The Advisors' Blog

– Kyoko Takahashi Lin, Davis Polk & Wardwell LLP

On Tuesday, after a sharply divided vote of 3-2, the FDIC Board voted to request public comment on whether compensation policies should be incorporated as a factor in the risk-based insurance premiums charged to insured depository institutions. The premise is that compensation systems that encourage excessively risky behavior pose a risk to the depository institution and its stakeholders, including the Deposit Insurance Fund, and the FDIC’s goal is to provide incentives for depository institutions to align employee and other stakeholders’ interests.

The FDIC joins a crowded field of regulators in this area. For example, the Federal Reserve announced in October 2009 a new regulatory framework intended to address risky incentive compensation practices at financial institutions. Additionally, just last month, the SEC finalized its rule to require all public companies to disclose more information about how they compensate their employees, including disclosure on how risks arising from a company’s compensation arrangements are reasonably likely to have a material adverse effect on the company.

The two FDIC Board members that opposed the proposal were the Comptroller of the Currency John Dugan and OTS acting director John Bowman. They voted against the proposal stating, among other things, that the FDIC is acting prematurely because other regulatory or legislative bodies, including the Federal Reserve and Congress, were looking to address banker compensation using different standards. The FDIC indicated that its proposal would not be inconsistent with other proposals being considered because it is meant to incentivize good behavior, such as good risk management practices, and not set limits on compensation.

While there is nothing in the rulemaking process that establishes a specific timeline for the final rule, there is speculation in the press that it will take the FDIC until the end of this year to put the final rule in place. Ultimately the timing will be up to the FDIC; however, issuing an advance notice of proposed rulemaking is an uncommon preliminary step available to the regulators which usually reflects an agency’s view that more information is necessary in order to issue a proposed rule. This indicates that the FDIC is not ready to issue a rule on this matter anytime soon.

As an example of how the criteria would be used in practice, the FDIC suggested that if a depository institution could attest that its compensation program contained the features below, it would pay a lower risk based assessment rate than a firm that could not make such an attestation. The compensation program features being considered are the following:

– A significant portion of compensation for employees, including senior managers, whose business activities present significant risk to the institution and who also receive a portion of their compensation based on performance goals, should be comprised of restricted, non-discounted company stock.

– Restricted, non-discounted company stock that becomes available to the employee at intervals over a period of years should be subject to a look-back mechanism (e.g., clawback). Additionally, the stock would initially be awarded at the closing price in effect on the day of the award.

– The compensation program should be administered by a committee of the Board composed of independent directors with input from independent compensation professionals.

Request for Comments

The FDIC has requested comment on all aspects of the proposal, including comments on the FDIC’s stated goals and the features of compensation programs that could meet such goals. For example, the FDIC invites comment on:

– Whether the size or types of activities of a depository institution should be taken into account in applying the criteria or whether compensation should be used as a criteria to decrease or increase deposit insurance fees across all types of institutions;

– How large of an adjustment to the initial risk-based assessment rate would be required to influence the practices of a depository institution;

Whether compensation systems of holding companies or affiliates should be considered as well; and

– Any other alternatives that would be effective in aligning the interests of employees with the firm’s stakeholders.

The release is subject to a 30-day comment period beginning upon its publication in the Federal Register. There are alternatives for the submission of comments in this advance notice of proposed rulemaking.