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Regulators Put Long Overdue Dodd-Frank Incentive Compensation Rulemaking on Short-Term Agenda

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 6 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 6 minute read

When the SEC in mid-June unveiled its semi-annual update to the rulemaking agenda, an unfinished Dodd-Frank executive compensation rule was finally put back on its short-term agenda. The rule in question is “incentive-based compensation arrangements” for financial institutions. Sec. 956 of PL111-203

Although the next step in the rulemaking process is a third round of proposal by spring of 2024 as opposed to adoption, this move is still significant because the project was absent from the short-term agenda for a long time—to the dismay of financial reform advocates.

Dodd-Frank, which Congress passed in 2010 in response to the 2008 financial crisis, included Section 956, which is intended to reign in reckless behavior on Wall Street caused by imprudent incentive compensation packages for bankers. And investor advocates have urged regulators over the years to write the rule. Sec. 956 of PL111-203

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 (NCUA).

Now that it is finally back on the agenda, Bartlett Naylor, financial policy advocate for Public Citizen’s Congress Watch, was very pleased with the development.

“Most excellent,” Naylor said on Aug. 18, 2023. “Rule is now high on priority list, and Biden publicly called for speedy completion.”

Regulators first started rulemaking 12 years ago and continued under different chairs with no end in sight. But now with Democrats in power and the sudden collapse of Silicon Valley Bank in March, reform advocates and Democratic lawmakers urged financial regulators to beef up banking supervision rules which were rolled back during the Trump administration. Moreover, some also urged regulators to quickly finish writing Section 956.

Silicon Valley Bank, which apparently had almost no risk management in place, could not withstand a massive run on deposit. Banking agencies quickly stepped in to try to prevent a wider financial meltdown.

Senator Gary Peters, a Democrat from Michigan, wrote a letter on March 22, asking financial regulators to write the incentive compensation rules for bankers.

“Section 956 of Dodd-Frank was intended to require financial regulators to quickly and collaboratively issue rules requiring financial institutions to disclose any incentive-based executive compensation arrangements that encourage excessive risk-taking at financial institutions or that may lead to financial loss,” Senator Peters wrote.

Congress gave regulators a May 2011 deadline to adopt the rule. But regulators had not advanced the rulemaking largely because of intense lobbying by the financial industry. In pressing for reform, however, consumer and investor protection 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. More than ever today, advocates believe it is time for regulators to act.

“The recent bank failure of Silicon Valley Bank and reported bonuses issued to its leadership further underscore the urgency and importance of this rule’s implementation,” Peters wrote.

To increase the sense of urgency, the White House, in a March 30 statement, said that President Biden urged regulators to strengthen banking regulations.

The rules “can be accomplished under existing law, and they build upon regulatory reforms already on this Administration’s agenda, like completion of the executive compensation rule for bank executives authorized under Section 956 of the Dodd-Frank Act,” the White House said. “It is important to put in place common-sense safeguards to reverse the Trump Administration’s harmful weakening of bank safeguards and supervision and help ensure that community and regional banks remain resilient and continue supporting small businesses and jobs.”

Various factors may have been at play that led to its demise, such as the bank’s susceptibility to runs when economic conditions deteriorate; a large portion of customers who were mainly in the tech sector had deposits of more than the FDIC-insured $250,000 limit. But the Federal Reserve had concerns about the bank’s risk management starting from 2019 as the bank grew rapidly.

Before its collapse, Silicon Valley Bank was the 16th largest bank and the second largest failure in history. The largest failure was Washington Mutual in the 2008 financial crisis. But Silicon Valley Chief Executive Officer Gregory Becker earned $9.9 million last year. Federal agencies also quickly had to take over Signature Bank, to try to stabilize the banking system. Signature Bank founder and CEO Joseph DePaolo, made $8.6 million in 2022.

Financial regulators over the years had attempted to write the rule twice, first issuing a proposal in 2011 then a revised proposal in 2016. Had regulators adopted the proposed rule as issued 12 years ago, financial firms would have been banned 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. The proposing release 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.”

In 2016, changes that financial companies made to their compensation practices since the 2011 proposal was released persuaded the regulators to modify the proposal. The requirements would apply to banks, broker-dealers, credit unions and investment advisers with $1 billion or more in assets.

2024 Adoption?

Now that regulators are picking the rulemaking back up, it could be adopted late next year. Even though the rulemaking agenda states a third round of proposal for spring 2024, that is just an estimate. Sometimes a rulemaking occurs sooner or later than the estimated timeline.

Asked about whether the proposal could be issued in 2023, Naylor said yes.

“We hope to see a third proposal this year,” he said on Aug. 21. “The hold-up is the NCUA, which is 2-1 controlled by Rs. Rodney E. Hood’s term expired in August, and we are waiting for the White House to nominate a replacement.“

Trump nominated Hood for the NCUA, and he became chairman in April 2019 and served until January 2021. Since then, he served as a board member. Current NCUA chair is Todd Harper, who was designed to the position in January 2021 by Biden. The remaining board member is Vice Chairman Kyle Hauptman, who was named by Trump in 2020.


This article originally appeared in the August 23, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.

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