Total Consolidated Assets Increase (b) When Total Consolidated Assets Decrease (c) Compliance of Covered Institutions That Are Subsidiaries of Covered Institutions § __.4 Requirements and Prohibitions Applicable to All Covered Institutions (a) In General (b) Excessive Compensation (c) Material Financial Loss (d) Performance Measures (e) Board of Directors (f) Disclosure and Recordkeeping Requirements and (g) Rule of Construction § __.5 Additional Disclosure and Recordkeeping Requirements for Level 1 and Level 2 Covered Institutions § __.6 Reservation of Authority for Level 3 Covered Institutions § __.7 Deferral, Forfeiture and Downward Adjustment, and Clawback Requirements for Level 1 and Level 2 Covered Institutions § __.7(a) Deferral § __.7(a)(1) and § __.7(a)(2) Minimum Deferral Amounts and Deferral Periods for Qualifying Incentive-Based Compensation and Incentive-Based Compensation Awarded Under a Long-Term Incentive Plan Pro Rata Vesting Acceleration of Payments Qualifying Incentive-Based Compensation and Incentive-Based Compensation Awarded Under a Long-Term Incentive Plan § __.7(a)(3) Adjustments of Deferred Qualifying Incentive-Based Compensation and Deferred Long-Term Incentive Plan Compensation Amounts § __.7(a)(4) Composition of Deferred Qualifying Incentive-Based Compensation and Deferred Long-Term Incentive Plan Compensation for Level 1 and Level 2 Covered Institutions Cash and Equity-Like Instruments Options § __.7(b) Forfeiture and Downward Adjustment § __.7(b)(1) Compensation at Risk § __.7(b)(2) Events Triggering Forfeiture and Downward Adjustment Review § __.7(b)(3) Senior Executive Officers and Significant Risk-Takers Affected by Forfeiture and Downward Adjustment § __.7(b)(4) Determining Forfeiture and Downward Adjustment Amounts § __.7(c) Clawback § __.8 Additional Prohibitions for Level 1 and Level 2 Covered Institutions § __.8(a) Hedging § __.8(b) Maximum Incentive-Based Compensation Opportunity § __.8(c) Relative Performance Measures § __.8(d) Volume-Driven Incentive-Based Compensation § __.9 Risk Management and Controls Requirements for Level 1 and Level 2 Covered Institutions § __.10 Governance Requirements for Level 1 and Level 2 Covered Institutions § __.11 Policies and Procedures Requirements for Level 1 and Level 2 Covered Institutions § __.12 Indirect Actions § __.13 Enforcement § __.14 NCUA and FHFA Covered Institutions in Conservatorship, Receivership, or Liquidation SEC Amendment to Exchange Act Rule 17a-4 SEC Amendment to Investment Advisers Act Rule 204-2 III. Appendix to the Supplementary Information: Example Incentive-Based Compensation Arrangement and Forfeiture and Downward Adjustment Review Ms. Ledger: Senior Executive Officer at Level 2 Covered Institution Balance Award of Incentive-Based Compensation for Performance Periods Ending December 31, 2024 Vesting Schedule Use of Options in Deferred Incentive-Based Compensation Other Requirements Specific to Ms. Ledger's Incentive-Based Compensation Arrangement Risk Management and Controls and Governance Recordkeeping Mr. Ticker: Forfeiture and Downward Adjustment Review IV. Request for Comments V. Regulatory Analysis A. Regulatory Flexibility Act B. Paperwork Reduction Act C. The Treasury and General Government Appropriations Act, 1999—Assessment of Federal Regulations and Policies on Families D. Riegle Community Development and Regulatory Improvement Act of 1994 E. Solicitation of Comments on Use of Plain Language F. OCC Unfunded Mandates Reform Act of 1995 Determination G. Differences Between the Federal Home Loan Banks and the Enterprises H. NCUA Executive Order 13132 Determination I. SEC Economic Analysis J. Small Business Regulatory Enforcement Fairness Act List of Subjects I. Introduction Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) 1 requires the Agencies to jointly prescribe regulations or guidelines with respect to incentive-based compensation practices at certain financial institutions (referred to as “covered financial institutions”). 2 Specifically, section 956 of the Dodd-Frank Act (“section 956”) requires that the Agencies prohibit any types of incentive-based compensation 3 arrangements, or any feature of any such arrangements, that the Agencies determine encourage inappropriate risks by a covered financial institution: (1) By providing an executive officer, employee, director, or principal shareholder of the covered financial institution with excessive compensation, fees, or benefits; or (2) that could lead to material financial loss to the covered financial institution. Under the Act, a covered financial institution also must disclose to its appropriate Federal regulator the structure of its incentive-based compensation arrangements sufficient to determine whether the structure provides excessive compensation, fees, or benefits or could lead to material financial loss to the institution. The Dodd-Frank Act does not require a covered financial institution to report the actual compensation of particular individuals. 1 Public Law 111-203, 124 Stat. 1376 (2010). 2 12 U.S.C. 5641. 3 Section 956(b) uses the term “incentive-based payment arrangement.” It appears that Congress used the terms “incentive-based payment arrangement” and “incentive-based compensation arrangement” interchangeably. The Agencies have chosen to use the term “incentive-based compensation arrangement” throughout the proposed rule and this SUPPLEMENTARY INFORMATION section for the sake of clarity. The Act defines “covered financial institution” to include any of the following types of institutions that have $1 billion or more in assets: (A) A depository institution or depository institution holding company, as such terms are defined in section 3 of the Federal Deposit Insurance Act (“FDIA”) (12 U.S.C. 1813); (B) a broker-dealer registered under section 15 of the Securities Exchange Act of 1934 (15 U.S.C. 78o); (C) a credit union, as described in section 19(b)(1)(A)(iv) of the Federal Reserve Act; (D) an investment adviser, as such term is defined in section 202(a)(11) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)(11)); (E) the Federal National Mortgage Association (Fannie Mae); (F) the Federal Home Loan Mortgage Corporation (Freddie Mac); and (G) any other financial institution that the appropriate Federal regulators, jointly, by rule, determine should be treated as a covered financial institution for these purposes. The Act also requires that any compensation standards adopted under section 956 be comparable to the safety and soundness standards applicable to insured depository institutions under section 39 of the FDIA 4 and that the Agencies take the compensation standards described in section 39 of the FDIA into consideration in establishing compensation standards under section 956. 5 As explained in greater detail below, the standards established by the proposed rule are comparable to the standards established under section 39 of the FDIA. 4 12 U.S.C. 1831p-1. The OCC, Board, and FDIC (collectively, the “Federal Banking Agencies”) each have adopted guidelines implementing the compensation-related and other safety and soundness standards in section 39 of the FDIA. See Interagency Guidelines Establishing Standards for Safety and Soundness (the “Federal Banking Agency Safety and Soundness Guidelines”), 12 CFR part 30, Appendix A (OCC); 12 CFR part 208, Appendix D-1 (Board); 12 CFR part 364, Appendix A (FDIC). 5 12 U.S.C. 1831p-1(c). In April 2011, the Agencies published a joint notice of proposed rulemaking that proposed to implement section 956 (2011 Proposed Rule). 6 Since the 2011 Proposed Rule was published, incentive-based compensation practices have evolved in the financial services industry. The Board, the OCC, and the FDIC have gained experience in applying guidance on incentive-based compensation, 7 FHFA has gained supervisory experience in applying compensation-related rules 8 adopted under the authority of the Safety and Soundness Act, 9 and foreign jurisdictions have adopted incentive-based compensation remuneration codes, regulations, and guidance. 10 In light of these developments and the comments received on the 2011 Proposed Rule, the Agencies are publishing a new proposed rule to implement section 956. 6 76 FR 21170 (April 14, 2011). 7 OCC, Board, FDIC, and Office of Thrift Supervision, “Guidance on Sound Incentive Compensation Policies” (“2010 Federal Banking Agency Guidance”), 75 FR 36395 (June 25, 2010). 8 These include the Executive Compensation Rule (12 CFR part 1230), the Golden Parachute Payments Rule (12 CFR part 1231), and the Federal Home Loan Bank Directors' Compensation and Expenses Rule (12 CFR part 1261 subpart C). 9 The Safety and Soundness Act means the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended (12 U.S.C. 4501 et seq. ). 12 CFR 1201.1. 10 See, e.g., the European Union, Directive 2013/36/EU (effective January 1, 2014); United Kingdom Prudential Regulation Authority (“PRA”) and Financial Conduct Authority (“FCA”), “PRA PS12/15/FCA PS15/16: Strengthening the Alignment of Risk and Reward: New Remuneration Rules” (June 25, 2015) (“UK Remuneration Rules”), available at http://www.bankofengland.co.uk/pra/Documents/publications/ps/2015/ps1215.pdf ; Australian Prudential Regulation Authority (“APRA”), Prudential Practice Guide SPG 511—Remuneration (November 2013), available at http://www.apra.gov.au/Super/Documents/Prudential-Practice-Guide-SPG-511-Remuneration.pdf ; Canada, The Office of the Superintendent of Financial Institutions (“OSFI”) Corporate Governance Guidelines (January 2013) (“OSFI Corporate Governance Guidelines”), available at http://www.osfi-bsif.gc.ca/eng/fi-if/rg-ro/gdn-ort/gl-ld/pages/cg_guideline.aspx and Supervisory Framework (December 2010) (“OSFI Supervisory Framework”), available at http://www.osfi-bsif.gc.ca/Eng/Docs/sframew.pdf ; Switzerland, Financial Market Supervisory Authority (“FINMA”), 2010/01 FINMA Circular on Remuneration Schemes (October 2009) (“FINMA Remuneration Circular”), available at https://www.finma.ch/en/documentation/circulars/#Order=2 . The first part of this SUPPLEMENTARY INFORMATION section provides background information on the proposed rule, including a summary of the 2011 Proposed Rule and areas in which the proposed rule differs from the 2011 Proposed Rule. The second part contains a section-by-section description of the proposed rule. 11 To help explain how the requirements of the proposed rule would work in practice, the Appendix to this SUPPLEMENTARY INFORMATION section sets out an example of an incentive-based compensation arrangement for a hypothetical senior executive officer at a hypothetical large banking organization and an example of how a forfeiture and downward adjustment review might be conducted for a senior manager at a hypothetical large banking organization. 11 This section-by-section description also includes certain examples of how the proposed rule would work in practice. These examples are intended solely for purposes of illustration and do not cover every aspect of the proposed rule. They are provided as an aid to understanding the proposed rule and do not carry the force and effect of law or regulation. For ease of reference, the proposed rules of the Agencies are referenced in this Supplementary Information section using a common designation of section __.1 to section __.14 (excluding the title and part designations for each agency). Each agency would codify its rule, if adopted, within its respective title of the Code of Federal Regulations. 12 12 Specifically, the Agencies propose to codify the rules as follows: 12 CFR part 42 (OCC); 12 CFR part 236 (the Board); 12 CFR part 372 (FDIC); 17 CFR part 303 (SEC); 12 CFR parts 741 and 751 (NCUA); and 12 CFR part 1232 (FHFA). A. Background Incentive-based compensation arrangements are critical tools in the management of financial institutions. These arrangements serve several important objectives, including attracting and retaining skilled staff and promoting better performance of the institution and individual employees. Well-structured incentive-based compensation arrangements can promote the health of a financial institution by aligning the interests of executives and employees with those of the institution's shareholders and other stakeholders. At the same time, poorly structured incentive-based compensation arrangements can provide executives and employees with incentives to take inappropriate risks that are not consistent with the long-term health of the institution and, in turn, the long-term health of the U.S. economy. Larger financial institutions in particular are interconnected with one another and with many other companies and markets, which can mean that any negative impact from inappropriate risk-taking can have broader consequences. The risk of these negative externalities may not be fully taken into account in incentive-based compensation arrangements, even arrangements that otherwise align the interests of shareholders and other stakeholders with those of executives and employees. There is evidence that flawed incentive-based compensation practices in the financial industry were one of many factors contributing to the financial crisis that began in 2007. Some compensation arrangements rewarded employees—including non-executive personnel like traders with large position limits, underwriters, and loan officers—for increasing an institution's revenue or short-term profit without sufficient recognition of the risks the employees' activities posed to the institutions, and therefore potentially to the broader financial system. 