Incentive-Based Compensation Arrangements

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Vol. 81

Friday,

No. 112

June 10, 2016

Part II

Department of the Treasury

Office of the Comptroller of the Currency

12 CFR Part 42

Federal Reserve System

12 CFR Part 236

Federal Deposit Insurance Corporation

12 CFR Part 372

National Credit Union Administration

12 CFR Parts 741 and 751

Federal Housing Finance Agency

12 CFR Part 1232

Securities and Exchange Commission

17 CFR Parts 240, 275, and 303

Incentive-Based Compensation Arrangements; Proposed Rule

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Federal Register / Vol. 81, No. 112 / Friday, June 10, 2016 / Proposed Rules

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

nsation

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

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.govhome 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

ngton, 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

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.

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• 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

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

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

e 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

thod:

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,

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

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)

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1 Public Law 111–203, 124 Stat. 1376 (2010).

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

02)

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

§ ll.1

Authority, Scope and Initial

Applicability

§ ll.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

§ ll.3

Applicability

(a) When Average Total Consolidated

Assets Increase

(b) When Total Consolidated Assets

Decrease

itutions

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

§ ll.3

Applicability

(a) When Average Total Consolidated

Assets Increase

(b) When Total Consolidated Assets

Decrease

That Are Subsidiaries of Covered

Institutions

§ ll.4

Requirements and Prohibitions

Applicable to All Covered Institutions

(a) In General

(b) Excessive Compensation

(d) Performance Measures

(e) Board of Directors

(f) Disclosure and Recordkeeping

Requirements and (g) Rule of

Construction

§ ll.5

Additional Disclosure and

Recordkeeping Requirements for Level 1

and Level 2 Covered Institutions

§ ll.6

Reservation of Authority for

Level 3 Covered Institutions

§ ll.7

Deferral, Forfeiture and

Downward Adjustment, and Clawback

Requirements for Level 1 and Level 2

Covered Institutions

§ ll.7(a) Deferral

§ ll.7(a)(1) and § ll.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

§ ll.7(a)(3) Adjustments of Deferred

Qualifying Incentive-Based

Compensation and Deferred Long-Term

Incentive Plan Compensation Amounts

§ ll.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

§ ll.7(b) Forfeiture and Downward

Adjustment

§ ll.7(b)(1) Compensation at Risk

§ ll.7(b)(2) Events Triggering Forfeiture

and Downward Adjustment Review

§ ll.7(b)(3) Senior Executive Officers and

Significant Risk-Takers Affected

tive-Based

Compensation and Deferred Long-Term

Incentive Plan Compensation for Level 1

and Level 2 Covered Institutions

Cash and Equity-Like Instruments

Options

§ ll.7(b) Forfeiture and Downward

Adjustment

§ ll.7(b)(1) Compensation at Risk

§ ll.7(b)(2) Events Triggering Forfeiture

and Downward Adjustment Review

§ ll.7(b)(3) Senior Executive Officers and

Significant Risk-Takers Affected by

Forfeiture and Downward Adjustment

§ ll.7(b)(4) Determining Forfeiture and

Downward Adjustment Amounts

§ ll.7(c) Clawback

§ ll.8

Additional Prohibitions for Level

1 and Level 2 Covered Institutions

§ ll.8(a) Hedging

§ ll.8(b) Maximum Incentive-Based

Compensation Opportunity

§ ll.8(c) Relative Performance Measures

§ ll.8(d) Volume-Driven Incentive-Based

Compensation

§ ll.9

Risk Management and Controls

Requirements for Level 1 and Level 2

Covered Institutions

§ ll.10

Governance Requirements for

Level 1 and Level 2 Covered Institutions

§ ll.11

Policies and Procedures

Requirements for Level 1 and Level 2

Covered Institutions

§ ll.12

Indirect Actions

§ ll.13

Enforcement

§ ll.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

1, 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

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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.

4 12 U.S.C. 1831p–1

m ‘‘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.

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).

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

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.

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

NMA Circular on

Remuneration Schemes (October 2009) (‘‘FINMA

Remuneration Circular’’), available at https://

www.finma.ch/en/documentation/circulars/

#Order=2.

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.

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).

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

ose 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.

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

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.

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.

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

ule 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.

For ease of reference, the proposed

rules of the Agencies are referenced in

this SUPPLEMENTARY INFORMATION section

using a common designation of section

ll.1 to section ll.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

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

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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

sion,

‘‘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%20

Registration%20Document.pdf, Pages, 52, 159–160;

http://www.societegenerale.com/sites/default/files/

12%20May%202008%20The%20report%20by

%20the%20General%20Inspection%20of%20

Societe%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

r 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.

15 Staff of S. Permanent Subcomm. on

Investigations, Wall Street and the Financial Crisis:

Anatomy of a Financial Collapse at 143 (Comm.

Print 2011).

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=080418Shareholder

Report.pdf

n_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=080418Shareholder

Report.pdf.

18 As discussed below, the proposed rule uses the

term ‘‘covered institution’’ rather than the statutory

term ‘‘covered financial institution.’’

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

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

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

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

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

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

ale 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

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.

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

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nd 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

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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.

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

s plc, Royal Bank of

Canada, The Royal Bank of Scotland Group plc,

Societe Generale, and UBS AG.

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.

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.

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

nstitution—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

oader

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.

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

Banking Agencies in this area is also

relevant to the incentive-based

compensation practices at broker-

dealers and investment advisers.

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

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.

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

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

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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

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37676

Federal Register / Vol. 81, No. 112 / Friday, June 10, 2016 / Proposed Rules

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.

23 12 CFR part 30, appendix D.

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.

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.

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

t 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.

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.

management influencing improper

incentives.22

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.

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

compliance with the OCC’s

Heightened Standards.

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

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

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

te payments in

the case of a regulated entity’s

insolvency, conservatorship, or troubled

condition.29

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

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

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

icies 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

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37677

Federal Register / Vol. 81, No. 112 / Friday, June 10, 2016 / Proposed Rules

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.

Guidance and the work of FHFA have

resulted in improved incentive-based

compensation practices, there are even

greater benefits possible under rule-

based supervision

llion 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.

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

rangements 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