CPA & Business Advisory Blog

Additional Proposed Regulations Limit Financial Institution Incentive Pay Packages

On March 29, 2011, the government agencies who are enforcing the Dodd-Frank Act’s provisions relating to financial institutions (including but not limited to the SEC, OCC, FDIC, OTS and NCUA) issued a further proposed rule relating to incentive compensation programs offered to employees of financial institutions with over $1 billion in assets. While echoing many parts of their February 4, 2011 proposal (click here for more information), the gist of these proposals is that incentive compensation programs must be sensitive to risk, the amount of incentive compensation needs to be limited and, for the first time, broker-dealers and registered investment advisors are now subject to this regulation.

It should be noted that the proposal deals with incentive compensation programs offered to any employee, director or principal shareholder of a financial institution, not merely the executive suite.  More stringent rules are proposed for institutions with over $50 billion in assets, but those rules aren’t discussed in this posting.

Too much incentive-based compensation?

Incentive-based compensation is any pay related to performance (cash, equity or other property); it does not include salary, bonuses for non-risk-taking activities (such as a bonus for obtaining a license) or arrangements that are based on pay (i.e. 401(k) plan matching contributions).

‘Excessive’ incentive-based compensation is not to be paid; the regulator will make that determination, seeking to determine if the amount paid is unreasonable or disproportionate to the amount, nature, quality and/or services performed by the recipient.  Factors include a recipient’s total pay and compensation history, payments to similarly situated people at the institution and at peer organizations, and the institution’s financial condition.

Making compensation more sensitive to risk

The agencies are concerned that many incentive-based compensation programs encourage risk taking so that annual bonuses can be earned.  The proposal lists four methods that an institution should consider to make its incentive compensation program less sensitive to risk:

  1. Risk adjusted rewards:  the amount of the person’s award is adjusted based on the amount of risk that the activities pose to the financial institution
  2. Longer performance periods: extending the performance period would allow for some or all of the risk outcomes associated with the person’s activities to become known
  3. Reduced sensitivity to short term performance:  adjusting the performance measures so that the rate of increase in the rewards as goals are met is reduced
  4. Deferred payment:  payment is deferred beyond the end of the performance period, and payments are adjusted for losses occurring during the deferral period

Other areas of concern:


  • The institution needs strong internal controls governing the process for designing, implementing and monitoring these programs.  Risk management, risk oversight and internal control personnel are to be involved in the entire process.  Regular monitoring and reporting of program results must be conducted by employees who are independent (with a separate reporting line to senior management) of program participants.
  • The proposal recognizes that smaller institutions may have fewer policies and procedures than larger institutions, as their operations may be less complex.

Final thoughts:

This new proposal should concern institutions for a number of reasons:


  • This proposal will serve to limit the amount of incentive compensation that could be paid, probably in a manner similar to the TARP recipients’ compensation package approval process.  As a result, financial institutions will spend more effort to review amounts of incentive pay when the programs are established and will need to provide their regulator with detailed justification of the payment amounts.
  • The incentive compensation design and review process will now involve employees who have never been involved in it before which will slow down and complicate the task.  Many institutions, particularly smaller ones, may not have the infrastructure and available personnel to separate the participants from the monitors.

This is a proposal, and comments are being accepted through mid-May.  Click here to access this 207 page proposal.

How do you think this proposed regulation would affect your financial institution? Let us know by posting a comment below.

Or, or more information on this topic, contact our Compensation & Benefits Advisory Services Group at 440-449-6800.

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