13 Traders with large position limits, underwriters, and loan officers are three examples of non-executive personnel who had the ability to expose an institution to material amounts of risk. Significant losses caused by actions of individual traders or trading groups occurred at some of the largest financial institutions during and after the financial crisis. 14 13 See, e.g., Financial Crisis Inquiry Commission, “Financial Crisis Inquiry Report” (January 2011), at 209, 279, 291, 343, available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf ; Senior Supervisors Group, “Observations on Risk Management Practices during the Recent Market Turbulence” (March 6, 2008), available at https://www.newyorkfed.org/medialibrary/media/newsevents/news/banking/2008/SSG_Risk_Mgt_doc_final.pdf . 14 A large financial institution suffered losses in 2012 from trading by an investment office in its synthetic credit portfolio. These losses amounted to approximately $5.8 billion, which was approximately 3.6 percent of the holding company's tier 1 capital. https://www.sec.gov/Archives/edgar/data/19617/000001961713000221/0000019617-13-000221-index.htm Form 10-K 2013, Pages 69 and 118. In 2007, a proprietary trading group at another large institution caused losses of an estimated $7.8 billion (approximately 25 percent of the firm's total stockholder's equity). http://www.morganstanley.com/about-us-ir/shareholder/10k113008/10k1108.pdf Form 10-K 2008, Pages 45 and 108. Between 2005 and 2008, one futures trader at a large financial institution engaged in activities that caused losses of an estimated EUR4.9 billion in 2007, which was approximately 23 percent of the firm's 2007 tier 1 capital. http://www.societegenerale.com/sites/default/files/03%20March%202008%202008%20Registration%20Document.pdf , Pages, 52, 159-160; http://www.societegenerale.com/sites/default/files/12%20May%202008%20The%20report%20by%20the%20General%20Inspection%20of%20Societe%20Generale.pdf , Pages 1-71. In 2011, one trader at another large financial institution caused losses of an estimated $2.25 billion, which represented approximately 5.4 percent of the firm's tier 1 capital. https://www.fca.org.uk/news/press-releases/fca-bans-kweku-mawuli-adoboli-from-the-financial-services-industry , Page 1; https://www.ubs.com/global/en/about_ubs/investor_relations/other_filings/sec.html . 2012 SEC Form 20-F, Page 34. In 2007, one trader caused losses of an estimated $264 million at a large financial institution, which represented approximately 1.7 percent of its tier 1 capital. http://www.federalreserve.gov/newsevents/press/enforcement/20081118a.htm , Page 1; https://www.bmo.com/ci/ar2008/downloads/bmo_ar2008.pdf , Page 61. Of particular note were incentive-based compensation arrangements for employees in a position to expose the institution to substantial risk that failed to align the employees' interests with those of the institution. For example, some institutions gave loan officers incentives to write a large amount of loans or gave traders incentives to generate high levels of trading revenues, without sufficient regard for the risks associated with those activities. The revenues that served as the basis for calculating bonuses were generated immediately, while the risk outcomes might not have been realized for months or years after the transactions were completed. When these, or similarly misaligned incentive-based compensation arrangements, are common in an institution, the foundation of sound risk management can be undermined by the actions of employees seeking to maximize their own compensation. The effect of flawed incentive-based compensation practices is demonstrated by the arrangements implemented by Washington Mutual (WaMu). According to the Senate Permanent Subcommittee on Investigations Staff's report on the failure of WaMu “[l]oan officers and processors were paid primarily on volume, not primarily on the quality of their loans, and were paid more for issuing higher risk loans. Loan officers and mortgage brokers were also paid more when they got borrowers to pay higher interest rates, even if the borrower qualified for a lower rate—a practice that enriched WaMu in the short term, but made defaults more likely down the road.” 15 15 Staff of S. Permanent Subcomm. on Investigations, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse at 143 (Comm. Print 2011). Flawed incentive-based compensation arrangements were evident in not just U.S. financial institutions, but also major financial institutions worldwide. 16 In a 2009 survey of banking organizations engaged in wholesale banking activities, the Institute of International Finance found that 98 percent of respondents recognized the contribution of incentive-based compensation practices to the financial crisis. 17 16 See Financial Stability Forum, “FSF Principles for Sound Compensation Practices” (April 2009) (the “FSB Principles”), available at http://www.financialstabilityboard.org/publications/r_0904b.pdf ; Senior Supervisors Group, “Risk-management Lessons from the Global Banking Crisis of 2008” (October 2009), available at http://www.newyorkfed.org/newsevents/news/banking/2009/ma091021.html . The Financial Stability Forum was renamed the Financial Stability Board (“FSB”) in April 2009. 17 See Institute of International Finance, Inc., “Compensation in Financial Services: Industry Progress and the Agenda for Change” (March 2009), available at http://www.oliverwyman.com/ow/pdf_files/OW_En_FS_Publ_2009_CompensationInFS.pdf . See also UBS, “Shareholder Report on UBS's Write-Downs,” (April 18, 2008), at 41-42 (identifying incentive effects of UBS compensation practices as contributing factors in losses suffered by UBS due to exposure to the subprime mortgage market), available at http://www.ubs.com/1/ShowMedia/investors/agm?contentId=140333&name=080418ShareholderReport.pdf . Shareholders and other stakeholders in a covered institution 18 have an interest in aligning the interests of executives, managers, and other employees with the institution's long-term health. However, aligning the interests of shareholders (or members, in the case of credit unions, mutual savings associations, mutual savings banks, some mutual holding companies, and Federal Home Loan Banks) and other stakeholders with employees may not always be sufficient to protect the safety and soundness of an institution, deter excessive compensation, or deter behavior or inappropriate risk-taking that could lead to material financial loss at the institution. Executive officers and employees of a covered institution may be willing to tolerate a degree of risk that is inconsistent with the interests of stakeholders, as well as broader public policy goals. 18 As discussed below, the proposed rule uses the term “covered institution” rather than the statutory term “covered financial institution.” Generally, the incentive-based compensation arrangements of a covered institution should reflect the interests of the shareholders and other stakeholders, to the extent that the incentive-based compensation makes those covered persons demand more or less reward for their risk-taking at the covered institution, and to the extent that incentive-based compensation changes those covered persons' risk-taking. However, risks undertaken by a covered institution—particularly a larger institution—can spill over into the broader economy, affecting other institutions and stakeholders. Therefore, there may be reasons why the preferences of all of the stakeholders are not fully reflected in incentive-based compensation arrangements. Hence, there is a public interest in curtailing the inappropriate risk-taking incentives provided by incentive-based compensation arrangements. 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. 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. As a result, supervision and regulation of incentive-based compensation can play an important role in helping safeguard covered institutions against incentive-based compensation practices that threaten safety and soundness, are excessive, or could lead to material financial loss. In particular, such supervision and regulation can help address the negative externalities affecting the broader economy or other institutions that may arise from inappropriate risk-taking by large financial institutions. B. Supervisory Experience To address such practices, the Federal Banking Agencies proposed, and then later adopted, the 2010 Federal Banking Agency Guidance governing incentive-based compensation programs, which applies to all banking organizations regardless of asset size. This Guidance uses a principles-based approach to ensure that incentive-based compensation arrangements appropriately tie rewards to longer-term performance and do not undermine the safety and soundness of banking organizations or create undue risks to the financial system. In addition, to foster implementation of improved incentive-based compensation practices, the Board, in cooperation with the OCC and FDIC, initiated in late 2009 a multidisciplinary, horizontal review (“Horizontal Review”) of incentive-based compensation practices at 25 large, complex banking organizations, which is still ongoing. 19 One goal of the Horizontal Review is to help improve the Federal Banking Agencies' understanding of the range and evolution of incentive-based compensation practices across institutions and categories of employees within institutions. The second goal is to provide guidance to each institution in implementing the 2010 Federal Banking Agency Guidance. The supervisory experience of the Federal Banking Agencies in this area is also relevant to the incentive-based compensation practices at broker-dealers and investment advisers. 19 The financial institutions in the Horizontal Review are Ally Financial Inc.; American Express Company; Bank of America Corporation; The Bank of New York Mellon Corporation; Capital One Financial Corporation; Citigroup Inc.; Discover Financial Services; The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; Northern Trust Corporation; The PNC Financial Services Group, Inc.; State Street Corporation; SunTrust Banks, Inc.; U.S. Bancorp; and Wells Fargo & Company; and the U.S. operations of Barclays plc, BNP Paribas, Credit Suisse Group AG, Deutsche Bank AG, HSBC Holdings plc, Royal Bank of Canada, The Royal Bank of Scotland Group plc, Societe Generale, and UBS AG. As part of the Horizontal Review, the Board conducted reviews of line of business operations in the areas of trading, mortgage, credit card, and commercial lending operations as well as senior executive incentive-based compensation awards and payouts. The institutions subject to the Horizontal Review have made progress in developing practices that would incorporate the principles of the 2010 Federal Banking Agency Guidance into their risk management systems, including through better recognition of risk in incentive-based compensation decision-making and improved practices to better balance risk and reward. Many of those changes became evident in the actual compensation arrangements of the institutions as the review progressed. In 2011, the Board made public its initial findings from the Horizontal Review, recognizing the steps the institutions had made towards improving their incentive-based compensation practices, but also noting that each institution needed to do more. 20 In early 2012, the Board initiated a second, cross-firm review of 12 additional large banking organizations (“2012 LBO Review”). The Board also monitors incentive-based compensation as part of ongoing supervision. Supervisory oversight focuses most intensively on large banking organizations because they are significant users of incentive-based compensation and because flawed approaches at these organizations are more likely to have adverse effects on the broader financial system. As part of that supervision, the Board also conducts targeted incentive-based compensation exams and considers incentive-based compensation in the course of wider line of business and risk-related reviews. 