Description
Client Alert
April 25, 2016
New Executive Compensation Rule At-A-Glance
On April 21, 2016, the National Credit Union Administration approved a proposed rule on incentive compensation under Section 956
of the Dodd-Frank Act. The other appropriate Federal regulators, as defined in Section 956, are expected to follow suit shortly.
Following is a chart of the key provisions of the proposal. Comments are due July 22, 2016. This chart summarizes the proposed
rules required under Dodd-Frank regarding incentive compensation at certain “covered financial institutions” (Level 1, Level 2 and
Level 3):
“Covered financial
institutions”
Average total consolidated
assets held
“Senior executive officer”
“Significant risk-taker”
1
Level 1
Level 2
Level 3
Include (1) banks and bank holding companies, (2) broker-dealers, (3) investment advisers and
(4) credit unions, each with $1 billion or more in assets.
Greater than or equal to
Greater than or equal to
Greater than or equal to
$250 billion.
$50 billion and less than
$1 billion and less than
$250 billion.
$50 billion.
A covered person who holds the title or, without regard to title, salary, or compensation, performs
the function of one or more of the following positions at a credit union for any period of time in the
relevant performance period: president, chief executive officer, executive chairman, chief operating
officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief
risk officer, chief compliance officer, chief audit executive, chief credit officer, chief accounting
officer, or head of a major business line or control function.
Non-senior executive officer
Non-senior executive officer
N/A
whose compensation for the
whose compensation for the
last calendar year was at least
last calendar year was at least
one-third incentive-based
one-third incentive-based
compensation and: (1) had the
compensation and: (1) had the
highest 5% in annual base
highest 2% in annual base
salary and incentive-based
salary and incentive-based
compensation among all
compensation among all
covered persons (excluding
covered persons (excluding
senior executive officers); or
senior executive officers); or
Attorney Advertisement
.
General requirement Performance measures Risk management and controls Deferral requirement for qualifying incentive-based compensation awards: Minimum deferral amount Minimum deferral period 1 2 2 (2) who may commit or expose (2) who may commit or expose 0.5% or more of the net 0.5% or more of the net worth or total capital of worth or total capital of the institution. the institution. Cannot have incentive-based compensation plans that encourage inappropriate risks by providing a covered person1 with excessive compensation, fees, or benefits, or that could lead to material financial loss for the institution. An incentive-based compensation arrangement encourages inappropriate risks that could lead to material financial loss for the institution unless the arrangement (1) appropriately balances risk and reward; (2) is compatible with effective risk management and controls; and (3) is supported by effective governance. “Excessive” means amounts paid are unreasonable or disproportionate to the value of the services performed by a covered person, taking into consideration all relevant factors such as: combined value of all compensation, fees, or benefits provided to the covered person; the compensation history of the covered person and other individuals with comparable expertise; the financial condition of the institution; etc. Must appropriately balance risk and reward. The Board of Directors must conduct oversight, approve incentive-based compensation arrangements for senior executive officers and approve material exceptions or adjustments to incentive-based compensation for senior executive officers. Yes Yes No Senior executive officers: at least 60% Senior executive officers: at least 50% Significant risk takers: at least 50% At least 4 years (or at least 2 years for incentive-based compensation awarded under a long-term incentive plan2) Significant risk takers: at least 40% At least 3 years (or at least 1 year for incentive-based compensation awarded under a long-term incentive plan) N/A N/A Covered person means any executive officer, employee, or director who receives incentive-based compensation. “Long-term incentive plan” is defined as a plan that is based on a performance period of at least 3 years. Attorney Advertisement . Vesting during deferral period Adjustments of deferred qualifying incentive-based compensation and deferred long-term incentive plan compensation amounts Forfeiture requirements? Downward adjustment requirements? Forfeiture and downward adjustment triggering event: 3 Pro rata: may not vest faster than on a pro rata annual basis beginning no earlier than the first anniversary of the end of the performance period for which the amounts were awarded. Acceleration: no acceleration of vesting except in the case of (1) death or disability of the covered person; or (2) the payment of income taxes that become due on deferred amounts before the covered person is vested in the deferred amount. Any accelerated vesting must be