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SEC Proposes Rules on Disclosure of Incentive-Based Compensation Arrangements at Financial Institutions


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Chairman's statement

Washington, D.C., March 2, 2011 – The Securities and Exchange Commission today proposed a rule that would require certain financial institutions to disclose the structure of their incentive-based compensation practices, and prohibit such institutions from maintaining compensation arrangements that encourage inappropriate risks.

The proposed rule stems from Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires the SEC and several other agencies to jointly write rules and guidelines in this regard. The SEC-regulated financial institutions affected by the rulemaking include broker-dealers and investment advisers with $1 billion or more in assets.

“Our staff has worked closely with other federal regulators and the proposal reflects a series of carefully considered compromises,” said SEC Chairman Mary L. Schapiro. “As with any such undertaking, there’s a challenge in finding common means to appropriately address Congress’s mandate, so we look forward to hearing public comment on the proposed rules.”

The SEC’s proposed rules for certain financial institutions would:

  • Require reports related to incentive-based compensation that they would file annually with SEC.
  • Prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material financial loss to the firm.
  • Provide additional requirements for financial institutions with $50 billion or more in assets, including deferral of incentive-based compensation of executive officers and approval of compensation for people whose job functions give them the ability to expose the firm to a substantial amount of risk.
  • Require them to develop policies and procedures that ensure and monitor compliance with requirements related to incentive-based compensation.

Public comments on the rule proposal should be received within 45 days after it is published in the Federal Register.

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Fact Sheet

Incentive-Based Compensation Arrangements


In 2010, the Dodd-Frank Act mandated that financial regulators jointly develop rules or guidelines governing incentive-based compensation practices at certain financial institutions with total assets of $1 billion or more.

In particular, the Act requires the SEC, the Federal Reserve, OCC, FDIC, OTS, FHFA, and the NCUA, to jointly write rules or guidelines that:

  • Require these “covered financial institutions” to disclose to their appropriate federal regulator the structure of their incentive-based compensation arrangements so the regulator can determine whether such compensation is excessive or could lead to material financial loss to the firm.
  • Prohibit any type of incentive-based compensation that the regulators determine encourages inappropriate risks by providing excessive compensation or that could lead to material financial loss to the covered firm.

The proposed rule, which is substantially similar from agency to agency, contains technical differences to account for the different entities that the various agencies regulate. Each agency must individually review and approve the proposed rule for public comment before jointly publishing the proposal in the Federal Register.

The Proposal

The proposed rule, which would apply to brokers, dealers or investment advisers with assets of at least $1 billion, contains three elements:

1) Disclosures About Incentive-Based Compensation Arrangements

Under the proposed rules, a covered financial institution would be required to file annually with its appropriate federal regulator a report describing the firm’s incentive-based compensation arrangements. The information submitted would include but not be limited to:

  • A narrative description of the components of the firm’s incentive-based compensation arrangements.
  • A succinct description of the firm’s policies and procedures governing its incentive-based compensation arrangements.
  • A statement of the specific reasons as to why the firm believes the structure of its incentive-based compensation arrangement will help prevent it from suffering a material financial loss or does not provide covered persons with excessive compensation.

2) Prohibition on Encouraging Inappropriate Risk

General prohibitions

The proposed rule applies to executive officers, employees, directors, or principal shareholders – “covered persons” – at a covered financial institution.

Under the proposed rule, a covered financial institution would be prohibited from establishing or maintaining an incentive-based compensation arrangement that encourages inappropriate risks by providing covered persons with excessive compensation, or that could lead to material financial loss.

The proposal states that incentive-based compensation arrangements would be deemed to encourage inappropriate risks unless the incentive-based compensation arrangements meet certain standards, which are drawn from standards established in prior legislation and from guidance published by bank regulators last July.

Prohibitions for larger financial institutions

The proposed rule lays out more specific requirements for executive officers and certain other designated individuals at financial institutions with $50 billion or more in total consolidated assets. For executive officers at these larger firms, the proposed rule would require the firms to defer for three years at least 50 percent of any incentive-based compensation for executive officers – and award such compensation no faster than on a pro rata basis. Any incentive-based compensation payments must be adjusted for losses incurred by the covered financial institution after the compensation was initially awarded.

The proposed rule recognizes that some employees of a firm other than the executive officers may have the ability to impact the risk profile of the covered financial institution. Accordingly, at larger covered financial institutions, the proposed rule would set forth additional requirements for employees exposing such institution to risk of significant loss.

Under the proposed rule, the board of directors or a committee of the board would be charged with identifying the covered persons, other than executive officers, that individually have the ability to expose the firm to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance. This could include, for example, a trader with large position limits relative to the institution’s overall risk tolerance. Once the board identifies such covered persons, the board or a committee would need to approve the incentive-based compensation arrangement for each such person.

3) Establishing Policies and Procedures

Under the proposed rule, a covered financial institution would be barred from establishing an incentive-based compensation arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.

The proposed rule recognizes the diversity of institutions covered by the rule and explicitly states that the policies and procedures should be commensurate with the size and complexity of the organization, as well as the scope and nature of its use of incentive-based compensation.

What’s Next

When all of the federal agencies involved in this statutory rulemaking approve their proposed incentive-based compensation rule for public comment, the rule will be published in the Federal Register. Once published, the public will be given 45 days to comment on the joint proposal.



Modified: 03/02/2011