Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires that six agencies — the Federal Reserve System (FRS), Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Federal Housing Finance Agency (FHFA), the National Credit Union Administration (NCUA) and the Securities and Exchange Commission (SEC) — jointly prescribe regulations or guidelines prohibiting incentive-based payment arrangements that:

• Encourage inappropriate risks by a covered financial institution by providing excessive compensation, fees or benefits; or
• Could lead to a material financial loss to the institution.

In addition, all incentive-based compensation arrangements sponsored by covered financial institutions must (1) appropriately balance risk and reward, (2) work in the context of risk management and control procedures, and (3) be supported by effective governance.

The rule-making process has seen a number of starts and stops, with the agencies initially issuing principles-based interagency guidance in 2010, which was followed with proposed regulations in 2011, only to repropose a new set of highly prescriptive regulations in 2016. In 2019, the agencies announced they would repropose another set of regulations based on the 2010 guidance while considering comments to the 2011 and 2016 proposals, but never released anything. 

On May 6, four of the six agencies — FDIC, OCC, FHFA and NCUA — issued a notice of proposed rulemaking that largely mirrors the 2016 proposed regulations, but includes additional questions and alternative regulations and have requested comments. Importantly, neither the FRS nor the SEC have adopted this most recent proposal.

Click here for our white paper on the 2016 proposed regulations. Below is an overview of the material new questions and alternative provisions, which risk making the 2016 proposed regulations even more prescriptive and onerous.

New Questions

• Covered Institutions & Consolidation: Should other financial institutions be covered by the rules? Do the consolidation provisions prevent evasion of the rules/capture asset thresholds for Level 1 and Level 2 purposes?
• Covered Persons: Are there adjustments needed to the “senior executive officer” and “significant risk-taker” definitions?
• Deferral, Forfeiture, Downward Adjustment & Clawback: The applicable agencies invite feedback on all aspects of these requirements, including minimum periods/percentages, level playing fields, tax/accounting, use of debt-like instruments and triggering events.

Alternative Provisions

• Utilize a Two-Level Structure: The applicable agencies are considering replacing the three-tier regulatory structure with a two-tiered regime with a $50 billion threshold and uniform deferral percentages and periods.
• Significant Risk-Taker Test: Are there ways to streamline the definition and provide covered institutions flexibility to designate SRTs?
• New Restrictions/Mandates: The agencies are contemplating requirements to set performance goals prior to the start of a performance period, limits on use of stock options, nondiscretionary forfeiture, downward adjustment and clawback, contractual bans on personal hedging, and outright prohibitions on volume-driven awards.
• Risk Management Control Requirements: Assessment from independent risk and control functions required when setting incentive-based compensation for senior executive officers and significant risk-takers.

The four agencies have invited comments on all of these items as well as any matters covered by the 2016 proposed regulations. Since not all six agencies have reproposed the regulations, this new guidance cannot be published in the Federal Register, which means the comment period will remain open until formally published by all six agencies.

Moreover, the four agencies have explicitly acknowledged that Dodd-Frank section 956 requires all six agencies to act jointly. Thus, this latest guidance cannot become effective without buy-in from the SEC and the FRS. The SEC has indicated it is performing a cost/benefit analysis and the FRS has stated it wants to better understand the potential problem before moving to issue new regulations.