deducted from the scheduled deferred amounts proportionally to the deferral schedule. Not allowed. Not allowed. N/A Yes, must place at risk of forfeiture all unvested deferred incentive-based compensation of any senior executive officer or significant risk-taker, including unvested deferred amounts awarded under long-term incentive plans. Yes, must place at risk of downward adjustment all of a senior executive officer’s or significant risk-taker’s incentive-based compensation amounts not yet awarded for the current performance period, including amounts payable under long-term incentive plans. No Must consider forfeiture and downward adjustment due to any of the following adverse outcomes at the institution: (i) poor financial performance attributable to a significant deviation from the institution’s policy risk parameters; (ii) inappropriate risk taking, regardless of financial performance; (iii) material risk management or control failures; (iv) non-compliance with statutory, regulatory, or supervisory standards that results in enforcement or legal action by a federal or state regulator or agency or a requirement that the institution report a restatement of a financial statement to correct a material error; and (v) other aspects of conduct or poor performance. N/A N/A No Attorney Advertisement . Determining forfeiture or downward adjustment amounts: Clawback requirements? Hedging prohibitions? 4 At a minimum, must consider the following factors: (i) intent of the senior executive officer or significant risk-taker to operate outside the risk governance framework approved by the Board of Directors or to depart from the institution’s policies and procedures; (ii) the senior executive officer’s or significant risktaker’s level of participation in, awareness of, and responsibility for, the events triggering the forfeiture and downward adjustment review; (iii) any actions the senior executive officer or significant risk-taker took or could have taken to prevent the events triggering the forfeiture and downward adjustment review; (iv) the financial and reputational impact of the events triggering the forfeiture and downward adjustment review including the magnitude of any financial loss and the cost of known or potential subsequent fines, settlements, and litigation; (v) the causes of the events triggering the forfeiture and downward adjustment review including any decision-making by other individuals; and (vi) any other relevant information, including past behavior and past risk outcomes attributable to the senior executive officer or significant risk-taker. Yes, must include clawback provisions in incentive-based compensation arrangements for senior executive officers and significant risk-takers that, at a minimum, allow the institution to recover incentive-based compensation from a current or former senior executive officer or significant risk-taker for seven years following the date on which such compensation vests, if the institution determines that the senior executive officer or significant risk-taker engaged in: (i) misconduct that resulted in significant financial or reputational harm to the institution; (ii) fraud; or (iii) intentional misrepresentation of information used to determine the senior executive officer or significant risk-taker’s incentive-based compensation. Yes, must not purchase a hedging instrument or similar instrument on behalf of a covered person to hedge or offset any decrease in the value of the covered person’s incentive-based compensation. N/A No No Attorney Advertisement . Maximum incentive-based compensation requirement? Performance measure requirements? Risk management control requirements? Policy and procedure requirements? 5 Yes, must not award a senior executive officer in excess of 125% of the target amount for that incentive-based compensation; or a significant risk-taker in excess of 150% of the target amount for that incentive-based compensation. Yes, incentive-based compensation cannot be based (1) solely on industry peer performance comparisons; or (2) solely on transaction revenue or volume without regard to transaction quality or compliance of the covered person with sound risk management. Yes, must employ a risk framework for incentive-based compensation that: (1) is independent of any lines of business; (2) includes an independent compliance program that provides for internal controls, testing, monitoring, and training with written policies and procedures; and (3) is commensurate with the size and complexity of the institution’s operations. Yes, must develop and implement policies and procedures that: (1) are consistent with the requirements of this rule; (2) specify the substantive and procedural criteria for the application of forfeiture and clawback, including the process for determining the amount of incentive-based compensation to be clawed back; (3) require that the institution maintain documentation of final forfeiture, downward adjustment, and clawback decisions; (4) specify the substantive and procedural criteria for the acceleration of payments of deferred incentive-based compensation to a covered person; (5) identify and describe the role