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US Securities and Exchange Commission

12 Years and Waiting: Dodd-Frank Banker Incentive Compensation Rules Remain on Hold

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 7 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 7 minute read

July 21, 2022, marked the 12th anniversary of Dodd-Frank, which Congress passed in 2010 in response to the 2008 financial crisis. But a crucial provision in the financial reform law remains on regulatory hold: incentive compensation for bankers.

Financial regulators over the years had attempted to write the rule twice already but have yet to finalize it. And now there seems to be no urgency among regulators to adopt a rule that is intended to rein in reckless behavior on Wall Street.

But reform advocates have repeatedly pressed regulators to complete this rule as soon as possible. When he was an SEC commissioner, Robert Jackson in 2018 also implored his colleagues to complete the remaining Dodd-Frank regulations related to executive compensation, including incentive pay in the financial industry. There was no regulatory movement at the time because Jackson served during the Trump administration, which took a business-friendly approach to regulation. And financial institutions are not exactly enamored of this provision in Section 956, aggressively pushing back in their comment letters and in their lobbying. They want a watered-down rule to be implemented. Sec. 956 of P:L111-203

In pressing for the rule, reform advocates said that flawed compensation plans made bankers and other financial services professionals take excessive and reckless risks in pursuit of big payouts in the leadup to the crisis.

“Bankers caused the 2008 financial crash because their pay packages promoted reckless lending and even fraud,” Bartlett Naylor, financial policy advocate for Public Citizen, said in a statement.

Naylor pointed out that Congress required financial regulators to develop the rule by May 2011. The rulemaking is a joint effort with the Treasury Department, the Federal Reserve, Comptroller of the Currency, Federal Deposit Insurance Corp., Federal Housing Finance Agency, and National Credit Union Administration.

“Yet more than 18 months into the Biden administration, this rule isn’t even listed in the agendas for any of the responsible agencies except the U.S. Securities and Exchange Commission,” Naylor added. “JP Morgan’s London Whale fiasco, Wells Fargo’s fake accounts scandal, and Goldman Sachs’ Malaysian bribery crimes all show that Wall Street won’t reform itself without pay reforms. It’s long past time to finish this rule.”

While the SEC may technically have it on its rulemaking agenda, it is not a priority as it was relegated to “long-term” action in the most recent update, and it says next step “to be determined.” Often, this means that there is no interest on the part of the agency to take it up any time soon. And this is another way of quietly dropping a rulemaking project.

The chair of the SEC sets the agenda, and Gary Gensler had put this item in the short-term item after he became chair. And as recently as last fall, the SEC had aimed to issue a third round of proposal by fall 2022. Federal agencies update their rulemaking agenda twice a year.

“We’re concerned about the delay, and the demotion on the SEC,” Naylor told Thomson Reuters in a follow-up.

Since this is joint rulemaking, the SEC’s hands may have been tied.

The SEC declined to comment. The American Bankers Association (ABA) did not respond to a request for comment.

Rulemaking History

Regulators first started rulemaking 11 years ago and continued under different chairs. The SEC’s version of the first rulemaking attempt was issued in March 2011 in proposed Release No. 34-64140Incentive-Based Compensation Arrangements, when Mary Schapiro was chairman. She was President Obama’s appointee.

It proposed banning financial firms from giving out pay packages that encourage excessive risk-taking. Firms would have to file annual reports describing the financial incentives, including narrative descriptions of pay packages and the firm’s compensation policies and procedures.

In May 2016, the regulators followed up with a revised proposal in Release No. 34-77776Incentive-based Compensation Arrangements, that contained some changes in definitions and modified requirements for smaller institutions, among other things. This was when Mary Jo White was chair, and she was also Obama’s appointee.

At the time, changes that financial companies made to their compensation practices since the 2011 proposal was released persuaded the regulators to modify the proposal, according to Release No. 34-77776. The requirements would apply to banks, broker-dealers, credit unions, and investment advisers with $1 billion or more in assets.

After Jay Clayton became chairman during the Trump administration, he moved this project under long-term action, most likely in coordination with other agencies since this is joint-rulemaking.

Proposals in Detail

In the meantime, 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.”

Among the changes from the original, the agencies added a definition for “significant risk-taker,” which describes a non-senior executive who nevertheless ranks among the top compensated employees at an institution or someone who has the power to expose a certain percentage of a firm’s capital. Under the proposal, significant risk-takers would be subject to compensation restrictions alongside senior executive officers.

Release No. 34-77776 set up a two-pronged test for identifying significant risk-takers. Under the “relative compensation test,” employees whose annual salary and incentive-based pay put them in the top 2 percent or 5 percent of earners, depending on the size of the institution, would qualify under the definition. Alternatively, the “exposure test” would classify a person as a significant risk-taker if they have the authority to expose 0.5 percent of an institution’s capital to loss due to market risk or credit risk.

A coalition of industry groups in a July 2016 comment letter criticized the inclusion of the new significant risk-taker definition, arguing that it is outside the statutory bounds of Dodd-Frank. The groups included ABA, the U.S. Chamber of Commerce, and the Securities Industry and Financial Markets Association.

The trade groups challenged the proposal’s “bright-line test” for determining the employees who would have their compensation regulated under the rule.

“The structure of the bright-line test operates off an assumption that equates pay magnitude with risk-taking activities,” the coalition wrote. “Further, by failing to focus on risk, the test fundamentally fails to identify some non-senior executive officers who have the potential to subject a firm to material financial harm.”

The groups provided this example: the rule regulates the compensation of individuals whose job is to mitigate risk, “like those in the legal department or a control function,” while possibly missing other risk-takers who can collectively, but not individually, expose more than 0.5 percent of a firm’s capital to losses.

“The obvious shortcomings of the bright-line approach should counsel the agencies to abandon it in favor of a more flexible framework in which businesses identify the material risk takers in their respective organizations,” the industry groups wrote in the letter.

Under Release No. 34-77776, the exposure test would not apply to employees with the ability “to expose a covered institution to other types of risk that may be more difficult to measure or quantify, such as compliance risk.”

But Public Citizen at the time praised the addition of a significant risk-taker definition in the updated rule as an improvement from the original.

Nevertheless, reform advocates said in comment letters that the reproposal suffers from material weaknesses that must be addressed in the final release.

For example, Better Markets said that the types of conduct that trigger clawbacks must be expanded beyond culpable behavior. Moreover, the rule should require, not just allow, institutions to recoup pay.

The organization also said the deferral periods should be extended; pro rata vesting should be abandoned in favor of cliff vesting. Further, Better Markets urged the SEC to ban stock options as a form of incentive compensation. In addition, the ban on hedging should also cover individuals, not only the institutions acting on their behalf.


This article originally appeared in the July 27, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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