The Dodd-Frank Act (the ‘Act’), which was signed into law on July 21, 2010, covered a wide range of topics relating to the financial meltdown of 2008. The topic of incentive compensation at financial institutions received a lot of attention in the Act, with the underlying concept that incentive compensation programs should not encourage employees to actions that would put the financial institution at risk. Rules were proposed on April 14, 2011 that implemented the Act’s provisions. These rules are now being applied and are having a tremendous impact on the design and administration of incentive compensation programs.
All banks should be dealing with this issue
Although the Act’s provisions apply to institutions with over $1 billion of assets, smaller institutions should also be concerned with these guidelines.
- Banking regulators are actively seeking information, as part of the examination process, on this topic from institutions with assets of less than $1 billion; it is clearly on the regulatory agenda for all institutions.
- Community banks that cross the $1 billion threshold through growth or consolidation will need to comply with these provisions.
- Monitoring incentive compensation for risk is good business practice. The argument that incentive compensation program oversight is unnecessary until an asset threshold is surpassed does not make sense. An institution that has made a decision to pay no incentive compensation will have a difficult time attracting and retaining talent in a market where incentive compensation programs are typical.
- Incentive compensation is more than a commission for closing a loan or opening a new account—it impacts executives who receive a bonus based on the institution’s overall performance.
A plan of action
All compensation programs that do not involve base salary should be reviewed, in light of Sound Incentive Compensation Policies (SICP), which are contained in regulations that were finalized in June 2010. SICP applies to all financial institutions, regardless of size, and forces them to review incentive compensation arrangements, in light of the following:
- Every incentive compensation program has to balance risk and financial rewards, by using some mechanism that makes sure that payments are not being made until it is clear that the ‘risk’ has passed.
- Incentive programs need to be tailored to each participant, to reflect that person’s activities and the impact of that person on the organization. The institution should be aware of other compensation program restrictions that exist in the industry, such as those involving mortgage originations.
- These programs must be compatible with effective controls and risk management. Appropriate policies and procedures to promote compliance and accountability are needed. Risk management personnel, who do not report to the employees who benefit under the program, should be involved in the program’s design and administration.
A second step would be to make sure that this process has strong corporate support. The board of directors must be involved. Additionally, monitoring, documentation and reporting of program results should be conducted on a regular basis.
We would also suggest that the institution’s commitment to this process be communicated to employees, investors and the general public. This practice should instill greater confidence in the management and stability of the institution, as well as demonstrate to the regulators that the institution is paying attention to this important issue.
We can help
All financial institutions need to be concerned with this issue. We would be pleased to discuss your institution’s progress in incentive compensation, as well as what is occurring, in regards to incentive compensation in the marketplace.
For more information, post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.