20 Board, “Incentive Compensation Practices: A Report on the Horizontal Review of Practices at Large Banking Organizations” (October 2011) (“2011 FRB White Paper), available at http://www.federalreserve.gov/publications/other-reports/files/incentive-compensation-practices-report-201110.pdf . For the past several years, the Board also has been actively engaged in international compensation, governance, and conduct working groups that have produced a variety of publications aimed at further improving incentive-based compensation practices. 21 21 See, e.g., FSB Principles; FSB, “FSB Principles for Sound Compensation Practices: Implementation Standards, Basel, Switzerland” (September 2009), available at http://www.fsb.org/wp-content/uploads/r_090925c.pdf?page_moved=1 (together with the FSB Principles, the “FSB Principles and Implementation Standards”); Basel Committee on Banking Supervision, “Report on Range of Methodologies for Risk and Performance Alignment of Remuneration” (May 2011); Basel Committee on Banking Supervision, “Principles for the Effective Supervision of Financial Conglomerates” (September 2012); FSB, “Implementing the FSB Principles for Sound Compensation Practices and their Implementation Standards—First, Second, Third, and Fourth Progress Reports” (June 2012, August 2013, November 2014, November 2015), available at http://www.fsb.org/publications/?policy_area%5B%5D=24 . The FDIC reviews incentive-based compensation practices as part of its safety and soundness examinations of state nonmember banks, most of which are smaller community institutions that would not be covered by the proposed rule. FDIC incentive-based compensation reviews are conducted in the context of the 2010 Federal Banking Agency Guidance and Section 39 of the FDIA. Of the 518 bank failures resolved by the FDIC between 2007 and 2015, 65 involved banks with total assets of $1 billion or more that would have been covered by the proposed rule. Of the 65 institutions that failed with total assets of $1 billion or more, 18 institutions or approximately 28 percent, were identified as having some level of issues or concerns related to compensation arrangements, many of which involved incentive-based compensation. Overall, most of the compensation issues related to either excessive compensation or tying financial incentives to metrics such as corporate performance or loan production without adequate consideration of related risks. Also, several cases involved poor governance practices, most commonly, dominant management influencing improper incentives. 22 22 The Inspector General of the appropriate federal banking agency must conduct a Material Loss Review (“MLR”) when losses to the Deposit Insurance Fund from failure of an insured depository institution exceed certain thresholds. See FDIC MLRs, available at https://www.fdicig.gov/mlr.shtml ; Board MLRs available at http://oig.federalreserve.gov/reports/audit-reports.htm ; and OCC MLRs, available at https://www.treasury.gov/about/organizational-structure/ig/Pages/audit_reports_index.aspx. See also the Subcommittee Report. The OCC reviews and assesses compensation practices at individual banks as part of its normal supervisory activities. For example, the OCC identifies matters requiring attention (MRAs) relating to compensation practices, including matters relating to governance and risk management and controls for compensation. The OCC's Guidelines Establishing Heightened Standards for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches 23 (the “OCC's Heightened Standards”) require covered banks to establish and adhere to compensation programs that prohibit incentive-based payment arrangements that encourage inappropriate risks by providing excessive compensation or that could lead to material financial loss. The OCC includes an assessment of the banks' compensation practices when determining compliance with the OCC's Heightened Standards. 23 12 CFR part 30, appendix D. In addition to safety and soundness oversight, FHFA has express statutory authorities and mandates related to compensation paid by its regulated entities. FHFA reviews compensation arrangements before they are implemented at Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Office of Finance of the Federal Home Loan Bank System. By statute, FHFA must prohibit its regulated entities from providing compensation to any executive officer of a regulated entity that is not reasonable and comparable with compensation for employment in other similar businesses (including publicly held financial institutions or major financial services companies) involving similar duties and responsibilities. 24 FHFA also has additional authority over the Enterprises during conservatorship, and has established compensation programs for Enterprise executives. 25 24 12 U.S.C. 4518(a). 25 As conservator, FHFA succeeded to all rights, titles, powers and privileges of the Enterprises, and of any shareholder, officer or director of each company with respect to the company and its assets. The Enterprises have been under conservatorship since September 2008. In early 2014, FHFA issued two final rules related to compensation pursuant to its authority over compensation under the Safety and Soundness Act. 26 The Executive Compensation Rule sets forth requirements and processes with respect to compensation provided to executive officers by the Enterprises, the Federal Home Loan Banks, and the Federal Home Loan Bank System's Office of Finance. 27 Under the rule, those entities may not enter into an incentive plan with an executive officer or pay any incentive compensation to an executive officer without providing advance notice to FHFA. 28 FHFA's Golden Parachute Payments Rule governs golden parachute payments in the case of a regulated entity's insolvency, conservatorship, or troubled condition. 29 26 12 CFR parts 1230 and 1231, under the authority of the Safety and Soundness Act (12 U.S.C. 4518), as amended by the Housing and Economic Recovery Act of 2008. Congress enacted HERA, including new or amended provisions addressing compensation at FHFA's regulated entities, at least in part in response to the financial crisis that began in 2007. 27 12 CFR part 1230. 28 12 CFR 1230.3(d). 29 12 CFR part 1231. In part because of the work described above, incentive-based compensation practices and the design of incentive-based compensation arrangements at banking organizations supervised by the Federal Banking Agencies have improved significantly in the years since the recent financial crisis. However, the Federal Banking Agencies have continued to evaluate incentive-based compensation practices as a part of their ongoing supervision responsibilities, with a particular focus on the design of incentive-based compensation arrangements for senior executive officers; deferral practices (including compensation at risk through forfeiture and clawback mechanisms); governance and the use of discretion; ex ante risk adjustment; and control function participation in incentive-based compensation design and risk evaluation. The Federal Banking Agencies' supervision has been focused on ensuring robust risk management and governance practices rather than on prescribing levels of pay. Generally, the supervisory work of the Federal Banking Agencies and FHFA has promoted more risk-sensitive incentive-based compensation practices and effective risk governance. Incentive-based compensation decision-making increasingly leverages underlying risk management frameworks to help ensure better risk identification, monitoring, and escalation of risk issues. Prior to the recent financial crisis, many institutions had no effective risk adjustments to incentive-based compensation at all. Today, the Board has observed that incentive-based compensation arrangements at the largest banking institutions reflect risk adjustments, the largest banking institutions take into consideration adverse outcomes, more pay is deferred, and more of the deferred amount is subject to reduction based on failure to meet assigned performance targets or as a result of adverse outcomes that trigger forfeiture and clawback reviews. 30 30 See generally 2011 FRB White Paper. The 2011 FRB White Paper provides specific examples of how compensation practices at the institutions involved in the Board's Horizontal Review of Incentive Compensation have changed since the recent financial crisis. Similarly, prior to the recent financial crisis, institutions rarely involved risk management and control personnel in incentive-based compensation decision-making. Today, control functions frequently play an increased role in the design and operation of incentive-based compensation, and institutions have begun to build out frameworks to help validate the effectiveness of risk adjustment mechanisms. Risk-related performance objectives and “risk reviews” are increasingly common. Prior to the recent financial crisis, boards of directors had begun to consider the relationship between incentive-based compensation and risk, but were focused on incentive-based compensation for senior executives. Today, refined policies and procedures promote some consistency and effectiveness across incentive-based compensation arrangements. The role of boards of directors has expanded and the quality of risk information provided to those boards has improved. Finance and audit committees work together with compensation committees with the goal of having incentive-based compensation result in prudent risk-taking. 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. Congress has required the Agencies to jointly prescribe regulations or guidelines that cover not only depository institutions and depository institution holding companies, but also other financial institutions. While the Federal Banking Agencies' supervisory approach based on the 2010 Federal Banking Agency Guidance and the work of FHFA have resulted in improved incentive-based compensation practices, there are even greater benefits possible under rule-based supervision. Using their collective supervisory experiences, the Agencies are proposing a uniform set of enforceable standards applicable to a larger group of institutions supervised by all of the Agencies. The proposed rule would promote better incentive-based compensation practices, while still allowing for some flexibility in the design and operation of incentive-based compensation arrangements among the varied institutions the Agencies supervise, including through the tiered application of the proposed rule's requirements. C. Overview of the 2011 Proposed Rule and Public Comment The Agencies proposed a rule in 2011, rather than guidelines, to establish requirements applicable to the incentive-based compensation arrangements of all covered institutions. The 2011 Proposed Rule would have supplemented existing rules, guidance, and ongoing supervisory efforts of the Agencies. The 2011 Proposed Rule would have prohibited incentive-based compensation arrangements that could encourage inappropriate risks. It would have required compensation practices at regulated financial institutions to be consistent with three key principles—that incentive-based compensation arrangements should appropriately balance risk and financial rewards, be compatible with effective risk management and controls, and be supported by strong corporate governance. The Agencies proposed that financial institutions with $1 billion or more in assets be required to have policies and procedures to ensure compliance with the requirements of the rule, and submit an annual report to their Federal regulator describing the structure of their incentive-based compensation arrangements. The 2011 Proposed Rule included two additional requirements for “larger financial institutions.” 31 The first would have required these larger financial institutions to defer 50 percent of the incentive-based compensation for executive officers for a period of at least three years. The second would have required the board of directors (or a committee thereof) to identify and approve the incentive-based compensation for those covered persons 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, such as traders with large position limits and other individuals who have the authority to place at risk a substantial part of the capital of the covered institution. 