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US Securities and Exchange Commission

Regulators Not Working on Dodd-Frank Banker Incentive Compensation Rules is Troubling, Reform Advocate Says

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 5 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 5 minute read

When the SEC in early January unveiled its semi-annual update to the rulemaking agenda, an unfinished Dodd-Frank executive compensation rule was once more absent from the agency’s near-term plan—to the dismay of at least one reform group. The rule in question is “incentive-based compensation arrangements” as regulators call it, and it is still on the agency’s long-term rulemaking agenda.

Dodd-Frank, which Congress passed in 2010 in response to the 2008 financial crisis, includes this crucial provision—Section 956—intended to reign in reckless behavior on Wall Street because of imprudent incentive compensation packages for bankers. And investor advocates have urged regulators over the years to write the rule with no success. Sec. 956 of PL111-203

But now, adding insult to injury, the SEC put some Dodd-Frank compensation rules on the short-term agenda and adopted them in short order last year. Moreover, the first rulemaking open meeting for this year—scheduled for Jan. 25, 2023—is another Dodd-Frank rule, though it has to do with conflicts of interest in asset-backed securities.

“It’s discouraging that they haven’t placed it on the first tier-to-do list,” said Bartlett Naylor, financial policy advocate for Public Citizen.

“Congress mandated a deadline: May 2011,” Naylor added. “To miss the deadline raises eyebrows; to fail even to consider it as a priority furrows the brow and invites invective.”

This is a joint rulemaking 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. And for a while, financial regulators had attempted to write the rule before putting it on the back burner.

Regulators first started rulemaking 12 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. 34-64140, Incentive-Based Compensation Arrangements, when Mary Schapiro was chairman. She was President Obama’s appointee. The chair of the regulatory agency sets the rulemaking agenda.

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. 34-77776, Incentive-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. Clayton pursued a more business-friendly agenda.

Long-term action means there is no interest on the part of the agency to take it up any time soon. Oftentimes, this is another way of quietly dropping a rulemaking project.

But when Gary Gensler, who has been a champion of investors’ interest, became chair of the SEC in the Biden administration, he put incentive compensation on the near-term agenda. And in the fall of 2021, the commission had aimed to issue a third round of proposals by fall 2022. But in the spring of 2022, the project was relegated to long-term, and it stayed there without change in the latest update, which is fall of 2022 agenda, unveiled on Jan. 4.

Public Citizen: No Excuse for Failure to Act on Rulemaking

For Public Citizen’s Naylor, this is an important rulemaking that needs to be wrapped up quickly.

Banks have arrangements that rewarded employees for increasing their revenue or short-term profit without sufficiently taking into account the risks the employees were taking.

In part to prompt regulators to act with urgency, Public Citizen in September last year issued a report called Inappropriate: Banker Scams Continue as Washington Fails to Reform Pay as Mandated by 2010 Law. The report is authored by Naylor and Zachary Brown.

“The 2008 financial crash stemmed from numerous causes, and risk-taking by bankers in pursuit of incentive-based compensation figured as one of the most conspicuous triggers,” the report states. “Bankers committed massive frauds selling flawed mortgages, ultimately sending the economy into a Great Recession.”

The authors note that there might be an excuse for the government’s inaction if the rule were no longer relevant or urgent, but they emphasize that that is not the case, citing well-known examples of inappropriate risk-taking and fraud.

For example, the report points to JP Morgan’s $6 billion loss in flawed derivatives bets known as the London Whale, which was a plan to boost senior executive pay. Wells Fargo had quotas on its sales reps to increase consumer accounts, leading them to create fake accounts and boost senior executive pay linked to account growth metrics.

“In 2022 alone, numerous cases link compensation to fraud and investor abuse by banks, including examples such as: a fake account scam at U.S. Bank; abuse in student loans by Navient; investor abuse by Allianz, Schwab, First Republic Bank, and Credit Suisse; and maintaining insufficient anti-money laundering controls by USAA Federal Savings Bank and Wells Fargo,” the report notes. “This ongoing litany of inappropriate action by executives in search of enrichment clearly demonstrates the urgency of why regulators must take swift action to finalize this pay reform rule.”


This article originally appeared in the January 25, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.

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