of any employees, committees, or groups authorized to make incentive-based compensation decisions, including when discretion is authorized; (6) describe how discretion is expected to be exercised to appropriately balance risk and reward; (7) require that the institution maintain documentation of the establishment, implementation, modification, and monitoring of incentive-based compensation arrangements, sufficient to support the institution’s decisions; (8) describe how incentive-based compensation arrangements will be monitored; (9) specify the substantive and procedural requirements of the independent compliance program; and (10) ensure appropriate roles for risk management, risk oversight, and other control. No No Risk management control requirements? No Attorney Advertisement . Governance requirements? General recordkeeping Additional disclosure and record keeping 6 function personnel in the institution’s processes for designing incentive-based compensation arrangements and determining awards, deferral amounts, deferral periods, forfeiture, downward adjustment, clawback and vesting, and assessing the effectiveness of incentive-based compensation arrangements in restraining inappropriate risk-taking. Yes, must establish a compensation committee composed solely No of directors who are not senior executive officers to assist the Board of Directors in carrying out its responsibilities. The compensation committee must obtain: (1) input from the risk and audit committees of the Board of Directors, or groups performing similar functions, and risk management function on the effectiveness of risk measures and adjustments used to balance risk and reward in incentive-based compensation arrangements; (2) a written assessment of the effectiveness of the institution’s incentive-based compensation program and related compliance and control processes in providing risk-taking incentives that are consistent with the risk profile of the institution, submitted on an annual or more frequent basis by management and developed with input from the risk and audit committees of its Board of Directors, or groups performing similar functions, and from the institution’s risk management and audit functions; and (3) an independent written assessment of the effectiveness of the institution’s incentive-based compensation program and related compliance and control processes in providing risk-taking incentives that are consistent with the institution’s risk profile, submitted on an annual or more frequent basis by the internal audit or risk management function of the institution, developed independently of management. Must create annually and maintain for a period of at least seven years records that document the structure of all its incentive-based compensation arrangements. Annually create and maintain documentation for None. However, the applicable federal regulator seven years: may require a Level 3 with average total consolidated assets greater than or equal to $10 - List of senior executive officers and billion and less than $50 billion to comply with significant risk-takers by job function, some or all of the Level 1 and Level 2 recordorganizational hierarchy and line keeping provisions if it is determined that the of business; Attorney Advertisement . Level 3’s complexity of operations or Incentive-based compensation compensation practices are consistent with those arrangements for senior executive officers of a Level 1 or Level 2. Factors considered in and significant risk-takers, including making this determination include the activities, information on percentage of incentivecomplexity of operations, risk profile, and based compensation deferred and form compensation practices of the Level 3, in of award; addition to any other relevant factors. - Any forfeiture and downward adjustment or clawback reviews and decisions for senior executive officers and significant risk-takers; and - Any material changes to incentive-based compensation arrangements and policies. Within 540 days after the date that the institution qualifies as a Level 1. Will continue to be a Level 1 until average total assets drops below $250 billion for four consecutive quarters. - Compliance date The deadline for submitting comments is July 22, 2016. Authors Oliver Ireland (202) 778-1614 oireland@mofo.com Anna Pinedo (212) 468-8179 apinedo@mofo.com Ze’-ev Eiger (212) 468-8222 zeiger@mofo.com Alexandra Perry (212) 336-4261 aperry@mofo.com About Morrison & Foerster We are Morrison & Foerster—a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, Fortune 100, technology and life sciences companies.
We’ve been included on The American Lawyer’s A-List for 12 straight years, and Fortune named us one of the “100 Best Companies to Work For.” Our lawyers are committed to achieving innovative and business-minded results for our clients while preserving the differences that make us stronger. This is MoFo. Visit us at www.mofo.com.
© 2016 Morrison & Foerster LLP. All rights reserved. For more updates, follow Thinkingcapmarkets, our Twitter feed: www.twitter.com/Thinkingcapmkts. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. 7 Attorney Advertisement .