31 In the 2011 Proposed Rule, the term “larger covered financial institution” for the Federal Banking Agencies and the SEC meant those covered institutions with total consolidated assets of $50 billion or more. For the NCUA, all credit unions with total consolidated assets of $10 billion or more would have been larger covered institutions. For FHFA, Fannie Mae, Freddie Mac, and all Federal Home Loan Banks with total consolidated assets of $1 billion or more would have been larger covered institutions. The Agencies received more than 10,000 comments on the 2011 Proposed Rule, including from private individuals, community groups, several members of Congress, pension funds, labor federations, academic faculty, covered institutions, financial industry associations, and industry consultants. The vast majority of the comments were substantively identical form letters of two types. The first type of form letter urged the Agencies to minimize the incentives for short-term risk-taking by executives by requiring at least a five-year deferral period for executive bonuses at big banks, banning executives' hedging of their pay packages, and requiring specific details from banks on precisely how they ensure that executives will share in the long-term risks created by their decisions. These commenters also asserted that the final rule should apply to the full range of important financial institutions and cover all the key executives at those institutions. The second type of form letter stated that the commenter or the commenter's family had been affected by the financial crisis that began in 2007, a major cause of which the commenter believed to be faulty pay practices at financial institutions. These commenters suggested various methods of improving these practices, including basing incentive-based compensation on measures of a financial institution's safety and stability, such as the institution's bond price or the spread on credit default swaps. Comments from community groups, members of Congress, labor federations, and pension funds generally urged the Agencies to strengthen the proposed rule and many cited evidence suggesting that flawed incentive-based compensation practices in the financial industry were a major contributing factor to the recent financial crisis. Their suggestions included: Revising the 2011 Proposed Rule's definition of “incentive-based compensation”; defining “excessive compensation”; increasing the length of time for or amount of compensation subject to the mandatory deferral provision; requiring financial institutions to include quantitative data in their annual incentive-based compensation reports; providing for the annual public reporting by the Agencies of information quantifying the overall sensitivity of incentive-based compensation to long-term risks at major financial institutions; prohibiting stock ownership by board members; and prohibiting hedging strategies used by highly-paid executives on their own incentive-based compensation. The academic faculty commenters submitted analyses of certain compensation issues and recommendations. These recommendations included: Adopting a corporate governance measure tied to stock ownership by board members; regulating how deferred compensation is reduced at future payment dates; requiring covered institutions' executives to have “skin in the game” for the entire deferral period; and requiring disclosure of personal hedging transactions rather than prohibiting them. A number of covered institutions and financial industry associations favored the issuance of guidelines instead of rules to implement section 956. Others expressed varying degrees of support for the 2011 Proposed Rule but also requested numerous clarifications and modifications. Many of these commenters raised questions concerning the 2011 Proposed Rule's scope, suggesting that certain types of institutions be excluded from the coverage of the final rule. Some of these commenters questioned the need for the excessive compensation prohibition or requested that the final rule provide specific standards for determining when compensation is excessive. Many of these commenters also opposed the 2011 Proposed Rule's mandatory deferral provision, and some asserted that the provision was unsupported by empirical evidence and potentially harmful to a covered institution's ability to attract and retain key employees. In addition, many of these commenters asserted that the material risk-taker provision in the 2011 Proposed Rule was unclear or imposed on the boards of directors of covered institutions duties more appropriately undertaken by the institutions' management. Finally, these commenters expressed concerns about the burden and timing of the 2011 Proposed Rule. D. International Developments The Agencies considered international developments in developing the 2011 Proposed Rule, mindful that some covered institutions operate in both domestic and international competitive environments. 32 Since the release of the 2011 Proposed Rule, a number of foreign jurisdictions have introduced new compensation regulations that require certain financial institutions to meet certain standards in relation to compensation policies and practices. In June 2013, the European Union adopted the Capital Requirements Directive (“CRD”) IV, which sets out requirements for compensation structures, policies, and practices that apply to all banks and investment firms subject to the CRD. 33 The rules require that up to 100 percent of the variable remuneration shall be subject to malus 34 or clawback arrangements, among other requirements. 35 The PRA's and the FCA's Remuneration Code requires covered companies to defer 40 to 60 percent of a covered person's variable remuneration—and recently updated their implementing regulations to extend deferral periods to seven years for senior executives and to five years for certain other covered persons. 36 The PRA also implemented, in July 2014, a policy requiring firms to set specific criteria for the application of malus and clawback. The PRA's clawback policy requires that variable remuneration be subject to clawback for a period of at least seven years from the date on which it is awarded. 37 32 See 76 FR at 21178. See, e.g., FSB Principles and Implementation Standards. 33 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 (effective January 1, 2014). The remuneration rules in CRD IV were carried over from CRD III with a few additional requirements. CRD III directed the Committee of European Bank Supervisors (“CEBS”), now the European Banking Authority (“EBA”), to develop guidance on how it expected the compensation principles under CRD III to be implemented. See CEBS Guidelines on Remuneration Policies and Practices (December 10, 2010) (“CEBS Guidelines”), available at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32010L0076&from=EN . 34 Malus is defined by the European Union as “an arrangement that permits the institution to prevent vesting of all or part of the amount of a deferred remuneration award in relation to risk outcomes or performance.” See, PRA expectations regarding the application of malus to variable remuneration—SS2/13 UPDATE, available at: http://www.bankofengland.co.uk/pra/Documents/publications/ss/2015/ss213update.pdf . 35 CRD IV provides that at least 50 percent of total variable remuneration should consist of equity-linked interests and at least 40 percent of any variable remuneration must be deferred over a period of three to five years. In the case of variable remuneration of a particularly high amount, the minimum amount required to be deferred is increased to 60 percent. 36 See UK Remuneration Rules. 37 See PRA, “PRA PS7/14: Clawback” (July 2014), available at http://www.bankofengland.co.uk/pra/Pages/publications/ps/2014/ps714.aspx . Also in 2013, the EBA finalized the process and criteria for the identification of categories of staff who have a material impact on the institution's risk profile (“Identified Staff”). 38 These Identified Staff are subject to provisions related, in particular, to the payment of variable compensation. The standards cover remuneration packages for Identified Staff categories and aim to ensure that appropriate incentives for prudent, long-term oriented risk-taking are provided. The criteria used to determine who is identified are both qualitative ( i.e., related to the role and decision-making authority of staff members) and quantitative ( i.e., related to the level of total gross remuneration in absolute or in relative terms). 38 EBA Regulatory Technical Standards on criteria to identify categories of staff whose professional activities have a material impact on an institution's risk profile under Article 94(2) of Directive 2013/36/EU. Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 (December 16, 2013), available at https://www.eba.europa.eu/documents/10180/526386/EBA-RTS-2013-11+%28On+identified+staff%29.pdf/c313a671-269b-45be-a748-29e1c772ee0e . More recently, in December 2015, the EBA released its final Guidelines on Sound Remuneration Policies. 39 The final Guidelines on Sound Remuneration Policies set out the governance process for implementing sound compensation policies across the European Union under CRD IV, as well as the specific criteria for categorizing all compensation components as either fixed or variable pay. The final Guidelines on Sound Remuneration Policies also provide guidance on the application of deferral arrangements and pay-out instruments to ensure that variable pay is aligned with an institution's long-term risks and that any ex-post risk adjustments can be applied as appropriate. These Guidelines will apply as of January 1, 2017, and will replace the Guidelines on Remuneration Policies and Practices that were published by the CEBS in December 2010. 39 EBA, “Guidelines for Sound Remuneration Policies under Articles 74(3) and 75(2) of Directive 2013/36/EU and Disclosures under Article 450 of Regulation (EU) No 575/2013” (December 21, 2015) (“EBA Remuneration Guidelines”), available at https://www.eba.europa.eu/documents/10180/1314839/EBA-GL-2015-22+Guidelines+on+Sound+Remuneration+Policies.pdf/1b0f3f99-f913-461a-b3e9-fa0064b1946b . Other regulators, including those in Canada, Australia, and Switzerland, have taken either a guidance-based approach to the supervision and regulation of incentive-based compensation or an approach that combines guidance and regulation that is generally consistent with the FSB Principles and Implementation Standards. In Australia, 40 all deposit-taking institutions and insurers are expected to comply in full with all the requirements in the APRA's Governance standard (which includes remuneration provisions). APRA also supervises according to its Remuneration Prudential Practice Guide (guidance). In Canada, 41 all federally regulated financial institutions (domestic and foreign) are expected to comply with the FSB Principles and Implementation Standards, and the six Domestic Systemically Important Banks and three largest life insurance companies are expected to comply with the FSB's Principles and Implementation Standards. OSFI has also issued a Corporate Governance Guideline that contain compensation provisions. 42 Switzerland's Swiss Financial Markets Supervisory Authority has also published a principles-based rule on remuneration consistent with the FSB Principles and Implementation Standards that applies to major banks and insurance companies. 43 40 See APRA, “Prudential Standard CPS 510 Governance” (January 2015), available at http://www.apra.gov.au/CrossIndustry/Documents/Final-Prudential-Standard-CPS-510-Governance-%28January-2014%29.pdf ; APRA, Prudential Practice Guide PPG 511—Remuneration (November 30, 2009), available at http://www.apra.gov.au/adi/PrudentialFramework/Pages/adi-prudential-framework.aspx. 41 See OSFI Corporate Governance Guidelines and OSFI Supervisory Framework. 42 See OSFI Corporate Governance Guidelines. 