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Revised Incentive Compensation Proposal Faces Challenges on Two Fronts

The business lobby wants the SEC and the federal banking agencies to rework a proposed rule to link risk taking to executive compensation and add a cost-benefit analysis to it. But a major consumer lobbying organization says the proposal is so weak as to be meaningless. Both groups want to see significant changes to the proposal before it becomes a final rule.

The business lobby wants the SEC and the federal banking agencies to rework a proposed rule to link risk taking to executive compensation and add a cost-benefit analysis to it.

A major consumer lobbying organization says the proposal is so weak as to be meaningless.

Neither group is satisfied with the regulators’ work.

The proposal in question, Release No. 34-77776, Incentive-Based Compensation Arrangements, was issued by the SEC on May 6, 2016. The Federal Deposit Insurance Corp. published its version on May 16. Comments are due by July 22.

The proposal is intended to restrict incentive-based compensation arrangements deemed to “encourage inappropriate risk” by banks and other regulated financial companies. The original proposal, Release No. 34-64140, Incentive-Based Compensation Arrangements, was issued in 2011 under the Dodd-Frank Act.

In a May 31 comment letter, the U.S. Chamber of Commerce told the regulators that their failure to include a thorough cost-benefit analysis in the proposal interfered with “the ability of stakeholders to fully comprehend the reproposal and provide fully informed comments.”

The chamber asked the regulators to again revise the proposal and include an analysis of its costs by the time it is published in the Federal Register.

For their part, the consumer advocates at Public Citizen say the rule proposal has restrictions that are so weak that they do not even deserve to be called restrictions. According to the organization’s May 26 comment letter, the proposal does no more than ask banks to “consider” recovering a bonus that is later found to be excessive.

“The regulators themselves won’t order a pay penalty,” Public Citizen wrote. “Nor do the regulators propose requiring that the pay penalties be disclosed publicly.”

The group also criticized the proposal for failing to require public disclosure of the names of the executives who are forced to return old bonuses or how many people were penalized. In addition, Public Citizen said the final rule should force clawbacks for as much as 10 years after an infraction in order to adequately discourage fraudulent activity.

The proposed requirements in Release No. 34-77776 apply to banks, broker-dealers, credit unions, and investment advisers with $1 billion or more in assets. Mortgage wholesalers Fannie Mae and Freddie Mac are also covered by the requirements. Broker-dealers and advisers fall under the SEC’s purview.

The Dodd-Frank rules are based on the reasoning that “flawed incentive-based compensation practices” in the financial industry contributed to the financial crisis, SEC staff wrote in Release No. 34-77776. The proposal cited arrangements that “rewarded employees — including non-executive personnel like traders with large position limits, underwriters, and loan officers — for increasing an institution’s revenue or short-term profit without sufficient recognition of the risks the employees’ activities posed to the institutions, and therefore potentially to the broader financial system.”

Changes that financial companies have made to their compensation practices since the 2011 proposal was released persuaded the regulators to modify the proposal and issue it for a second round of public comment.