Financial regulators last year finally decided to propose once again an unfinished Dodd-Frank executive compensation rule. While some reform advocates might have been disappointed that the regulators will not be completing the dozen year-old rulemaking just yet, it may be a good move to get the public’s input before adoption.
Regulators plan to issue a third rulemaking document on incentive-based compensation arrangements for financial institutions around the spring of 2024.
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 adopt the rule. Sec. 956 of PL111
This is joint rulemaking by the SEC, the Treasury Department, the Federal Reserve, Comptroller of the Currency, Federal Deposit Insurance Corp., Federal Housing Finance Agency, and National Credit Union Administration (NCUA).
Asked by Thomson Reuters why the regulators are not moving to finalize but instead do another proposal, SEC Chair Gary Gensler said regulators “have to get appropriate comment from the public after a certain period of time.”
“It’s often just better to repropose something, and we did that as well. When I came in ’21, there were some things that had maybe been proposed under [immediate predecessor] Chair [Jay] Clayton, and it was only a year or two years, [so] we could go to final,” Gensler told reporters on the sidelines of a conference in Washington in December 2023. “But there were some things that had been proposed maybe under Chair [Mary Jo] White, and we reproposed. So, sometimes it’s just the length of time.”
History of Rulemaking
Regulators first started rulemaking almost 13 years ago, then did another round of proposal five years later under Democratic administrations. Now once again with Democrats in power and the sudden collapse of Silicon Valley Bank in March 2023, reform advocates and Democratic lawmakers urged financial regulators to beef up banking supervision rules which were rolled back during the Trump administration. Moreover, some urged regulators to quickly finish writing Section 956. And soon after, the project was finally added back to the short-term rulemaking agenda.
Meanwhile, Gensler signaled he has been waiting for the banking regulators to move. It wasn’t for lack of trying on his part. Heads of agencies decide which projects would be on their rulemaking agenda.
“We’ve stood ready for two and a half years in my time here,” Gensler told reporters. He became SEC chair in April 2021.
He pointed to the first proposal in March 2011 when Mary Schapiro was chair of the SEC and another one in May 2016 during White’s tenure as chair. And today, “we stand ready,” Gensler said.
Had regulators adopted the proposed rule as issued almost 13 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.
Legal Scholars’ Views on Adoption Vs. Reproposal
In the meantime, a group of legal scholars wrote a joint letter to the regulators—purely in terms of due process under the Administrative Procedure Act (APA)—that it may be wise for them to reopen the rulemaking up for more comments instead of moving to final straight away.
Five law professors wrote on June 6, 2023, describing the pros and cons of three paths to adoption: finalizing the 2016 proposal without providing the opportunity for the public to comment; reopening the comment opportunity and then finalizing the 2016 proposal; and issuing a new proposal.
The first approach—finalizing the rule without reopening the comment—will obviously produce a set of rules the fastest, but it is also fraught with peril.
Courts give agencies deference regarding rulemaking timetable, and if the original rulemaking is still relatively fresh, a new round of notice and comment might be unnecessary, the letter states.
However, a “court may conclude that a lengthy delay has denied the public a fair opportunity to comment because the state of the world has changed,” the letter states. “Only if an agency can show that ‘[n]ew information relevant to the agency’s decisionmaking [did not] come to light after the original notice and comment proceedings’ will courts find that the record retains its useful life.”
The professors said that if the agencies were to modify the proposed requirements in 2016 based on lessons learned from recent events but neither reopen nor issue a new proposal, the final rule could be subject to challenge under the “logical outgrowth doctrine.”
Considering that it has been seven and a half years since the second proposal was issued, it may be prudent for the agencies to go ahead and reopen the proposal and float requirements that are relevant today for comment.
Reopening the 2016 proposal would alert the public that the agencies are working on the rule again. They could ask questions on events that have occurred since 2016, and interested parties could provide fresh information and insight.
“This would adequately address any concerns about logical outgrowth if the agencies were to make changes in the final rule,” the professors wrote. And reopening the comment period would arguably be better because the agencies can preserve the comments that were submitted for the 2016 proposal whereas proposing a new rule would require all previous commenters to send in new letters.
As Chair Gensler said, the SEC in January 2022 reopened a 2015 proposal on another Dodd-Frank Act executive compensation rule—pay versus performance—because pay practices have continued to develop and evolve. It was adopted in August 2022.
As for the third option, issuing a new proposal, in the professors’ view, is unnecessary as long as the final rule is a “logical outgrowth” of the original proposal.
The agencies have to be mindful of staff resources and time, and putting together a new proposal will take away staff’s attention from other regulatory matters.
“Simply put, the agencies will be able to move much more quickly in reopening the 2016 Proposal rather than starting anew,” they wrote.
Potential 2024 Adoption
Now that regulators are working on the rule again, it could be adopted later this year. Even though the rulemaking agenda states a third round of proposal for April 2024, that is just an estimate. Also, the agenda gives no indication about whether it is reopening up the 2016 proposal or if it’s an entirely new one. The SEC has not historically done new proposals.
But regulators should hurry—to be on the safe side—since 2024 is an election year. There is a chance that a change of administration will occur. And Congress can enact a joint resolution of disapproval to invalidate a rule within 60 legislative days of the rule’s enactment with a simple majority vote under the Congressional Review Act (CRA).
“Given their extensive prior work on the 2016 Proposal, the agencies should be able to reopen the proposal, analyze new comments, and negotiate and develop a final rule before the CRA window,” the letter states. “By contrast, requiring the agencies to negotiate and develop a new proposal, as well as analyze a host of new comments, on that timeline would likely prove difficult.”
Hold-Up No More
In the meantime, financial reform advocates were cautiously optimistic that the rule could finally be wrapped up.
The hold-up at the banking regulators was the NCUA, which until recently was controlled by Republicans by a vote of 2-1.
Tanya Otsuka was sworn is as a member of the NCUA board on January 8, succeeding Rodney Hood who was nominated by President Donald Trump and became chairman until January 2021. Since then, he served as a board member, and his term expired last year.
Now all bank regulators have the votes to move forward with the rulemaking.
“With all key regulators in place, the time is now for decisive action to protect the public from the reckless actions of executives, who too often put their own greed ahead of the health and stability of their companies and the financial system,” Natalia Renta, senior policy counsel for corporate governance and power at Americans for Financial Reform Education Fund, said in a statement. “We cannot afford to wait until another Silicon Valley Bank-style crisis for regulators to finalize a strong executive pay rule — a task Congress assigned them over a decade ago.”
NCUA chair is Todd Harper, who was designed to the position in January 2021 by President Joseph Biden. The other board member is Vice Chairman Kyle Hauptman, who was named by Trump in 2020.
2016 Proposal
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 reproposal, significant risk-takers would be subject to compensation restrictions alongside senior executive officers.
A coalition of industry groups, including the American Bankers Association, 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 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.”
But reform advocates at the time praised the addition of a significant risk-taker definition in the updated rule as an improvement from the original. Nevertheless, they 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 five legal scholars who wrote the joint letter on APA are: Michael Herz of Yeshiva University, Ronald Levin of Washington University in St. Louis, Nina Mendelson of University of Michigan, Peter Shane of Ohio State University, and Peter Strauss of Columbia University.
Editor’s Note: This article was updated on January 10, 2024, to include changes at NCUA and a statement from Americans for Financial Reform.
This article originally appeared in the January 3, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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