General requirement Performance measures Risk management and controls Deferral requirement for qualifying incentive-based compensation awards: Minimum deferral amount Minimum deferral period 1 2 2 (2) who may commit or expose (2) who may commit or expose 0.5% or more of the net 0.5% or more of the net worth or total capital of worth or total capital of the institution. the institution. Cannot have incentive-based compensation plans that encourage inappropriate risks by providing a covered person1 with excessive compensation, fees, or benefits, or that could lead to material financial loss for the institution. An incentive-based compensation arrangement encourages inappropriate risks that could lead to material financial loss for the institution unless the arrangement (1) appropriately balances risk and reward; (2) is compatible with effective risk management and controls; and (3) is supported by effective governance. “Excessive” means amounts paid are unreasonable or disproportionate to the value of the services performed by a covered person, taking into consideration all relevant factors such as: combined value of all compensation, fees, or benefits provided to the covered person; the compensation history of the covered person and other individuals with comparable expertise; the financial condition of the institution; etc. Must appropriately balance risk and reward. The Board of Directors must conduct oversight, approve incentive-based compensation arrangements for senior executive officers and approve material exceptions or adjustments to incentive-based compensation for senior executive officers. Yes Yes No Senior executive officers: at least 60% Senior executive officers: at least 50% Significant risk takers: at least 50% At least 4 years (or at least 2 years for incentive-based compensation awarded under a long-term incentive plan2) Significant risk takers: at least 40% At least 3 years (or at least 1 year for incentive-based compensation awarded under a long-term incentive plan) N/A N/A Covered person means any executive officer, employee, or director who receives incentive-based compensation. “Long-term incentive plan” is defined as a plan that is based on a performance period of at least 3 years. Attorney Advertisement . Vesting during deferral period Adjustments of deferred qualifying incentive-based compensation and deferred long-term incentive plan compensation amounts Forfeiture requirements? Downward adjustment requirements? Forfeiture and downward adjustment triggering event: 3 Pro rata: may not vest faster than on a pro rata annual basis beginning no earlier than the first anniversary of the end of the performance period for which the amounts were awarded. Acceleration: no acceleration of vesting except in the case of (1) death or disability of the covered person; or (2) the payment of income taxes that become due on deferred amounts before the covered person is vested in the deferred amount. Any accelerated vesting must be deducted from the scheduled deferred amounts proportionally to the deferral schedule. Not allowed. Not allowed. N/A Yes, must place at risk of forfeiture all unvested deferred incentive-based compensation of any senior executive officer or significant risk-taker, including unvested deferred amounts awarded under long-term incentive plans. Yes, must place at risk of downward adjustment all of a senior executive officer’s or significant risk-taker’s incentive-based compensation amounts not yet awarded for the current performance period, including amounts payable under long-term incentive plans. No Must consider forfeiture and downward adjustment due to any of the following adverse outcomes at the institution: (i) poor financial performance attributable to a significant deviation from the institution’s policy risk parameters; (ii) inappropriate risk taking, regardless of financial performance; (iii) material risk management or control failures; (iv) non-compliance with statutory, regulatory, or supervisory standards that results in enforcement or legal action by a federal or state regulator or agency or a requirement that the institution report a restatement of a financial statement to correct a material error; and (v) other aspects of conduct or poor performance. N/A N/A No Attorney Advertisement . Determining forfeiture or downward adjustment amounts: Clawback requirements? Hedging prohibitions? 4 At a minimum, must consider the following factors: (i) intent of the senior executive officer or significant risk-taker to operate outside the risk governance framework approved by the Board of Directors or to depart from the institution’s policies and procedures; (ii) the senior executive officer’s or significant risktaker’s level of participation in, awareness of, and responsibility for, the events triggering the forfeiture and downward adjustment review; (iii) any actions the senior executive officer or significant risk-taker took or could have taken to prevent the events triggering the forfeiture and downward adjustment review; (iv) the financial and reputational impact of the events triggering the forfeiture and downward adjustment review including the magnitude of any financial loss and the cost of known or potential subsequent fines, settlements, and litigation; (v) the causes of the events triggering the forfeiture and downward adjustment review including any decision-making by other individuals; and (vi) any other relevant information, including past behavior and past risk outcomes attributable to the senior executive officer or significant risk-taker. Yes, must include clawback provisions in incentive-based compensation arrangements for senior executive officers and significant risk-takers that, at a minimum, allow the institution to recover incentive-based compensation from a current or former senior executive officer or significant risk-taker for seven years following the date on which such compensation vests, if the institution determines that the senior executive officer or significant risk-taker engaged in: (i) misconduct that resulted in significant financial or reputational harm to the institution; (ii) fraud; or (iii) intentional misrepresentation of information used to determine the senior executive officer or significant risk-taker’s incentive-based compensation. Yes, must not purchase a hedging instrument or similar instrument on behalf of a covered person to hedge or offset any decrease in the value of the covered person’s incentive-based compensation. N/A No No Attorney Advertisement . Maximum incentive-based compensation requirement? Performance measure requirements? Risk management control requirements? Policy and procedure requirements? 