43 See FINMA Remuneration Circular. As compensation practices continue to evolve, the Agencies recognize that international coordination in this area is important to ensure that internationally active financial organizations are subject to consistent requirements. For this reason, the Agencies will continue to work with their domestic and international counterparts to foster sound compensation practices across the financial services industry. Importantly, the proposed rule is consistent with the FSB Principles and Implementation Standards. E. Overview of the Proposed Rule The Agencies are re-proposing a rule, rather than proposing guidelines, to establish general requirements applicable to the incentive-based compensation arrangements of all covered institutions. Like the 2011 Proposed Rule, the proposed rule would prohibit incentive-based compensation arrangements at covered institutions that could encourage inappropriate risks by providing excessive compensation or that could lead to a material financial loss. However, the proposed rule reflects the Agencies' collective supervisory experiences since they proposed the 2011 Proposed Rule. These supervisory experiences, which are described above, have allowed the Agencies to propose a rule that incorporates practices that financial institutions and foreign regulators have adopted to address the deficiencies in incentive-based compensation practices that helped contribute to the financial crisis that began in 2007. For that reason, the proposed rule differs in some respects from the 2011 Proposed Rule. This section provides a general overview of the proposed rule and highlights areas in which the proposed rule differs from the 2011 Proposed Rule. A more detailed, section-by-section description of the proposed rule and the reasons for the proposed rule's requirements is provided later in this Supplementary Information section. Scope and Initial Applicability. Similar to the 2011 Proposed Rule, the proposed rule would apply to any covered institution with average total consolidated assets greater than or equal to $1 billion that offers incentive-based compensation to covered persons. The compliance date of the proposed 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 . The proposed rule would not apply to any incentive-based compensation plan with a performance period that begins before the compliance date. Definitions. The proposed rule includes a number of new definitions that were not included in the 2011 Proposed Rule. These definitions are described later in the section-by-section analysis in this Supplementary Information section. Notably, the Agencies have added a definition of significant risk-taker, which is intended to include individuals who are not senior executive officers but who are in the position to put a Level 1 or Level 2 covered institution at risk of material financial loss. This definition is explained in more detail below. Applicability. The proposed rule distinguishes covered institutions by asset size, applying less prescriptive incentive-based compensation program requirements to the smallest covered institutions within the statutory scope and progressively more rigorous requirements to the larger covered institutions. Although the 2011 Proposed Rule contained specific requirements for covered financial institutions with at least $50 billion in total consolidated assets, the proposed rule creates an additional category of institutions with at least $250 billion in average total consolidated assets. These larger institutions are subject to the most rigorous requirements under the proposed rule. The proposed rule identifies three categories of covered institutions based on average total consolidated assets: 44 44 For covered institutions that are subsidiaries of other covered institutions, levels would generally be determined by reference to the average total consolidated assets of the top-tier parent covered institution. A detailed explanation of consolidation under the proposed rule is included under the heading “Definitions pertaining to covered institutions” below in this Supplementary Information section. • Level 1 (greater than or equal to $250 billion); • Level 2 (greater than or equal to $50 billion and less than $250 billion); and • Level 3 (greater than or equal to $1 billion and less than $50 billion). 45 45 As explained later in this Supplementary Information section, the proposed rule includes a reservation of authority that would allow the appropriate Federal regulator of a Level 3 covered institution with average total consolidated assets greater than or equal to $10 billion and less than $50 billion to require the Level 3 covered institution to comply with some or all of the provisions of sections __.5 and __.7 through __.11 of the proposed rule if the agency determines that the complexity of operations or compensation practices of the Level 3 covered institution are consistent with those of a Level 1 or Level 2 covered institution. Upon an increase in average total consolidated assets, a covered institution would be required to comply with any newly applicable requirements under the proposed rule no later than the first day of the first calendar quarter that begins at least 540 days after the date on which the covered institution becomes a Level 1, Level 2, or Level 3 covered institution. The proposed rule would grandfather any incentive-based compensation plan with a performance period that begins before such date. Upon a decrease in total consolidated assets, a covered institution would remain subject to the provisions of the proposed rule that applied to it before the decrease until total consolidated assets fell below $250 billion, $50 billion, or $1 billion, as applicable, for four consecutive regulatory reports ( e.g., Call Reports). A covered institution under the Board's, the OCC's, or the FDIC's proposed rule that is a subsidiary of another covered institution under the Board's, the OCC's, or the FDIC's proposed rule, respectively, may meet any requirement of the Board's, OCC's, or the FDIC's proposed rule if the parent covered institution complies with that requirement in such a way that causes the relevant portion of the incentive-based compensation program of the subsidiary covered institution to comply with that requirement. Requirements and Prohibitions Applicable to All Covered Institutions. Similar to the 2011 Proposed Rule, the proposed rule would prohibit all covered institutions from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risk by providing covered persons with excessive compensation, fees, or benefits or that could lead to material financial loss to the covered institution. Also consistent with the 2011 Proposed Rule, the proposed rule provides that compensation, fees, and benefits will be considered excessive when amounts paid are unreasonable or disproportionate to the value of the services performed by a covered person, taking into consideration all relevant factors, including: • The combined value of all compensation, fees, or benefits provided to a covered person; • The compensation history of the covered person and other individuals with comparable expertise at the covered institution; • The financial condition of the covered institution; • Compensation practices at comparable institutions, based upon such factors as asset size, geographic location, and the complexity of the covered institution's operations and assets; • For post-employment benefits, the projected total cost and benefit to the covered institution; and • Any connection between the covered person and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse with regard to the covered institution. The proposed rule is also similar to the 2011 Proposed Rule in that it provides that an incentive-based compensation arrangement will be considered to encourage inappropriate risks that could lead to material financial loss to the covered institution, unless the arrangement: • Appropriately balances risk and reward; • Is compatible with effective risk management and controls; and • Is supported by effective governance. However, unlike the 2011 Proposed Rule, the proposed rule specifically provides that an incentive-based compensation arrangement would not be considered to appropriately balance risk and reward unless it: • Includes financial and non-financial measures of performance; • Is designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and • Is subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance. The proposed rule also contains requirements for the board of directors of a covered institution that are similar to requirements included in the 2011 Proposed Rule. Under the proposed rule, the board of directors of each covered institution (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 amounts of awards and, at the time of vesting, payouts under such arrangements; and • Approve material exceptions or adjustments to incentive-based compensation policies or arrangements for senior executive officers. The 2011 Proposed Rule contained an annual reporting requirement, which has been replaced by a recordkeeping requirement in the proposed rule. 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. The records would be required to be disclosed to the covered institution's appropriate Federal regulator upon request. Disclosure and Recordkeeping Requirements for Level 1 and Level 2 Covered Institutions. The proposed rule includes more detailed disclosure and recordkeeping requirements for larger covered institutions than the 2011 Proposed Rule. The proposed rule would require all Level 1 and Level 2 covered institutions to create annually and maintain for at least seven years records that document: (1) The covered institution's senior executive officers and significant risk-takers, listed by legal entity, job function, organizational hierarchy, and line of business; (2) the incentive-based compensation arrangements for senior executive officers and significant risk-takers, including information on the percentage of incentive-based compensation deferred and form of award; (3) any forfeiture and downward adjustment or clawback reviews and decisions for senior executive officers and significant risk-takers; and (4) any material changes to the covered institution's incentive-based compensation arrangements and policies. Level 1 and Level 2 covered institutions would be required to create and maintain records in a manner that would allow for an independent audit of incentive-based compensation arrangements, policies, and procedures, and to provide the records described above in such form and frequency as the appropriate Federal regulator requests. Deferral, Forfeiture and Downward Adjustment, and Clawback Requirements for Level 1 and Level 2 Covered Institutions. The proposed rule would require incentive-based compensation arrangements that appropriately balance risk and reward. For Level 1 and Level 2 covered institutions, the proposed rule would require that incentive-based compensation arrangements for certain covered persons include deferral of payments, risk of downward adjustment and forfeiture, and clawback to appropriately balance risk and reward. The 2011 Proposed Rule required deferral for three years of 50 percent of annual incentive-based compensation for executive officers of covered financial institutions with $50 billion or more in total consolidated assets. The proposed rule would apply deferral requirements to significant risk-takers as well as senior executive officers, and, as described below, would require 40, 50, or 60 percent deferral depending on the size of the covered institution and whether the covered person receiving the incentive-based compensation is a senior executive officer or a significant risk-taker. Unlike the 2011 Proposed Rule, the proposed rule would explicitly require a shorter deferral period for incentive-based compensation awarded under a long-term incentive plan. The proposed rule also provides more detailed requirements and prohibitions than the 2011 Proposed Rule with respect to the measurement, composition, and acceleration of deferred incentive-based compensation; the manner in which deferred incentive-based compensation can vest; increases to the amount of deferred incentive-based compensation; and the amount of deferred incentive-based compensation that can be in the form of options. Deferral. Under the proposed rule, the mandatory deferral requirements for Level 1 and Level 2 covered institutions for incentive-based compensation awarded each performance period would be as follows: • A Level 1 covered institution would be required to defer at least 60 percent of a senior executive officer's “qualifying incentive-based compensation” (as defined in the proposed rule) and 50 percent of a significant risk-taker's qualifying incentive-based compensation for at least four years. A Level 1 covered institution also would be required to defer for at least two years after the end of the related performance period at least 60 percent of a senior executive officer's incentive-based compensation awarded under a “long-term incentive plan” (as defined in the proposed rule) and 50 percent of a significant risk-taker's incentive-based compensation awarded under a long-term incentive plan. Deferred compensation may vest no faster than on a pro rata annual basis, and, for covered institutions that issue equity or are subsidiaries of covered institutions that issue equity, the deferred amount would be required to consist of substantial amounts of both deferred cash and equity-like instruments throughout the deferral period. Additionally, if a senior executive officer or significant risk-taker receives incentive-based compensation in the form of options for a performance period, the amount of such options used to meet the minimum required deferred compensation may not exceed 15 percent of the amount of total incentive-based compensation awarded for that performance period. • A Level 2 covered institution would be required to defer at least 50 percent of a senior executive officer's qualifying incentive-based compensation and 40 percent of a significant risk-taker's qualifying incentive-based compensation for at least three years. A Level 2 covered institution also would be required to defer for at least one year after the end of the related performance period at least 50 percent of a senior executive officer's incentive-based compensation awarded under a long-term incentive plan and 40 percent of a significant risk-taker's incentive-based compensation awarded under a long-term incentive plan. Deferred compensation may vest no faster than on a pro rata annual basis, and, for covered institutions that issue equity or are subsidiaries of covered institutions that issue equity, the deferred amount would be required to consist of substantial amounts of both deferred cash and equity-like instruments throughout the deferral period. Additionally, if a senior executive officer or significant risk-taker receives incentive-based compensation in the form of options for a performance period, the amount of such options used to meet the minimum required deferred compensation may not exceed 15 percent of the amount of total incentive-based compensation awarded for that performance period. The proposed rule would also prohibit Level 1 and Level 2 covered institutions from accelerating the payment of a covered person's deferred incentive-based compensation, except in the case of death or disability of the covered person. Forfeiture and Downward Adjustment. Compared to the 2011 Proposed Rule, the proposed rule provides more detailed requirements for Level 1 and Level 2 covered institutions to reduce (1) incentive-based compensation that has not yet been awarded to a senior executive officer or significant risk-taker, and (2) deferred incentive-based compensation of a senior executive officer or significant risk-taker. Under the proposed rule, “forfeiture” means a reduction of the amount of deferred incentive-based compensation awarded to a person that has not vested. “Downward adjustment” means a reduction of the amount of a covered person's incentive-based compensation not yet awarded for any performance period that has already begun. The proposed rule would require a Level 1 or Level 2 covered institution to make subject to forfeiture all unvested deferred incentive-based compensation of any senior executive officer or significant risk-taker, including unvested deferred amounts awarded under long-term incentive plans. This forfeiture requirement would apply to all unvested, deferred incentive-based compensation for those individuals, regardless of whether the deferral was required by the proposed rule. Similarly, a Level 1 or Level 2 covered institution would also be required to make subject to downward adjustment all incentive-based compensation amounts not yet awarded to any senior executive officer or significant risk-taker for the current performance period, including amounts payable under long-term incentive plans. A Level 1 or Level 2 covered institution would be required to consider forfeiture or downward adjustment of incentive-based compensation if any of the following adverse outcomes occur: • Poor financial performance attributable to a significant deviation from the covered institution's risk parameters set forth in the covered institution's policies and procedures; • Inappropriate risk-taking, regardless of the impact on financial performance; • Material risk management or control failures; • Non-compliance with statutory, regulatory, or supervisory standards resulting in enforcement or legal action brought by a federal or state regulator or agency, or a requirement that the covered institution report a restatement of a financial statement to correct a material error; and • Other aspects of conduct or poor performance as defined by the covered institution. Clawback. In addition to deferral, downward adjustment, and forfeiture, the proposed rule would require a Level 1 or Level 2 covered institution to include clawback provisions in the incentive-based compensation arrangements for senior executive officers and significant risk-takers. The term “clawback” refers to a mechanism by which a covered institution can recover vested incentive-based compensation from a senior executive officer or significant risk-taker if certain events occur. The proposed rule would require clawback provisions that, at a minimum, allow the covered institution to recover incentive-based compensation from a current or former senior executive officer or significant risk-taker for seven years following the date on which such compensation vests, if the covered institution determines that the senior executive officer or significant risk-taker engaged in misconduct that resulted in significant financial or reputational harm to the covered institution, fraud, or intentional misrepresentation of information used to determine the senior executive officer or significant risk-taker's incentive-based compensation. The 2011 Proposed Rule did not include a clawback requirement. Additional Prohibitions. The proposed rule contains a number of additional prohibitions for Level 1 and Level 2 covered institutions that were not included in the 2011 Proposed Rule. These prohibitions would apply to: • Hedging; • Maximum incentive-based compensation opportunity (also referred to as leverage); • Relative performance measures; and • Volume-driven incentive-based compensation. Risk Management and Controls. The proposed rule's risk management and controls requirements for large covered institutions are generally more extensive than the requirements contained in the 2011 Proposed Rule. The proposed rule would require all Level 1 and Level 2 covered institutions to have a risk management framework 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 covered institution's operations. In addition, the proposed rule would require Level 1 and Level 2 covered institutions to: • Provide individuals in control functions with appropriate authority to influence the risk-taking of the business areas they monitor and ensure covered persons engaged in control functions are compensated independently of the performance of the business areas they monitor; and • Provide for independent monitoring of: (1) Incentive-based compensation plans to identify whether the plans appropriately balance risk and reward; (2) events related to forfeiture and downward adjustment and decisions of forfeiture and downward adjustment reviews to determine consistency with the proposed rule; and (3) compliance of the incentive-based compensation program with the covered institution's policies and procedures. Governance. Unlike the 2011 Proposed Rule, the proposed rule would require each Level 1 or Level 2 covered institution to establish a compensation committee composed solely of directors who are not senior executive officers to assist the board of directors in carrying out its responsibilities under the proposed rule. The compensation committee would be required to obtain input from the covered institution's risk and audit committees, or groups performing similar functions, and risk management function on the effectiveness of risk measures and adjustments used to balance incentive-based compensation arrangements. Additionally, management would be required to submit to the compensation committee on an annual or more frequent basis a written assessment of the effectiveness of the covered institution's incentive-based compensation program and related compliance and control processes in providing risk-taking incentives that are consistent with the risk profile of the covered institution. The compensation committee would also be required to obtain an independent written assessment from the internal audit or risk management function of the effectiveness of the covered institution's incentive-based compensation program and related compliance and control processes in providing risk-taking incentives that are consistent with the risk profile of the covered institution. Policies and Procedures. The proposed rule would require all Level 1 and Level 2 covered institutions to have policies and procedures that, among other requirements: • Are consistent with the requirements and prohibitions of the proposed rule; • Specify the substantive and procedural criteria for forfeiture and clawback; • Document final forfeiture, downward adjustment, and clawback decisions; • Specify the substantive and procedural criteria for the acceleration of payments of deferred incentive-based compensation to a covered person; • Identify and describe the role of any employees, committees, or groups authorized to make incentive-based compensation decisions, including when discretion is authorized; • Describe how discretion is exercised to achieve balance; • Require that the covered institution maintain documentation of its processes for the establishment, implementation, modification, and monitoring of incentive-based compensation arrangements; • Describe how incentive-based compensation arrangements will be monitored; • Specify the substantive and procedural requirements of the independent compliance program; and • Ensure appropriate roles for risk management, risk oversight, and other control personnel in the covered institution's processes for designing incentive-based compensation arrangements and determining awards, deferral amounts, deferral periods, forfeiture, downward adjustment, clawback, and vesting and assessing the effectiveness of incentive-based compensation arrangements in restraining inappropriate risk-taking. These policies and procedures requirements for Level 1 and Level 2 covered institutions are generally more detailed than the requirements in the 2011 Proposed Rule. Indirect Actions. The proposed rule would prohibit covered institutions from doing indirectly, or through or by any other person, anything that would be unlawful for the covered institution to do directly under the proposed rule. This prohibition is similar to the evasion provision contained in the 2011 Proposed Rule. Enforcement. For five of the Agencies, the proposed rule would be enforced under section 505 of the Gramm-Leach-Bliley Act, as specified in section 956. For FHFA, the proposed rule would be enforced under subtitle C of the Safety and Soundness Act. Conservatorship or Receivership for Certain Covered Institutions. FHFA's and NCUA's proposed rules contain provisions that would apply to covered institutions that are managed by a government agency or a government-appointed agent, or that are in conservatorship or receivership or are limited-life regulated entities under the Safety and Soundness Act or the Federal Credit Union Act. 46 46 The FDIC's proposed rule would not apply to institutions for which the FDIC is appointed receiver under the FDIA or Title II of the Dodd-Frank Act, as appropriate, as those statutes govern such cases. A detailed description of the proposed rule and requests for comments are set forth below. II. Section-by-Section Description of the Proposed Rule § __.1 Authority, Scope and Initial Applicability Section __.1 provides that the proposed rule is issued pursuant to section 956. The Agencies also have listed applicable additional rulemaking authority in their respective authority citations. The OCC is issuing the proposed rule under its general rulemaking authority, 12 U.S.C. 93a and the Home Owners' Loan Act, 12 U.S.C. 1461 et seq., its safety and soundness authority under 12 U.S.C. 1818, and its authority to regulate compensation under 12 U.S.C. 1831p-1. The Board is issuing the proposed rule under its safety and soundness authority under section 5136 of the Revised Statutes (12 U.S.C. 24), the Federal Reserve Act (12 U.S.C. 321-338a), the FDIA (12 U.S.C. 1818), the Bank Holding Company Act (12 U.S.C. 1844(b)), the Home Owners' Loan Act (12 U.S.C. 1462a and 1467a), and the International Banking Act (12 U.S.C. 3108). The FDIC is issuing the proposed rule under its general rulemaking authority, 12 U.S.C. 1819 Tenth, as well as its general safety and soundness authority under 12 U.S.C. 1818 and authority to regulate compensation under 12 U.S.C. 1831p-1. FHFA is issuing the proposed rule pursuant to its authority under the Safety and Soundness Act (particularly 12 U.S.C. 4511(b), 4513, 4514, 4518, 4526, and ch. 46 subch. III.). NCUA is issuing the proposed rule under its general rulemaking and safety and soundness authorities in the Federal Credit Union Act, 12 U.S.C. 1751 et seq. The SEC is issuing the proposed rule pursuant to its rulemaking authority under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 (15 U.S.C. 78q, 78w, 80b-4, and 80b-11). The approach taken in the proposed rule is within the authority granted by section 956. The proposed rule would prohibit types and features of incentive-based compensation arrangements that encourage inappropriate risks. As explained more fully below, incentive-based compensation arrangements that result in payments that are unreasonable or disproportionate to the value of services performed could encourage inappropriate risks by providing excessive compensation, fees, and benefits. Further, incentive-based compensation arrangements that do not appropriately balance risk and reward, that are not compatible with effective risk management and controls, or that are not supported by effective governance are the types of incentive-based compensation arrangements that could encourage inappropriate risks that could lead to material financial loss to covered institutions. Because these types of incentive-based compensation arrangements encourage inappropriate risks, they would be prohibited under the proposed rule. The Federal Banking Agencies have found that any incentive-based compensation arrangement at a covered institution will encourage inappropriate risks if it does not sufficiently expose the risk-takers to the consequences of their risk decisions over time, and that in order to do this, it is necessary that meaningful portions of incentive-based compensation be deferred and placed at risk of reduction or recovery. The proposed rule reflects the minimums that are required to be effective for that purpose, as well as minimum standards of robust governance, and the disclosures that the statute requires. The Agencies' position in this respect is informed by the country's experience in the recent financial crisis, as well as by their experience supervising their respective institutions and their observation of the experience and judgments of regulators in other countries. Consistent with section 956, section __.1 provides that the proposed rule would apply to a covered institution with average total consolidated assets greater than or equal to $1 billion that offers incentive-based compensation arrangements to covered persons. The Agencies propose the compliance date of the proposed rule to be the beginning of the first calendar quarter that begins at least 540 days after the final rule is published in the Federal Register . Any incentive-based compensation plan with a performance period that begins before such date would not be required to comply with the requirements of the proposed rule. Whether a covered institution is a Level 1, Level 2, or Level 3 covered institution 47 on the compliance date would be determined based on average total consolidated assets as of the beginning of the first calendar quarter that begins after a final rule is published in the Federal Register . For example, if the final rule is published in the Federal Register on November 1, 2016, then the compliance date would be July 1, 2018. In that case, any incentive-based compensation plan with a performance period that began before July 1, 2018 would not be required to comply with the rule. Whether a covered institution is a Level 1, Level 2, or Level 3 covered institution on July 1, 2018 would be determined based on average total consolidated assets as of the beginning of the first quarter of 2017. 47 As discussed below, the proposed rule includes baseline requirements for all covered institutions and additional requirements for Level 1 and Level 2 covered institutions, which are larger covered institutions. The Agencies recognize that most incentive-based compensation plans are implemented at the beginning of the fiscal or calendar year. Depending on the date of publication of a final rule, the proposed compliance date would provide at least 18 months, and in most cases more than two years, for covered institutions to develop and approve new incentive-based compensation plans and 18 months for covered institutions to develop and implement the supporting policies, procedures, risk management framework, and governance that would be required under the proposed rule. 1.1. The Agencies invite comment on whether this timing would be sufficient to allow covered institutions to implement any changes necessary for compliance with the proposed rule, particularly the development and implementation of policies and procedures. Is the length of time too long or too short and why? What specific changes would be required to bring existing policies and procedures into compliance with the rule? What constraints exist on the ability of covered institutions to meet the proposed deadline? 1.2. The Agencies invite comment on whether the compliance date should instead be the beginning of the first performance period that starts at least 365 days after the final rule is published in the Federal Register in order to have the proposed rule's policies, procedures, risk management, and governance requirements begin when the requirements applicable to incentive-compensation plans and arrangements begin. Why or why not? Section __.1 also specifies that the proposed rule is not intended to limit the authority of any Agency under other provisions of applicable law and regulations. For example, the proposed rule would not affect the Federal Banking Agencies' authority under section 39 of the FDIA and the Federal Banking Agency Safety and Soundness Guidelines. The Board's Enhanced Prudential Standards under 12 CFR part 252 (Regulation YY) would not be affected. The OCC's Heightened Standards also would continue to be in effect. The NCUA's authority under 12 U.S.C. 1761a, 12 CFR 701.2, part 701 App. A, Art. VII. section 8, 701.21(c)(8)(i), 701.23(g) (1), 701.33, 702.203, 702.204, 703.17, 704.19, 704.20, part 708a, 712.8, 721.7, and part 750, and the NCUA Examiners Guide, Chapter 7, 48 would not be affected. Neither would the proposed rule affect the applicability of FHFA's executive compensation rule, under section 1318 of the Safety and Soundness Act (12 U.S.C. 4518), 12 CFR part 1230. 48 The NCUA Examiners Guide, Chapter 7, available at https://www.ncua.gov/Legal/GuidesEtc/ExaminerGuide/Chapter07.pdf . The Agencies acknowledge that some individuals who would be considered covered persons, senior executive officers, or significant risk-takers under the proposed rule are subject to other Federal compensation-related requirements. Further, some covered institutions may be subject to SEC rules regarding the disclosure of executive compensation, 49 and mortgage loan originators are subject to the Consumer Financial Protection Bureau's restrictions on compensation. This rule is not intended to affect the application of these other Federal compensation-related requirements. 49 See Item 402 of Regulation S-K. 17 CFR 229.402. § __.2 Definitions Section __.2 defines the various terms used in the proposed rule. Where the proposed rule uses a term defined in section 956, the proposed rule generally adopts the definition included in section 956. 50 50 The definitions in the proposed rule would be for purposes of administering section 956 and would not affect the interpretation or construction of the same or similar terms for purposes of any other statute or regulation administered by the Agencies. Definitions Pertaining to Covered Institutions Section 956(e)(2) of the Dodd-Frank Act defines the term “covered financial institution” to mean a depository institution; a depository institution holding company; a registered broker-dealer; a credit union; an investment adviser; the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (together, the “Enterprises”); and any other financial institution that the Agencies determine, jointly, by rule, should be treated as a covered financial institution for purposes of section 956. Section 956(f) provides that the requirements of section 956 do not apply to covered financial institutions with assets of less than $1 billion. The Agencies propose to jointly, by rule, designate additional financial institutions as covered institutions. The Agencies propose to include the Federal Home Loan Banks as covered institutions because they pose risks similar to those of some institutions covered under the proposed rule and should be subject to the same regulatory regime. The Agencies also propose to include as covered institutions the state-licensed uninsured branches and agencies of a foreign bank, organizations operating under section 25 or 25A of the Federal Reserve Act ( i.e., Edge and Agreement Corporations), as well as the other U.S. operations of foreign banking organizations that are treated as bank holding companies pursuant to section 8(a) of the International Banking Act of 1978 (12 U.S.C. 3106). Applying the same requirements to these institutions would be consistent with other regulatory requirements that are applicable to foreign banking organizations operating in the United States and would not distort competition for human resources between U.S. banking organizations and foreign banking organizations operating in the United States. These offices and operations currently are referenced in the Federal Banking Agency Guidance and are subject to section 8 of the FDIA (12 U.S.C. 1818), which prohibits institutions from engaging in unsafe or unsound practices to the same extent as insured depository institutions and bank holding companies. 51 51 See 12 U.S.C. 1813(c)(3) and 1818(b)(4). In addition, the Agencies propose to jointly, by rule, designate state-chartered non-depository trust companies that are members of the Federal Reserve System as covered institutions. The definition of “covered financial institution” under section 956 of the Dodd-Frank Act includes a depository institution as such term is defined in section 3 of the FDIA (12 U.S.C. 1813); that term includes all national banks and any state banks, including trust companies, that are engaged in the business of receiving deposits other than trust funds. As a consequence of these definitions, all national banks, including national banks that are non-depository trust companies, are “depository institutions” within the meaning of section 956, but non-FDIC insured state non-depository trust companies that are members of the Federal Reserve System are not. In order to achieve equal treatment across similar entities with different charters, the Agencies propose to include state-chartered non-depository member trust companies as covered institutions. These institutions would be “regulated institutions” under the definition of “state member bank” in the Board's rule. Each Agency's proposed rule contains a definition of the term “covered institution” that describes the covered financial institutions the Agency regulates. The Agencies have tailored the requirements of the proposed rule to the size and complexity of covered institutions, and are proposing to designate covered institutions as Level 1, Level 2, or Level 3 covered institutions to effectuate this tailoring. The Agencies have observed through their supervisory experience that large financial institutions typically have complex business activities in multiple lines of business, distinct subsidiaries, and regulatory jurisdictions, and frequently operate and manage their businesses in ways that cross those lines of business, subsidiaries, and jurisdictions. Level 3 covered institutions would generally be subject to only the basic set of prohibitions and disclosure requirements. The proposed rule would apply additional prohibitions and requirements to incentive-based compensation arrangements at Level 1 and Level 2 covered institutions, as discussed below. Whether a covered institution that is a subsidiary of a depository institution holding company is a Level 1, Level 2, or Level 3 covered institution would be based on the average total consolidated assets of the top-tier depository institution holding company. Whether that subsidiary has at least $1 billion will be based on the subsidiary's average total consolidated assets. The Agency definitions of covered institution, Level 1, Level 2, and Level 3 covered institution, and related terms are summarized below. Covered Institution and Regulated Institution. Each Agency has set forth text for its Agency-specific definition of the term “covered institution” that specifies the entities to which that Agency's rule applies. 