5 Yes, must not award a senior executive officer in excess of 125% of the target amount for that incentive-based compensation; or a significant risk-taker in excess of 150% of the target amount for that incentive-based compensation. Yes, incentive-based compensation cannot be based (1) solely on industry peer performance comparisons; or (2) solely on transaction revenue or volume without regard to transaction quality or compliance of the covered person with sound risk management. Yes, must employ a risk framework for incentive-based compensation that: (1) is independent of any lines of business; (2) includes an independent compliance program that provides for internal controls, testing, monitoring, and training with written policies and procedures; and (3) is commensurate with the size and complexity of the institution’s operations. Yes, must develop and implement policies and procedures that: (1) are consistent with the requirements of this rule; (2) specify the substantive and procedural criteria for the application of forfeiture and clawback, including the process for determining the amount of incentive-based compensation to be clawed back; (3) require that the institution maintain documentation of final forfeiture, downward adjustment, and clawback decisions; (4) specify the substantive and procedural criteria for the acceleration of payments of deferred incentive-based compensation to a covered person; (5) identify and describe the role of any employees, committees, or groups authorized to make incentive-based compensation decisions, including when discretion is authorized; (6) describe how discretion is expected to be exercised to appropriately balance risk and reward; (7) require that the institution maintain documentation of the establishment, implementation, modification, and monitoring of incentive-based compensation arrangements, sufficient to support the institution’s decisions; (8) describe how incentive-based compensation arrangements will be monitored; (9) specify the substantive and procedural requirements of the independent compliance program; and (10) ensure appropriate roles for risk management, risk oversight, and other control. No No Risk management control requirements? No Attorney Advertisement . Governance requirements? General recordkeeping Additional disclosure and record keeping 6 function personnel in the institution’s processes for designing incentive-based compensation arrangements and determining awards, deferral amounts, deferral periods, forfeiture, downward adjustment, clawback and vesting, and assessing the effectiveness of incentive-based compensation arrangements in restraining inappropriate risk-taking. Yes, must establish a compensation committee composed solely No of directors who are not senior executive officers to assist the Board of Directors in carrying out its responsibilities. The compensation committee must obtain: (1) input from the risk and audit committees of the Board of Directors, or groups performing similar functions, and risk management function on the effectiveness of risk measures and adjustments used to balance risk and reward in incentive-based compensation arrangements; (2) a written assessment of the effectiveness of the institution’s incentive-based compensation program and related compliance and control processes in providing risk-taking incentives that are consistent with the risk profile of the institution, submitted on an annual or more frequent basis by management and developed with input from the risk and audit committees of its Board of Directors, or groups performing similar functions, and from the institution’s risk management and audit functions; and (3) an independent written assessment of the effectiveness of the institution’s incentive-based compensation program and related compliance and control processes in providing risk-taking incentives that are consistent with the institution’s risk profile, submitted on an annual or more frequent basis by the internal audit or risk management function of the institution, developed independently of management. Must create annually and maintain for a period of at least seven years records that document the structure of all its incentive-based compensation arrangements. Annually create and maintain documentation for None. However, the applicable federal regulator seven years: may require a Level 3 with average total consolidated assets greater than or equal to $10 - List of senior executive officers and billion and less than $50 billion to comply with significant risk-takers by job function, some or all of the Level 1 and Level 2 recordorganizational hierarchy and line keeping provisions if it is determined that the of business; Attorney Advertisement . Level 3’s complexity of operations or Incentive-based compensation compensation practices are consistent with those arrangements for senior executive officers of a Level 1 or Level 2. Factors considered in and significant risk-takers, including making this determination include the activities, information on percentage of incentivecomplexity of operations, risk profile, and based compensation deferred and form compensation practices of the Level 3, in of award; addition to any other relevant factors. - Any forfeiture and downward adjustment or clawback reviews and decisions for senior executive officers and significant risk-takers; and - Any material changes to incentive-based compensation arrangements and policies. Within 540 days after the date that the institution qualifies as a Level 1. Will continue to be a Level 1 until average total assets drops below $250 billion for four consecutive quarters. - Compliance date The deadline for submitting comments is July 22, 2016. Authors Oliver Ireland (202) 778-1614 oireland@mofo.com Anna Pinedo (212) 468-8179 apinedo@mofo.com Ze’-ev Eiger (212) 468-8222 zeiger@mofo.com Alexandra Perry (212) 336-4261 aperry@mofo.com About Morrison & Foerster We are Morrison & Foerster—a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, Fortune 100, technology and life sciences companies.
We’ve been included on The American Lawyer’s A-List for 12 straight years, and Fortune named us one of the “100 Best Companies to Work For.” Our lawyers are committed to achieving innovative and business-minded results for our clients while preserving the differences that make us stronger. This is MoFo. Visit us at www.mofo.com.
© 2016 Morrison & Foerster LLP. All rights reserved. For more updates, follow Thinkingcapmarkets, our Twitter feed: www.twitter.com/Thinkingcapmkts. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. 7 Attorney Advertisement .