52 Under the proposed rule, a “covered institution” would include all of the following: 52 The Agency-specific definitions are intended to be applied only for purposes of administering a final rule under section 956. • In the case of the OCC: ○ A national bank, Federal savings association, or Federal branch or agency of a foreign bank 53 with average total consolidated assets greater than or equal to $1 billion; and 53 The term “Federal branch or agency of a foreign bank” refers to both insured and uninsured Federal branches and agencies of foreign banks. ○ A subsidiary of a national bank, Federal savings association, or Federal branch or agency of a foreign bank, if the subsidiary (A) is not a broker, dealer, person providing insurance, investment company, or investment adviser; and (B) has average total consolidated assets greater than or equal to $1 billion. • In the case of the Board, the proposed definition of the term “covered institution” is a “regulated institution” with average total consolidated assets greater than or equal to $1 billion, and the Board's definition of the term “regulated institution” includes: ○ A state member bank, as defined in 12 CFR 208.2(g); ○ A bank holding company, as defined in 12 CFR 225.2(c), that is not a foreign banking organization, as defined in 12 CFR 211.21(o), and a subsidiary of such a bank holding company that is not a depository institution, broker-dealer or investment adviser; ○ A savings and loan holding company, as defined in 12 CFR 238.2(m), and a subsidiary of a savings and loan holding company that is not a depository institution, broker-dealer or investment adviser; ○ An organization operating under section 25 or 25A of the Federal Reserve Act (Edge and Agreement Corporation); ○ A state-licensed uninsured branch or agency of a foreign bank, as defined in section 3 of the FDIA (12 U.S.C. 1813); and ○ The U.S. operations of a foreign banking organization, as defined in 12 CFR 211.21(o), and a U.S. subsidiary of such foreign banking organization that is not a depository institution, broker-dealer, or investment adviser. • In the case of the FDIC, “covered institution” means a: ○ State nonmember bank, state savings association, and a state insured branch of a foreign bank, as such terms are defined in section 3 of the FDIA, 12 U.S.C. 1813, with average total consolidated assets greater than or equal to $1 billion; and ○ A subsidiary of a state nonmember bank, state savings association, or a state insured branch of a foreign bank, as such terms are defined in section 3 of the FDIA, 12 U.S.C. 1813, that: (i) Is not a broker, dealer, person providing insurance, investment company, or investment adviser; and (ii) Has average total consolidated assets greater than or equal to $1 billion. • In the case of the NCUA, a credit union, as described in section 19(b)(1)(A)(iv) of the Federal Reserve Act, meaning an insured credit union as defined under 12 U.S.C. 1752(7) or credit union eligible to make application to become an insured credit union under 12 U.S.C. 1781. Instead of the term “covered financial institution,” the NCUA uses the term “credit union” throughout its proposed rule, as credit unions are the only type of covered institution NCUA regulates. The scope section of the rule defines the credit unions that will be subject to this rule—that is, credit unions with $1 billion or more in total consolidated assets. • In the case of the SEC, a broker or dealer registered under section 15 of the Securities Exchange Act of 1934, 15 U.S.C. 78o; and an investment adviser, as such term is defined in section 202(a)(11) of the Investment Advisers Act of 1940, 15 U.S.C. 80b-2(a)(11). 54 The proposed rule would not apply to persons excluded from the definition of investment adviser contained in section 202(a)(11) of the Investment Advisers Act nor would it apply to such other persons not within the intent of section 202(a)(11) of the Investment Advisers Act, as the SEC may designate by rules and regulations or order. Section 956 does not contain exceptions or exemptions for investment advisers based on registration. 55 54 By its terms, the definition of “covered financial institution” in section 956 includes any institution that meets the definition of “investment adviser” under the Investment Advisers Act of 1940 (“Investment Advisers Act”), regardless of whether the institution is registered as an investment adviser under that Act. Banks and bank holding companies are generally excluded from the definition of “investment adviser” under section 202(a)(11) of the Investment Advisers Act, although they would still be “covered institutions” under the relevant Agency's proposed rule. 55 Commenters to the 2011 Proposed Rule requested clarification with respect to those entities that are excluded from the definition of “investment adviser” under the Investment Advisers Act and those that are exempt from registration as an investment adviser under the Investment Advisers Act. Section 956 expressly includes any institution that meets the definition of investment adviser regardless of whether the institution is registered under the Investment Advisers Act. See supra note 54. Thus, the proposed rule would apply to institutions that meet the definition of investment adviser under section 202(a)(11) of the Investment Advisers Act and would not exempt any such institutions that may be prohibited or exempted from registering with the SEC under the Investment Advisers Act. • In the case of FHFA, the proposed definition of the term “covered institution” is a “regulated institution” with average total consolidated assets greater than or equal to $1 billion, and FHFA's definition of the term “regulated institution” means an Enterprise, as defined in 12 U.S.C. 4502(10), and a Federal Home Loan Bank. Level 1, Level 2, and Level 3 covered institutions. The Agencies have tailored the requirements of the proposed rule to the size and complexity of covered institutions. All covered institutions would be subject to a basic set of prohibitions and disclosure requirements, as described in section__.4 of the proposed rule. The Agencies are proposing to group covered institutions into three levels. The first level, Level 1 covered institutions, would generally be covered institutions with average total consolidated assets of greater than $250 billion and subsidiaries of such institutions that are covered institutions. The next level, Level 2 covered institutions, would generally be covered institutions with average total consolidated assets between $50 billion and $250 billion and subsidiaries of such institutions that are covered institutions. The smallest covered institutions, those with average total consolidated assets between $1 and $50 billion, would be Level 3 covered institutions and generally would be subject to only the basic set of prohibitions and requirements. 56 56 As discussed later in this Supplemental Information section, under section __.6 of the proposed rule, an Agency would be able to require a covered institution with average total consolidated assets greater than or equal to $10 billion and less than $50 billion to comply with some or all of the provisions of section __.5 and sections __.7 through__.11, if the Agency determines that the activities, complexity of operations, risk profile, or compensation practices of the covered institution are consistent with those of a Level 1 or Level 2 covered institution. The proposed rule would apply additional prohibitions and requirements to incentive-based compensation arrangements at Level 1 and Level 2 covered institutions, as described in section __.5 and sections__.7 through __.11 of the proposed rule and further discussed below. The specific requirements of the proposed rule that would apply to Level 1 and Level 2 covered institutions are the same, with the exception of the deferral amounts and deferral periods described in section __.7(a)(1) and section__.7(a)(2). Consolidation Generally, the Agencies also propose that covered institutions that are subsidiaries of other covered institutions would be subject to the same requirements, and defined to be the same level, as the parent covered institution, 57 even if the subsidiary covered institution is smaller than the parent covered institution. 58 This approach of assessing risks at the level of the holding company for a consolidated organization recognizes that financial stress or the improper management of risk in one part of an organization has the potential to spread rapidly to other parts of the organization. Large depository institution holding companies increasingly operate and manage their businesses in such a way that risks affect different subsidiaries within the consolidated organization and are managed on a consolidated basis. For example, decisions about business lines including management and resource allocation may be made by executives and employees in different subsidiaries. Integrating products and operations may offer significant efficiencies but can also result in financial stress or the improper management of risk in one part of a consolidated organization and has the potential to spread risk rapidly to other parts of the consolidated organization. Even when risk is assessed at the level of the holding company, risk will also be assessed at individual institutions within that consolidated organization. For example, a bank subsidiary of a large, complex bank holding company might have a different risk profile than the bank holding company. In that situation, a risk assessment would have different results when conducted at the level of the bank and at the level of the bank holding company. 57 Commenters on the 2011 Proposed Rule questioned how the requirements would apply in the context of consolidated organizations where a parent holding company structure may include one or more subsidiary banks, broker-dealers, or investment advisers each with total consolidated assets either above or below, or somewhere in between, the relevant thresholds. They also expressed concern that the 2011 Proposed Rule could lead to “regulatory overlap” where the parent holding company and individual subsidiaries are regulated by different agencies. 58 For the U.S. operations of a foreign banking organization, level would be determined by the total consolidated U.S. assets of the foreign banking organization, including the assets of any U.S. branches or agencies of the foreign banking organization, any U.S. subsidiaries of the foreign banking organization, and any U.S. operations held pursuant to section 2(h)(2) of the Bank Holding Company Act. In contrast, the level of an OCC-regulated Federal branch or agency of a foreign bank would be determined with reference to the assets of the Federal branch or agency. This treatment is consistent with the determination of the level of a national bank or Federal savings association that is not a subsidiary of a holding company and the OCC's approach to regulation of Federal branches and agencies. Moreover, in the experience of the Federal Banking Agencies, incentive-based compensation programs generally are designed at the holding company level and are applied throughout the consolidated organization. Many holding companies establish incentive-based compensation programs in this manner because it can help maintain effective risk management and controls for the entire consolidated organization. More broadly, the expectations and incentives established by the highest levels of corporate leadership set the tone for the entire organization and are important factors of whether an organization is capable of maintaining fully effective risk management and internal control processes. The Board has observed that some large, complex depository institution holding companies have evolved toward comprehensive, consolidated risk management to measure and assess the range of their exposures and the way these exposures interrelate, including in the context of incentive-based compensation programs. In supervising the activities of depository institution holding companies, the Board has adopted and continues to follow the principle that depository institution holding companies should serve as a source of financial and managerial strength for their subsidiary depository institutions. 59 59 See 12 U.S.C. 1831o-1; 12 CFR 225.4(a)(1). The proposed rule is designed to reinforce the ability of institutions to establish and maintain effective risk management and controls for the entire consolidated organization with respect to the organization's incentive-based compensation program. Moreov [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2016-11788. Public record. Not legal advice.